Trading for a Living

Credit: Rayner Teo


Do you want to find high probability trading setups?

I’m sure you do, right? (Or you won’t be reading this right now)

But the thing is…

…you’re not sure how.

Instead of looking at price, you’re looking at indicators (without understanding the purpose of it).

Instead of following trends, you’re trying to predict market reversals.

Instead of proper risk management, you put on a huge bet because this trade “feels good”.

Now…

If you’re doing any of the above, then it will be difficult to identify high probability trading setups.

But don’t worry.

I’ve got good news for you.

Because in this post, I’ll teach you step-by-step on how to find high probability trading setups.

Here’s what you’ll learn:

Why trading with the trend increase your returns and reduce your risk
How to identify the best areas to trade on your chart
How to trade pullback, breakouts, and the failure test pattern
How to set a proper trading stop loss so you don’t get stopped out “too early”
A high probability trading strategy that lets you profit in bull & bear markets
Are you ready?

Then let’s begin…

Secret Bonus:

Get my free training video where you’ll learn how to identify high probability trading setups (include trading techniques that you can use to profit in the markets immediately)
The trend gives you the biggest bang for your buck
The definition of the trend is this…

Uptrend – consists of higher highs and lows

Downtrend – consists of lower highs and lows

If you want to know where’s the path of least resistance, look left (and follow the trend).

When the price is in an uptrend, you should stay long. When the price is in a downtrend, you should stay short.

By trading with the trend, you can see that the impulse move (green) goes much more in your favor, compared to the corrective move (red).

Here are a couple of examples…

most bang for buck 2most bang

Now you’re probably wondering:

Rayner, identifying a trend looks easy. But how do I enter an existing trend?

And this is what we’re covering next…

Trade in the direction of the general market. If it’s rising you should be long, if it’s falling you should be short. – Jesse Livermore

How to identify areas of value on your chart
You’d probably heard of the saying, “buy low sell high”.

But the question nobody asks is…

…what’s low and what’s high, right?

This is where Support & Resistance comes into the picture.

Support & Resistance
And this is the definition of it:

Support – an area with potential buying pressure to push price higher (area of value in an uptrend)

Resistance – an area with potential selling pressure to push price lower (area of value in a downtrend)

Here’s what I mean…

support in uptrendresistance in downtrend

Dynamic Support & Resistance
What you’ve seen earlier is what I call, classical Support & Resistance (horizontal lines)

Alternatively, it can come in the form of moving average. This is known as dynamic Support & Resistance (and I use the 20 & 50 EMA).

This is what I mean…

dynamic support2dynamic resistance2

Not only does support & resistance allows you to trade from an area of value, it improves your risk to reward and winning rate as well.

Watch this training video below and learn how:




Now, another “trick” you can use is to use overbought/oversold indicators.

High probability trading — using Stochastic to identify areas of value
A big mistake most traders make is, going short just because the price is overbought, or oversold.

Because in a strong trending market, the market can be overbought/oversold for a sustained period of time (and if you’re trading without stops, you risk losing your entire account).

Here’s what I mean:

oversold for long periodoverbought for long period

Now you’re wondering:

How do I use Stochastic to identify areas of value?

Here’s the secret…

Are you ready?

In an uptrend, you only look for longs, when the price is oversold.

In a downtrend, you only look for shorts, when the price is overbought.

Here’re some examples:

oversold in uptrendoverbought in downtrend

If you follow this simple rule, you can “predict” when a pullback will usually end.

So, you’ve learned how to identify areas of value on your chart.

Now…

…you’ll learn how to better time your entries.

How to enter your trades
There’re 3 ways you can enter a trade:

Pullback
Breakout
Failure test
Pullback
A pullback is when price temporarily moves against the underlying trend.

In an uptrend, a pullback would be a move a lower.

Here’s an example:

pullbacks in uptrend

And…

In a downtrend, a pullback would be a move higher.

An example:

pullbacks in downtrend

According to the work’s of Adam Grimes, trading pullbacks has a statistical edge in the markets as proven here.

You may wonder:

What are the pros and cons of trading pullbacks?

Advantages of trading pullbacks:

You get a good trade location as you’re buying into an area of value. This gives you a better risk to reward profile.
Disadvantages of trading pullbacks:

You may potentially miss a move if the price doesn’t come into your identified area.
You’ll be trading against the underlying momentum.
Breakout
A breakout is when price moves outside of a defined boundary.

The boundary can be defined using classical support & resistance.

Breakout to the upside:

upside breakout

Breakout to the downside:

downside breakout

You’re wondering:

What are the pros and cons of trading breakouts?

Advantages of trading breakouts:

You will always capture the move.
You are trading with the underlying momentum.
Disadvantages of trading breakouts:

You get a poor trade location as you’re paying a premium.
You may encounter a lot of false breakouts.
For a more in-depth explanation, go read The Definitive Guide to Trading Pullbacks and Breakouts.

Failure test
This technique possibly originated from Victor Sperandeo, and the works of Adam Grimes shows that it has a statistical edge in the markets.

It works like this…

You’re entering your trade when the price does a false breakout of Support/Resistance. Thus taking advantage of traders who are trapped from trading the breakout.

This entry can be applied in a trending or range market.

Here’re a few examples:

failure test2failure test3failure test1

For further explanation, watch this training video below:




Now, the next thing you’re going to learn is…

How to set your stop loss
Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined by the maximum dollar amount you are willing to lose. – Bruce Kovner

I’m going to share with you 3 ways to do it:

Volatility stop
Time stop
Structure stop
Volatility stop
A volatility stop takes into account the volatility of the market.

An indicator that measure volatility is the Average True Range (ATR), which can help set your stop loss.

You need to identify the current ATR value and multiply it by a factor of your choice. 2ATR, 3ATR, 4ATR etc.

atr

In the example above, the ATR is 71 pips.

So if you were to place a stop loss of 2ATR, take 2*71 = 142 pips

Your stop loss is 142 pips from your entry.

Pros:

Your stop loss is based on the volatility of the market
An objective way to define how much “buffer” you need from your entry
Cons:

It’s a lagging indicator because it is based on past prices
Time stop
A time stop determines when you exit your trades based on time.

Instead of exiting your trades based on price, you exit your trades after X amount of time has passed.

You need to define how much time you will allow before exiting it.

An example:

You took a short trade at resistance area. But after 5 days it’s not going anywhere, so you exit your trade.

time3

Pros:

You reduce losses
If you have trading records, you can identify optimal amount of time to give your trades
Cons:

You may exit prematurely only to see price move in your favor
Structure stop
A structure stop takes into account the structure of the market and set your stop loss accordingly.

An example…

Support is an area where price may potentially trade higher from. In other words, it’s a “barrier” that prevents further price decline.

Thus, it makes sense to have your stop loss below Support. Vice versa for Resistance.

Here’s what I mean:

sl below supportsl above resistance

You want to place your stop loss where there is a structure in the market that can act as a “barrier” for you.

Below is a training video that explains this concept in more detail…




Pros:

You know exactly when you’re wrong because market structure has broken
You’re using “barriers” in the market to prevent price from hitting your stops
Cons:

You need wider stop loss if the structure of the market is large (this results in smaller position size to keep your risk constant)
If you want to learn more, go read 13 ways to set your stop loss to reduce risk and maximise profits.

Now, let’s move on…

What is confluence and how it impacts your trading
Here’s the thing:

You’re not going to enter a long trade just because Stochastic is oversold, or the market is in an uptrend.

You’d need additional “supporting evidence” to give you the signal, to enter the trade. And this “supporting evidence” is known as, confluence.

Confluence is when two or more factors give the same trading signal. E.g. The market is in an uptrend, and price retraces to an area of support.

Here’re two guidelines for you:

1. Not more than four confluence factors

The more confluence you have, the higher the probability of your trade working out. But…

In the real world, your trading strategy should have anywhere between 2 – 4 confluence factors.

Anything more, chances are you’re going to get very little trading setups. And it’ll take you forever before your edge can play out.

You can take mediocre trading setups, and still make money in the long run.

2. Do not have more than one confluence factor in the same category

If you’re going to use indicators (oscillators) to identify overbought/oversold areas, then use that only.

Don’t add Stochastic, RSI and CCI because it’ll leave you with analysis paralysis. Similarly…

…adding simple, exponential and weighted moving average on your charts, doesn’t make any sense.

If you’re still reading at the point, you’re in for a treat. Because here comes the exciting part…

A high probability trading strategy that lets you profit in bull & bear markets
And here’s my secret (which is what you’ve just learned)…

Trade with the trend
Trade at areas of value
Find an entry
Set my stop loss
Plan my exit
If a trade meets these 5 criteria, then its a good trade to me.

Now, let’s learn a new trading strategy, that gives you high probability trading setups.

Are you ready?

Here it goes…
If 200ma is pointing higher and the price is above it, then it’s an uptrend (trading with the trend).

If it’s an uptrend, then wait for the price to pullback to an area of support (trading at an area of value).

If price pullback to an area of support, then wait for failure test entry (my entry trigger).

If there’s failure test entry, then go long on next candle’s open (my entry trigger).

If a trade is entered, then place a stop loss below the low of the candle, and take profit at nearest swing high (my exit and profit target).

Vice versa for a downtrend

**Disclaimer: I will not be responsible for any profit or loss resulting from using this trading strategy. Past performance is not an indication of future performance. Please do your own due diligence before risking your hard earned money.

Here’re a few trading examples:

high probability trading setup3high probability trading setup2high probability trading setup1

Secret Bonus:

Get my free training video where you’ll learn how to identify high probability trading setups (include trading techniques that you can use to profit in the markets immediately)
Here’s the thing:

You may not be comfortable using my trading strategy because it may not suit you.

So, what you need to do is, “tweak” it into something that fits you. And this is what we’ll cover next…

I don’t think traders can follow rules for very long unless they reflect their own trading style. – Ed Seykota

How to develop a high probability trading strategy (a template you can use)
You can “mix and match” different trading techniques I’ve shared with you earlier.

But ultimately, your trading strategy needs to answer these 7 questions:

1. How are you going to define a trend?

You can consider moving average, trendline, structure etc.

2. How are you going to define an area of value?

You can consider dynamic Support & Resistance, weekly highs/lows, Stochastic etc.

3. How are you going to enter your trade?

You can consider pullbacks, breakouts, failure test, moving average crossover etc.

4. How are you going to exit your trade?

There’re many ways to exit a trade. Go read 13 Ways to Set Your Stop Loss to Reduce Risk and Maximise Profits to learn more.

5. How much are you going to risk on each trade?

I would suggest risking no more than 1% of your account on each trade, to avoid the risk of ruin.

6. How are you going to manage your trade?

Will you scale out or scale in your trades? If so, how much?

7. Which markets will you be trading?

Are you focusing on one market or many markets?

If you trade a variety of markets, you want to be aware of the correlation between markets.

Labels: Forex, Investment Quote, Reference, Risk Management, Stock Trading System

Since ETFs exploded onto the investment scene, it is easier than ever to open up a market hedge at any time, and in a matter of seconds.

In the old days, the best you could do was to short a stock or buy tons of put options. Shorting, however, had to be on a uptick, which wouldn’t happen much during a correction. But ETFs give you that instantaneous ability to hedge your portfolio if you have cash or margin available, and to do so without selling out on long holdings.

The simplest and most obvious move is to buy the ProShares Short S&P 500 (SH), which does just as it says — you short S&P 500 index. Most investors are long the same index, so by buying an equal amount of this ETF to balance out your long position, you’ll become “market neutral.”

I like the market neutral position because it just means you are sitting on the sidelines. You aren’t losing or gaining anything, and you may not have to deal with constructive short sale rules (shorting against the box), which can be complex.

Of course, if you really feel we are in the midst of a significant correction or crash, you can purchase more of this ETF than you hold on the long side and earn money on the downside. SH costs 0.89% in expenses, or $89 for every $10,000 invested.

Another choice is the ProShares Short QQQ (PSQ), which allows you take a short position in the Nasdaq-100. During a correction, tech stocks tend to get hit harder. The Nasdaq-100 tends to have high volatility and offers a good way to make money on the way down. If, for example, you have a neutral position on the S&P 500, having a short position on the Nasdaq-100 is where you may make some money during the correction. PSQ charges 0.95%.

You also can use leverage on this play, by buying the ProShares UltraShort QQQ (QID), which gives you a double short position on the Nasdaq-100. QID, like PSQ, charges 0.95%.

If you want to go with an even broader short position, consider the ProShares Short Russell 2000 (RWM); small-cap stocks tend to get hit hard, particularly in crashes, so the RWM is a good way to play that. You also can buy the relatively illiquid ProShares Short Small Cap 600 (SBB); both charge 0.95%.

Lastly, if emerging-market stocks are swooning and you want a market hedge for the rest of the world, you can try the ProShares Short MSCI Emerging Markets (EUM), which was a great play earlier this year. Like most of this lot, EUM charges 0.95%.

Labels: ETF, Inverse ETF, Risk Management

期货风险类型较为复杂，传统意义上，大家普遍认可的一个标准是从保证金使用比率的角度来进行控制。1987年世界期货投资比赛冠军安德列·布施先生(Mr. Andreas Bosch)的资金管理秘诀，实用性很强，国内很多实战高手也采用类似的方法。如果你经过很长时间的使用与比较，就会有所体会。下面就是布施先生关于资金控制方法的经验之谈。

　 第一个原则是，你一定要有一个科学明智的资金管理方法，通常我们会讨论：用百分之几的资金来做保证金？拿出多少钱去承担风险？

　　因为使用止损措施，所以我们应该知道自己冒了多大的风险。在交易中，布施会使用几种方法：一种是正常方法，一种是积极方法，一种是保守方法。

　　正常方法，就是当市况一切正常，布施会拿出5%的钱来承担风险，比如账户上有10万元，就拿出5000元，若每次亏损控制在600元以内，就可以亏8次。也就是说，布施每次下止损单时，如果只允许亏600元的话，可以有8次入市的机会。

　　根据布施的原则，如果账户亏5%，只剩95000元，就要变成保守账户了。一个保守账户只拿2.5%用于承担风险，直到资金总额恢复原来的10万块钱。记住，如果你很久都没赚到大钱的话，那虽然不太妙，但你仍然“活”着。如果亏光了，那你就彻底完蛋了，一切都结束了。

　　要赢钱的话，投资者就一定要冒险，风险大小视资金数额而定。比如，有10万块钱，拿出5%，赚了5000块的话，那么就可以变成积极性账户。现在，你可以动用的钱等于6%的资金加20%利润。也就是100000×6%＋5000×20%，等于7000块了。每赚5%时，就增加1%作为积极性的支配资金。比如，客户赚到13万块钱的时候，10%账户金额＋20%利润＝13万×10%＋3万×20%＝19000块，13万块钱中拿出1.9万块，这样我们就能有30多次的入市机会了，现在客户所冒的风险仅由他的利润来承担了，并不是本金。

　　1987年，布施赢得世界冠军，用的就是这种方法。他是在1月2日拿到客户的200万块钱，接着用自己的理论系统炒作了12个月，得到了20倍的利润。在这里要特别提到的是，布施第一个月我亏损了18%。因为开头就处于劣势，所以他把账户调整为保守模式，做起来很闷。当他打平的时候，就转向积极的模式，投资额持续增大，因为积累的利润让可以让他加码更多的头寸，所以增长越来越快。这个原则告诉大家有3种处理资金的态度。

　　第二个原则是资金管理的比例要前后保持一致，在相同时段用同样的比例，因为交易是一项投资和事业性的决策，这可以帮助我们较容易地生存下来。假如你是一个很差劲的炒家，但只要你一直保持只亏2%的限度，你就可以生存很长时间。布施另外常用的一个原则是：如果任何一个账户亏损超过25%，就停止交易。他从未停过任何一个账户。并不是说这种管理模式能对投资者的资金得到100%的保障，重要的是，它使你认识到你目前处事的方法是正确的，决策是对的。

　　布施先生的风险控制方法的设计思路是基于最基本的资金变化，看似其貌不扬，其实实用性很强。参与期货投资需要一种激情，每个人选择的风险度要以不影响自己的思维为佳，任何时候，都要让自己的大脑保持清醒活跃状态。

Labels: Risk Management

Market will be likely to drop significantly in coming weeks since it is overbought (RSI 14 is greater than 80) and double divergences have been identified

between MACD and S&P 500, S&P 500 produced new highs in both August and September 2013 but MACD could not in both times; Evening star appeared on the daily S&P 500 Future chart, shooting star appeared on the daily and weekly S&P 500 Future chart;

between MACD and Dow Jones Industrial Average, Dow Jones Industrial Average produced new highs in both August and September 2013 but MACD could not in both times; Evening star appeared on the daily Dow Jones Industrial Average Future chart, shooting star appeared on the weekly Dow Jones Industrial Average Future chart;

between MACD and NASDAQ Composite, NASDAQ Composite produced new highs in both August and September 2013 but MACD could not in both times;

between MACD and NASDAQ 100, NASDAQ 100 produced new highs in both August and September 2013 but MACD could not in both times;

between MACD and DAX, DAX produced new highs in September 2013 but MACD could not do so;

between MACD and CAC 40, CAC 40 produced new highs in both August and September 2013 but MACD could not in both times;

between MACD and FTSE MIB, FTSE MIB produced new highs in both August and September 2013 but MACD could not in both times;

between MACD and ALL ORDINARIES, ALL ORDINARIES produced new highs in September 2013 but MACD could not do so.

Therefore, the market may give me another opportunity to profit from the potential panic in coming weeks due probably to fierce fighting between Obama and the Congress regards increasing of debt ceiling, and inevitable tapering of FED quantitative easing (money printing).

Labels: Risk Management, Thoughts

来源: snowboy128 于 09-07-22

理念篇

一、我永远只能是个观察者，而不是个控制者。

二、要想成为赢家就要从失败中找，而不是从胜利中找。因为失败者会选择变异，而胜利者却仰仗胜利而拒绝改变。这就是本质原因。

三、等候风险度有限而潜藏巨大收益的局面－－这才是投资的真正内涵。

四、我们应当树立这样的观念：趋势是第一位的，价格反而是第二位的。

五、美国证券投资上的名言：“多头和空头都可以在华尔街证券市场发大财，只有贪得无厌的人是例外。”

六、成功的人之所以成功，是因为他们总在想如何能够不失败；失败的人之所以失败，是因为他们太想成功。

七、期货市场的初段是勤奋和技艺，中段是智慧和心态，高段是人性和道德。

八、坚忍，耐心，信心并顽强执着地积累成功，这才是职业的交易态度。

九、成功必然来自于坚持正确的习惯方法和不断完善的性格修炼。

十、大自然本身是由规律性和大部分随机性组成，任何想完全、彻底、精确地把握世界的想法，都是狂妄、无知和愚蠢的表现。追求完美就是表现形式之一。“谋事在人，成事在天”，于人，我们讲是缘分而非最好；于事，我们讲究适应，能改变的是自己而非寄予外界提供。

十一、正确分析预测只是成功投资的第一步，成功投资的基础更需要严格的风险管理（仓位管理和止损管理），严谨的自我心理和情绪控制（宠辱不惊，处惊不变）。

十二、“把损失放在心上，利润就会照看好自己”。（克罗）

十三、亏钱与否和水平有关，赚钱多少和性格有关。

十四、选择市场的直接后果就是选择了风险，一切所谓的“安全”、“稳妥”都是相对的和有限的。

十五、经历和经验绝对是两回事：你可以什么都经历过、但未必注定就因此拥有丰富的经验--尽管经验一定来自经历。

十六、能够同时判断正确又坚持不动的人很罕见，我发现这是最难学习的一件事。

十七、专业的交易者，他首先是个具备丰富内心世界和涵养的人。

十八、任何时候忘记了去尊重市场，都会铸下大错。

十九、盯住止损，止损是自己控制的；不考虑利润，因为利润是由市场控制的！

二十、成功的交易者是技巧、心态和德行的统一，三者不可分离。


方法篇

一、进场和出场的条件是不对等的。进场的理由必须是充分的、审慎的，有必胜把握的；但是，出场却不同，理由可以是简单的、朦胧的，甚至符合一些必要条件就行。

二、交易体系是在操作中总结经市场验证的方法，而盘感、技巧往往与自己的体系一致。交易者的系统体现了交易者自己的交易思想：对市场的认知、出入市的条件、损失的处理、风险承受能力的大小，以及资金管理等等，而不是简单的买卖。

三、过分看重预测可谓是期货市场上最普遍也是最严重的错误之一。

四、依重要性的程度来看，心理控制第一，风险管理第二，分析技能最次。

五、 从主观情绪型交易者质变到客观系统型交易者是长期积累沉淀升华的结果：无意识----意识到---做到----做好----坚持----习惯----融会贯通----忘记----大成。

六、小钱靠技术（聪明），大钱靠意志（智慧）。长线（智慧）判方向，短线（聪明）找时机。

七、承认自己不太了解市场，却偏偏因此而去做所谓的“短线”、这基本属于“找死”；在做所谓的“短线”时，因为被套而改为做“长线”则肯定属于“等死”。

八、交易的原则是：（1）顺着趋势的方向交易；（2）抱紧盈利的头寸，砍掉亏损的头寸。

九、赚大钱不靠解盘，而是靠评估整个市场和市场趋势。

十、在多头市场里，你的做法就是买进和紧抱，一直到你看到多头市场正在结束时为止。要这样做，你必须用自己的头脑和眼光，

十一、任何人所能学到的一个最有帮助的事情，是放弃最后一档——或第一档。这两档是世界上最昂贵的东西。

十二、人们常说一句话，在期货市场中，纪律和心态控制重于一切。然而，我却要不客气的指出，这一切的前提，是你必须要有一套完善、经过市场考验的交易系统，否则，就有流于空谈的危险。

十三、各类技术都有他相应最擅长的场合和成功率，互为验证，取长补短，是适当使用技术分析的关键。

十四、其实，预测系统只是交易系统中很小的一部分。而且，盈利的大小和预测对错也并非总是成正比。顺势才是关键。我有个朋友，他几乎从来就不预测，只跟随趋势，永远在右侧交易。

十五、一切皆平常。当你用一颗宽容的心去和别人交往的是,你也会得到许多宽容。同时当你对市场宽容的时候,市场会给你带来收益。

十六、成功的交易者总是张着两只眼，一只望着市场，一只永远望着自己。 任何时候，最大的敌人，就是你自己。 校正自己，永远比观察市场重要。

十七、计划你的交易，交易你的计划。

十八、耐心比决心重要。

Labels: Futures Trading, Reference, Risk Management, Stock Trading System

Excerpted from book "Trade Like Jesse Livermore"

The market is driven by psychological factors, not logic. A stock
trader is caught in a maelstrom of thoughts and emotions once he
has pulled the trigger on a trade. It is in this area that most of the
grief occurs for the trader. So far, we have studied the Livermore Trading
System’s approach to timing and money management. We’re left with this
most important section—emotional control. Once we have made a trade,
how do we control the myriad of emotions and thoughts that can easily
cause us to make bad judgments and nullify all the other good work we
have done up to the execution of the trade? No one is exempt from the
emotional part of the trading equation with its pitfalls and dangers, including
Jesse Livermore.

Livermore had an unquenchable thirst for knowledge about his chosen
profession, and all his working life he was a constant student of the
stock market. He was also a great student of the psychology of the market.
At one point, he took psychology courses at night school in New York
to better understand human nature. Livermore drew a conclusion from
his studies: There may be millions of minds at work in the market, but
there were basically only a few psychological patterns that had to be
studied and understood—since human nature in market dealings is primarily
driven by the common emotions of fear and greed, this leads to
common traits of human behavior when buying and selling. In the stock
market, this ultimately equates to common numerical and chart patterns.

Later in his life he was asked an important question by his sons, Paul
and Jesse, Jr.:

“Dad, why are you so good in the market and other people lose all
their money?”

He said, “Well, boys, I have also lost money, but each time I lost, I tried
to learn why I had lost. The stock market must be studied, not in a casual
way, but in a deep, knowledgeable way. It’s my conclusion that most people
pay more care and attention to the purchase of an appliance for their
house, or to buying a car, than they do to the purchase of stocks. The
stock market, with its allure of easy money and fast action, induces people
into foolishness and the careless handling of their hard-earned money,
like no other entity.

“You see, the purchase of a stock is simple, easily done by placing
your buy order with a broker; later a phone call to sell completes the
trade. If you profit from this transaction, it appears to be easy money with
seemingly no work. You didn’t have to get to work and labor for eight
hours a day. It was simply a paper transaction, requiring what appears to
be no labor. It gives the clear appearance of an easy way to get rich. Simply
buy the stock at $10 and sell it later for more than $10. The more you
trade, the more you made, that’s how it appears.

“Simply put, it’s ignorance.”

The boys listened attentively, but they never had any interest in trading
the market like their father.

A stock trader must constantly deal with emotions—when things go
bad, there’s often fear to deal with. Fear lies buried just beneath the surface
of all normal human life. Fear, like violence, can suddenly appear in
your life in the space of a single heartbeat, a fast breath, a blink of the eye,
the grab of a hand, the noise of a gun. When it appears, natural survival
tactics come alive, normal reasoning is distorted. Reasonable people act
unreasonably when they are afraid. And people become afraid when they
start to lose money; their judgment becomes impaired. This is our human
nature in this stage of our evolution. It cannot be denied. It must be understood,
particularly in trading the market. Sooner or later, fear will come to
visit every stock trader who actively trades the market.

The unsuccessful investor or trader is usually best friends with
hope—when it comes to the stock market, hope skips along the trader’s
path hand in hand with greed, but fear is always trailing along as well, hiding
in the shadows.

Once a stock trade is entered, hope springs to life. It is human nature
to be hopeful, to be positive, to hope for the best. Hope has been and will
always be an important survival technique for the human race. But hope,
like its stock market cousins ignorance, greed, and fear, distorts reason.

The trader must be acutely aware that the stock market only deals in
facts, in reality, in cold numbers; the stock market is never wrong—
traders are wrong. Similar to the spinning of a roulette wheel, the little
black ball tells the final outcome—not greed, fear, or hope. The final result
of stock market trading, which is posted in the newspaper at the end of
every day, is objective and conclusive, with no appeal, like pure nature in
the raw, a life and death struggle.

Livermore believed that the public wanted to be led, to be instructed,
to be told what to do. They wanted reassurance. He believed
that they would always move en masse, a mob, a herd, a group, because
people want the safety of human company. They are afraid to stand
alone because the belief is that it is safer to be included within the herd,
not to be the lone calf standing on the desolate, dangerous wolf-patrolled
prairie of contrary opinion—and the truth is that it usually is
safer to go with the trend.

This is where it gets slightly complicated for most traders. Livermore
was an independent thinker, yet he always wanted to trade along the line
of least resistance—the trend, so he was generally moving along with the
crowd, the herd, most of the time. It was when the change in trend
started to appear, the change in overall market direction—that was the
most difficult moment to catch and act upon.

He was always on the hunt for the clues to recognize a coming change
in basic trend, looking for the Pivotal Point to form. A trader can never be
come complacent. Livermore was always alert, ready, prepared to separate
himself from the popular thinking of the moment, the group thinking
that usually always drives the market, and to go in the opposite direction.
Livermore believed in cycles. There is a time when things are good
and a time when things turn bad. It is true in this life for all of us, and it is
true in the stock market. The good times are coming and so are the bad
times—the question for a successful trader is not will they come...it is
when will they come? Livermore’s conclusion—usually when you least expect
it, the trend will change.

The change in trend is the most difficult time in a speculator’s trading
life. These major changes in trends were and remain hell. But Livermore
knew these were the points where most of the money was lost, as was just
experienced from 1999 to 2002. It is best to avoid the downhill slide of
stocks, unless you have sold stocks short. There is always a way to make
money in the stock market.

With this in mind, Livermore developed two rules:

First, do not be invested in the market all the time. There are many
times when you should be completely in cash, especially when you are unsure
of the direction of the market and waiting for a confirmation of the
next move. In Livermore’s later life, whenever he deduced that a change
was coming, and he wasn’t sure exactly when or how severe the change
might be, he cashed in all his positions and waited.

Second, it is the change in the major trend that hurts most speculators.
They simply get caught invested in the wrong direction, on the
wrong side of the market. To determine if you are right in your appraisal
that a change in market trend may be coming use small position probes by
placing small orders, either buy or sell, depending on the direction of the
trend change you anticipate occurring. This will test the correctness of
your judgment. By sending out exploratory orders and investing real
money, you will get the signal that the trend is changing because each
stock purchase will be at a cheaper price than the prior purchase—the
signal—prices are dropping—time to go short.

The trader’s job is to continually observe the tape and to interpret the
tape as a person would look at a movie with no two frames exactly the
same. No two markets are ever exactly the same, but they all have similar
traits, like humans. These individual messages must be extracted from the
tape and run through your brain in a rapid fashion.

The stock market always follows the line of least resistance until it
meets with an at-first almost imperceptible force that slowly, but inexorably,
stops its upward or downward momentum. It is at these key junctures—
recognizing the Reversal Pivotal Points—being able to identify
them and not be confused by natural reactions or the appearance of Continuation
Pivotal Points—that the real money is made.

Just as the panics always encouraged Livermore to go long when
things looked the bleakest, conversely, when everything looked perfect
and blissful, it occurred to him that it might be time to go short. He tried
to see this before everyone else did. That is why he kept his own counsel
in silence and avoided, whenever possible, talking to anyone who might
alter his thinking.

Sometimes, Livermore accumulated his line of stocks at what he believed
to be the turning point in a great decline or at the crest of a mighty
upward wave. He understood that it required time for general business to
recover and for the earning power of these stocks to be reinstated, and so
he was patient and prudent in assembling his line of stocks for either a
new rally or in going short in a downward trading market.

He started trading at age 15 in the stock market. It was the focus of his
life. He was very fortunate in calling the Crash of 1907 almost to the actual
hour and very flattered when J. P. Morgan sent a special envoy to ask him
to discontinue his short selling, which he did.

On his best single day during the Crash of 1907, he made $3 million.
He was also prescient in his trading during the Crash of 1929 when he
decided to go short with the market at its very zenith, he profited by
$100 million.

But at first in the great collapse of the market in 1929, he went to
the short side too early with the motors (car companies) as they rolled
over—he lost over a quarter million dollars before he finally found the
correct Reversal Pivotal Points as the key market leaders of the time
rolled over and tumbled headlong into the great crash. He went short in
earnest at that moment and increased all his positions. During the
Crash of 1929, he made the largest amount of money he had made. He
was blamed personally by the press and the public for the crash, which
was pure nonsense. Nobody—no single person—could cause a market
to do something that it did not want to do. Nevertheless, his life was
threatened, and he was forced to protect his family with special security
measures.

By 1929, Livermore had been trading for almost 40 years and had a
finely developed intuition resulting from his enormous experience. But
he later explained that, in retrospect, in all these cases the clues were
evident in the actions of the stocks and spoke to him as clearly as can
be imagined.

For Livermore, the people who invest in the market are akin to a large
school of bait fish who have no specific leader, and they are capable of
very quick, random action whenever they fear they are in danger. In other
words, there are millions of minds involved in the stock market, these
minds form decisions based on the two main emotions in the stock market,
hope and fear. Hope is often generated by greed; fear is often generated
by ignorance.

Livermore’s main success emanated from his ability to find the main
turning points, the Reversal Pivotal Points. In the long-term trends, this is
the most crucial and important thing a stock trader must do. He was also
convinced that if a trader, during the panics and the booms, was able to
accurately find the perfect psychological moment (the pivot points) to
exit and enter the market he could amass a fortune of great proportion.
For a successful trader must be able to find and trade in the direction of
the momentum—the direction of the line of least resistance. Livermore
never had a problem in playing either side of the market (bull or bear, although
he did not use these terms) because it was only logical to him,
since he believed in cycles, that there were always going to be times to go
long and times to also go short. The market goes up a third of the time,
down a third, and sideways a third of the time.

If Livermore was exiting a long position, because he believed the
stock has topped out, it was easy for him to consider getting on the
short side of that same stock. He had no feelings for a stock, as some
people do.

For instance, if a trader has made money with General Motors on the
long side, the trader should have no emotional feelings for General Motors—
the stock has simply done what the trader deduced it would do. If
the trader can now make a profit as General Motors declines—by going
short—he should do so with no feeling toward the stock, which is after all
an inanimate thing with no feelings for the trader. There are no good
stocks, nor are there any bad stocks; there are only stocks that make (or
lose) money for the speculator.

Livermore had heard many of his fellow traders say: “That stock was
good to me.” Or “That stock cost me money, so I am staying away from it!”
The stock had nothing to do with it. Everything that happens is a result of
the trader’s judgment and no excuses are acceptable. To put it simply, it is
the trader or speculator who makes the conscious decision to enter a
trade, and it is always the trader who makes the conscious decision to exit
a trade. The judgment was either correct or it wasn’t.

All traders must beware of a kind of arrogance, for when a stock
moves against us we must decide that we were wrong and must exit that
trade instantly. Most traders forget that it is a proven fact that we will always
be wrong on some trades. It is getting out of those trades quickly
that is the key to success.

Another trap the inexperienced trader must deal with is trying to
find the exact bottom and top of a major trading cycle. Remember,
there are times when a trader must be out of the market and waiting on
the sidelines. It is virtually impossible to call the exact top and the bottom
of any market, but it is much better to err on the side of caution.
Getting out and waiting for the market to establish itself is very difficult
while you are invested, because by being invested you will have an automatic
bias toward the direction of your position. This bias stems from
the hope. If you are long, you will subconsciously favor the long side, if
you are short, you will subconsciously favor the downside. Hope lives
in us all; remember, it is human nature to be hopeful. That is why Livermore
often sold out all his positions and reevaluated the market from a
cash position. It cost him the commissions, but he viewed this as a
small insurance premium cost toward the overall profit goal. It is not
what the millions of people think about the market, or say about the
market . . . no, no, no, it is what they do about the market by their actual
buying and selling; all this is immediately revealed on the tape; the
problem is in the interpretation of this news, this evidence, as the tape
flows past the reader.

This was Livermore’s business, his life’s vocation and the thing he
most enjoyed. The work of solving the puzzle was what always fascinated
him. It was never the money—it was solving the puzzle, the money
was the reward for solving the puzzle. Going broke, which happened to
him several times in his life, was the penalty for not solving the puzzle.
The chief deception is that trading the market looks easy when it is one
of the most difficult things to do—anticipate the trend. We must be
aware of our emotional flaws and have the discipline to control and conquer
the weaknesses of our human nature. It is the most difficult task a
trader faces.

As Livermore explained to his sons: “I lost money when I broke my
own rules—when I followed my rules, I made money.”

HOW TO KEEP YOUR EMOTIONAL CONTROL IN DEALING WITH MEDIA NEWS

Livermore was always suspicious of everything he read in the newspaper
and never accepted what he read at face value. He tried to look for hidden
agendas and self-serving reasons that could have generated the articles,
no matter what paper published the information. In Livermore’s time,
many news reporters were convicted of trading against the news they
wrote about a stock. The reporters were also fed pure fiction, actual lies,
by insiders to hype the stock.

He always tried to read between the lines and formulate his own judgment;
that is why he often preferred to be alone, to formulate his own
opinions and to use his own judgment when reading the newspapers. He
did not seek the opinions of others in dealing with news releases. He tried
to look below the surface.

Livermore told a friend: “I interpret these newspaper articles in two
ways. First, I try to interpret their immediate and direct influence on the
opinions and actions of stock traders with regard to a particular stock.
Second, I watch the actual stock quotes to detect how the news has influenced
the buying and selling of specific stocks as a whole in that market
industry group. Often my interpretation of a news event is wrong. But I always
know that if the news development is of sufficient importance it will
eventually affect the tape.

“In other words, I watch the tape like a hawk to see how it is reacting
to actual news. I do not listen to people, the pundits, the reporters, the analysts
who are trying to interpret the news item and predict what will happen
to a stock, an industry group, or the overall market.
“It is my experience that it is far better to look objectively at the tape,
for the tape will provide the actual facts as to how the public is reacting to
the news. These actual facts revealed by the tape are a far better indicator
than any reporter or pundit can provide. It is up to the skillful market

trader to watch the tape and react only to what the tape is saying. Learn
how to read the tape—the truth is in the tape—listen to it. Try and avoid
the opinions of so-called-experts.”

One of the problems with looking too deeply into economic news is
that it may plant ‘suggestions’ in your mind, and suggestions can be subliminal
and dangerous to your emotional stock market health where
you have to deal in reality, not supposition. These suggestions are very
often logical, but that does not mean they are true and will necessarily
affect the market. Logic does not drive the market. It is driven by human
emotion.

CUT YOUR LOSSES, LET THE WINNERS RIDE

Note: This conversation and story are excerpted from The Amazing Life
of Jesse Livermore: World’s Greatest Stock Trader by Richard Smitten.
The conversation, held at lunch, was between Jesse Livermore, Walter
Chrysler (Chrysler Motors), Ed Kelley (head of United Fruit Co.), T. Coleman
DuPont (DuPont Family), and Colonel Ed Bradley of Bradley’s
Casino in Palm Beach (Bradley was the owner of the longest running illegal
gambling club in the United States).

“I’ve been hearing rumors on the Street about you and a wheat trade. Tell
us about it, J.L., entertain us at lunch.”

“Well, I just felt the demand for wheat in America was underestimated,
and the price was going to rise. I waited for what I call my Pivotal
Point and stepped in and bought 5 million bushels of wheat, about 7 million
dollars worth.

“I watched the market closely after the purchase. It lagged. It was a
dull market, but it never declined below where I bought it. Then one morning
the market started upwards, and after a few days the rise consolidated,
forming another of my Pivotal Points. It laid around in there for a little
while, and then one day it popped out on the upside with heavy volume.

“A good signal, so I put in an order for another 5 million bushels. This
order was filled at higher and higher prices. This was good news to me because
it clearly indicated that the market line of least resistance was upward.

“I liked the fact that it was much more difficult to acquire the second lot
of 5 million bushels. I then had filled out my predetermined target position
of 10 million bushels, so I stepped back, and kept my eye on the market. It
formed into a strong bull market and rose steadily for several months.

“When wheat rose 25 cents above my average price I cashed in. This
was a bad mistake.” Livermore paused as the lobster salads were served
and the second bottle of champagne was opened.

Walter Chrysler asked, “J.L., how the hell could it be a bad mistake to
make a profit of two and a half million dollars?”

“Because, Walter, I sat back and watched wheat rise another 20 cents
in price in three days.”

“I still don’t get it,” Chrysler said.

“Why was I afraid? Why did I sell? There was no good reason to sell the
wheat. I simply wanted to take my profit.”

“It still looks like a pretty good trade to me. I’m afraid you lost me,
J.L.,” Ed Kelley added.

“All right, let me explain. You remember that old joke about the guy
who goes to the race track and bets on the daily double and wins, then
takes all his winnings and bets it on the third race and wins. He does the
same on all the other races, and wins. Then on the eighth and final race he
takes his hundred thousand dollars in winnings and bets it all to win on a
horse, and the horse loses.”

“Yeah,” Chrysler nodded.

“Well, he’s walking out of the track and he meets a pal of his, who
says. ‘How’d you do today?’

“ ‘Not bad,’ he answers, smiling, ‘I lost two bucks.’ ”

They laughed. “That’s a good story J.L., but how the hell does it apply
to the wheat story?” Chrysler asked.

“Simple—why was I afraid of losing the track’s money, my profits? In
effect, I was simply acting out of fear. I was in too big a hurry to convert a
paper profit into a cash profit. I had no other reason for selling out that
wheat, except that I was afraid to lose the profit I had made.”

“What’s wrong with being afraid?” Dupont asked.

“So, what did you do, J.L.?” Kelley asked.

“Well, after I booked my profit in the wheat I realized I had made a
great mistake. I had not had the courage to play the deal out to the end—
’til I got a signal to sell, a real definitive sell signal.”

“So . . . ?”

“I re-entered the market and went back at an average price 25 cents
higher than where I had sold out my entire original position. It rose another
30 cents, and then it gave a danger signal, a real strong danger signal.
I sold out near the high of $2.06 a bushel. About a week later it sold
off to $1.77 a bushel.”

“Well, you have more guts than me, J.L., and it sounds a little like
greed to me,” Ed Kelley said.

THE WILL

Livermore agreed with his friend, the gambler, Colonel Ed Bradley—after
timing and money management comes emotions. It is one thing to know
what to do. It is quite another thing to have the will to actually do it. This
is true of the stock market. This is true of life. Who knew better than Jesse
Livermore?

Having the discipline to follow your rules is essential. Without specific,
clear, and tested rules speculators do not have any real chance of
success. Speculators without a plan are like a general without a strategy,
and therefore without an actionable battle plan. Speculators without a single
clear plan can only act randomly and they must react, to the “slings
and arrows of stock market misfortune.” This leads inevitably to the
trader’s defeat.

Playing the market is partly an art form, it is not just pure reason. If it
were pure reason, then somebody would have figured it out long ago.
That’s why every speculator must analyze his own emotions to find out
just what stress level he can endure. Every speculator is different; every
human psyche is unique; every personality is unique and exclusive to an
individual. Learn your own emotional limits before attempting to speculate.
If you can’t sleep at night because of your stock market position, then
“That’s because you sell fruit, Ed. The way you know how to diagnose
the market on fruit is the way I am supposed to know how to diagnose the
stock and commodities markets, and the wheat futures market had shown
no signs of weakness when I first sold it.

“The next time I sold the wheat it was different. I could see definite
symptoms of weakness. It gave the clues, the hints, the tell-tale signs of
topping out. The tape always gives plenty of warning time for the savvy
speculator to heed.”

“Well, J.L., I like your story but sometimes I think maybe you got a
set of those lucky horseshoes up your ass, just like Ed Bradley here,”
Chrysler added.

“Well Walter, a little luck never hurt anyone.” Livermore paused and
looked around at the group. “I’d say we all had our share of luck at one
time or another.”

They all laughed.

you have gone too far. If this is the case, then sell your position down to
the sleeping level.

On the other hand, anyone who is intelligent, conscientious, and willing
to put in the necessary time can be successful on Wall Street. As long
as they realize the market is a business like any other business, they have
a good chance to prosper.

Until this latest decline in the market starting in 1999, many people
believed making money in the market was easy. Yet most Americans
work, and anyone who works knows how hard it is to consistently
make money in business, no matter what the business; it is never easy
to make money. Livermore’s friends all had their own businesses. He
would never ask his good friends like Ed Kelly, the head of the United
Fruit Company, to tell him the secrets of the fruit business or Walter
Chrysler about the automotive business. It would just never occur to
him. So, he could never understand when people asked him the question,
over and over again: “How can I make some fast money in the
stock market?”

He would smile and say to himself, “How could he possibly know how
you could make money in the market?” He always evaded the question. He
felt it was the same as asking him “How can I make some quick money in
brain surgery? Or how can I make a few fast bucks defending some person
in a murder case? He remained silent when asked because he believed
that even attempting to answer these questions affects a person’s emotions,
because you have to take a firm position and actively defend your
recommendations, which could change tomorrow, depending on the conditions
of a dynamic stock market.

But he fully understood that he was not the only one who knew that
the stock market is the world’s biggest, most profitable gold mine, sitting
at the foot of the island of Manhattan. A gold mine that opens its doors
every day and invites any and all people in to plumb its depths and leave
with wheelbarrows full of gold bars, if they can. And Livermore had done
it many times.

The gold mine is there all right, and when the bell rings at the end of
the day, someone has gone from pauper to prince, or from prince to
supreme potentate . . or stony broke. And it’s always there, the mountain
of gold, waiting for the trader to pick up the phone and pull the trigger on
a trade.

Livermore truly believed that uncontrolled basic emotions were the
true and deadly enemy of the speculator: Hope, fear, and greed are always
present, sitting on the edge of a trader’s psyche, waiting on the
sidelines, waiting to jump into the action, plow into the game and mess
things up.

This is one of the reasons he never used the words “bullish” or “bearish.”
These words were removed from his vocabulary because he believed
they create an emotional mindset of a specific market direction in a
trader’s mind. Saying it’s a bull market or a bear market causes the trader
to believe that is the direction of the market. And there is a good chance
the speculator will blindly follow that trend or direction for an extended
period of time, even if the facts change.

Well-defined trends often do not last for extended periods of time.

When people asked Livermore for a tip, he would say, the market is currently
in an “upward trend” or a “downward trend” or a “sideways
trend”—or tell them that the “line of least resistance is currently up—or
down,” as the case might be. That is all he would say and even that often
got him in trouble with the public, because he wasn’t around to tell them
when the trend changed.

This strategy left him with the flexibility to change his mind, according
to market behavior. He tried never to “predict” or “anticipate” the market,
he only tried to “react” to what the market was telling him by its
behavior.

Always be aware that when stocks decline swiftly, and abruptly,
they are being driven by fear. When they rise, they are being driven by
hope. That’s why stocks go up slowly and fall rapidly. If people are hoping
a stock will rise, they are slower to sell. If they fear the stock will
decline, they are usually fast to dump that stock. That is why declines
produce faster, more abrupt market action. So, if you play the short side
you must be ready to react to faster, more drastic market patterns and
conditions.

There is no good direction to trade, short or long, there is only the
money-making way. To sell short often goes against human nature,
which is basically optimistic and positive. In 2003, less than 4 percent of
traders ever traded the short side of the stock market. There is also no
question that it is extremely dangerous to sell short because the potential
loss is unlimited. It takes strong control of your emotions to trade
on the short side.

But the stock market moves up roughly a third of the time, sideways a
third of the time, and downward a third of the time. If you only played the
bull side of the market, you are out of the action, and your chance to make
money, two-thirds of the time. And for good or bad, Livermore was not a
man who wanted to wait, and hope, and wonder. He wanted to play the
game, and he wanted to win more times than he lost.

Livermore was fully aware that, even in his time, of the millions of
people who speculate in the stock market, few people spend full time involved
in the art of speculation. Yet, as far as he was concerned, it was a
full-time job, perhaps even more than a job, perhaps it is a vocation—
where many are called and few are singled out for real success.

It is also interesting to observe that there are now, in 2004, more mutual
funds than stocks on the NYSE. Most of these funds have strict charters
demanding that they stay no less that 95 percent invested, with no
more than 5 percent in cash. Also, in the charters of most mutual funds
the managers of the funds can only go long in their trades. So, they have
broken two of the Livermore rules–always keep a cash reserve, and always
be ready to trade either long or short and also feel free to just sit in
cash and wait for the perfect trade to appear. This is one of the reasons
the hedge funds have done so well in the last few years.

BEWARE OF STOCKS TIPS

By far, the hardest emotional pitfall a speculator must deal with is tips.
It was the main reason Livermore moved uptown to Fifth Avenue—to
get out of the reach of everyone who was trying to help him by giving
him sure things and inside information. Beware of all inside information
and tips.

Below is an excerpt from the biography Jesse Livermore—World’s
Greatest Stock Trader.

Tips come from all sources. Once, long ago, one of these tips was passed
on to me from the Chairman of a major American corporation who spoke
to me at a dinner party at my house in Great Neck.

“How are things going?” I asked him.

“Great, we’ve turned the company around, not that it was really in
trouble, but it looks like clear sailing from here. In fact, our quarterly earnings
are coming out in a week and they are going to be terrific.”

I liked him and believed him. So, the next morning I bought a thousand
shares to test it out. The earnings came in just as the chief executive
said they would. The stock rose nicely, the earnings continued to rise for
the next three quarters, and the stock rose steadily. I was lulled into a feeling
of security, as the stock continued to rise. Then it stopped and started
plummeting in the opposite direction, like a waterfall.

I called the Chairman and said: “This fall in your stock price has me
worried. What’s going on?”

He answered,”I know the price has fallen, J.L., but we consider it nothing
more than a natural correction—after all we have had a pretty damn
steady rise in the price of the stock for almost a year now.”

“How’s business?” I asked.

“Well, our sales are slightly off and that news may have leaked out,
I’m afraid. Looks like the bears got hold of that information and are hammering
the stock. Its mostly short selling, a bear raid, we think. We’ll drive
them out on the next rally, squeeze them a little, eh J.L.?”

“Are you guys selling any of your holdings?” I asked.

“Absolutely not! Where would I put my money with more safety than
my own company?”

Well, sure enough, I later found out that the insiders were busy selling
into the stock’s strength, the minute they got wind of the business going
into a slump.

I never got mad. It was my stupidity and greed. I knew that all key
executives were basically cheerleaders, and they must remain positive,
must be bearers of only good news. They could never tell shareholders
or competitors that things were not as rosy as they appeared. In fact,
it always made me smile to listen to their mendacity. The misstatements,
the lies, were just a matter of self-preservation, an essential
part of the job of a chief executive officer—at every level of power, including
politics.

But it was my self-preservation I was interested in, not the top executives
and shareholders of the companies I invested in. Therefore after a
while, and some substantial lost money, I never asked an insider again
about how their business was doing.

Why waste my time listening to half-truths, shadowy statements, inaccurate
projections, and just plain bold-faced lies when I could simply
just look at the behavior of the stock? The story was clear in the action of
the stock. The truth was in the tape for anyone and everyone to see.

I have suggested to people who were interested in the stock market
that they carry around a small notebook, keep notes on interesting general
market information and perhaps develop their own stock market
trading strategy. I always suggested that the first thing they write down
in their little notebooks was Beware of inside information . . . all inside information!
There is only one way to achieve success in speculation—through
hard work, persistently hard work. If there is any easy money lying
around, no one is going to try and give it to me—this I know. My satisfaction
always came from beating the market, solving the puzzle. The money
was the reward, but it was not the main reason I loved the market. The
stock market is the greatest, most complex puzzle ever invented, and it
pays the biggest jackpot.

And always remember: You can win a horse race, but you can’t beat
the races. You can win on a stock, but you cannot beat Wall Street all the
time—nobody can.

People always talked about my instincts, especially after the Union Pacific
story and the San Francisco earthquake. But I never thought my instincts
were that special. The instincts of a seasoned speculator are really
no different than the instincts of a farmer, like my father. In fact, I consider
farmers the biggest gamblers in the world. Planting their crops every year,
gambling on the price of wheat, corn, cotton, or soy beans, choosing the
right crop to plant, gambling on the weather, and insects—the unpredictable
demand for the crop—was more speculative. These same principles
apply to all business. So, after 20, 30, 40 years, of growing wheat or
corn or raising cattle or making automobiles or bicycles, the person naturally
gets his sixth sense, his intuition, his experience-based hunches for
his business. I consider myself no different.

The only area I may have differed from most speculators was when I
felt I was truly right, dead right, for-damn-sure right—then I would go all
the way, shoot the works. The way I did during the 1929 market crash
when I had a line of one million shares of stock out on the short side, and
every rise and fall of a single point meant a million dollars profit or loss to
me. Even then, during my biggest play, it was never the money that drove
me. It was the game, solving the puzzle, beating a game that confused
and confounded the greatest minds in the history of mankind. For me, the
passion, the challenge, the exhilaration, was in beating the game, a game
that was a living dynamic riddle, a conundrum, to all the men and women
who speculated on Wall Street.

Perhaps it was like combat is to a soldier. It’s a mental high that’s visceral,
where all your senses are pushed to the limit and the stakes are
very high.

“I told my boys—stay in the business you’re good at.” I was good at
speculating. Over the years I took many millions of dollars out of Wall
Street and invested them in Florida land, aircraft companies, oil wells, and
new miracle products based on new inventions—they were all abject failures,
disasters. I lost every cent I ever invested in them.

Just remember, without discipline, a clear strategy, and a concise
plan, the speculator will fall into all the emotional pitfalls of the market
and jump from one stock to another, hold a losing position too long, cutout
of a winner too soon, and for no reason other than fear of losing the
profit. Greed, fear, impatience, ignorance, and hope will all fight for mental
dominance over the speculator. Then, after a few failures and catastrophes,
the speculator may become demoralized, depressed, despondent,
and abandon the market and the chance to make a fortune from what the
market has to offer.

Develop your own strategy, discipline and approach to the market. I
offer my suggestions as one who has traveled the road before you. Perhaps
I can act as a guide for you and save you from falling into some of
the pitfalls that befell me.

But in the end the decisions must be your own.

Labels: Reference, Risk Management, Stock Trading System

Excerpted from book "Trade Like Jesse Livermore"

MONEY MANAGEMENT RULE 1:DON’T BUY YOUR ENTIRE POSITION ALL AT ONE TIME

He liked to call this his probe system. Don’t lose money, don’t lose your
stake, don’t lose your line. A speculator without cash is like a store owner
with no inventory. Cash is your inventory, your lifeline, your best friend—
without cash you’re out of business. Don’t lose your damn line!

Livermore felt that it is wrong and dangerous to establish your full
stock position at only one price. Rather, you must first decide how many
shares you want to trade. For example, if you want to purchase 1000
shares as the full final position do it this way:

Start with a 200-share purchase on the Pivotal Point—if the price goes
up, buy an additional 200 shares, still within the Pivotal Point range. If it
keeps rising, buy another 200 shares. Then see how it reacts—if it keeps
on rising or corrects and then rises, you can go ahead and purchase the final
400 shares.

It is very important to note that each additional purchase must be
made at a higher price. The same rules, of course, would apply to selling
short, only each short sale would be at a lower price than the preceding
one.

The basic logic is simple and concise: Each trade, as it is established
toward the total 1000-share position, must always show the speculator a
profit on his prior trades. The fact that each trade showed a profit is living
proof, hard evidence, that your basic judgement is correct in the trade.
The stock is going in the right direction—and that is all the proof you
need. Conversely, if you lose money, then you know immediately that your
judgment was wrong.

The tough psychological part for the inexperienced speculator is to
pay more for each position. Why? Because everyone wants a bargain. It
goes against human nature to pay more for each trade. People want to buy
at the bottom and sell at the top.

The speculator may choose a different ratio for purchasing the stock
than Livermore’s ratio of 20 percent on the first purchase, 20 percent on the
second purchase, 20 percent on the third purchase, and a final purchase of
40 percent. He could, for instance, purchase 30 percent as the first probe position,
30 percent as the second and 40 percent for the final probe position.
In summary, it is up to each individual speculator to decide the ratio
that works best for him. Livermore simply outlined what worked best for
him. The main money management rule is comprised of three factors:

1. Do not take your entire position all at once.

2. Wait for confirmation of your judgment—pay more for each lot you buy—dollar average upward.

3. At the beginning of each trade first establish in your mind the total,
exact amount of shares you want to purchase if all goes well, or specify
the amount of dollars you are willing to commit; do this before you
begin the trade.

MONEY MANAGEMENT RULE 2: NEVER LOSE MORE THAN 10 PERCENT OF YOUR INVESTMENT

He called this his Bucket Shop rule because he learned it in the bucket
shops as a young man, when he worked all his trades with 10 percent margin.
In the bucket shops, if the price of the stock went down below your
margin requirements you were automatically sold out. If the loss exceeded
the 10 percent limit, you were sold out and lost your bet. The 10
percent loss rule became Livermore’s most important rule for managing
money. In some respects, it is also a key timing rule, since it often automatically
sets the time to exit a trade—when you have lost 10 percent or
more of your invested capital, you must exit the trade. Also, a trader must
set a firm stop before opening a trade. The consequences of big losses are
drastic—you must gain back 100 percent to cover a loss of 50 percent.

TABLE 5.1 Livermore Percentage Loss Table

Starting Position Amount Lost Remainder %Loss %to Recover Loss
$1000 $ 80 $920 8.0 8.7
100 900 10.0 11.1
200 800 20.0 25.0
300 700 30.0 42.8
400 600 40.0 66.6
500 500 50.0 100.0

Also understand that when your broker calls and tells you he needs
more money for a margin requirement on a stock that is declining, always
tell him to sell out your position. When you buy a stock at 50 and it goes to
45, do not buy more in order to average out your price. The stock has not
done what you predicted; that is enough of an indication that your judgment
was faulty! Take your losses quickly and get out.

Remember, never meet a margin call, and never average losses.
Many times Livermore would close out a position before suffering a
10% loss. He did this simply because the stock was not acting right from
the start. He told friends that often his instincts would whisper to him,
“ ‘J.L., this stock has a malaise, it is a lagging dullard or just does not feel
right,’and I would sell out my position in the beat of a bird’s wing.”
Perhaps this was the inner mind working, distilling numerical patterns
and formations that he had seen thousands of times before, and
sending subconscious signals to his brain, unconsciously registering repeating
patterns to be stored in his memory bank. Perhaps these patterns
were subliminally remembered and awakened when recognized. Whatever
it was, he learned over the years, through many of his market experiences,
to respect these instincts.

He had observed countless times that people often become “involuntary
investors.” They buy a stock that goes down, and they refuse to sell
and take their loss. They prefer to hold on to the stock in the hope that it
will rally eventually and climb back up. This is why the 10% rule is essential.
Livermore’s advice: Don’t ever become an involuntary investor. Take
your losses quickly! Easy to say, hard to do.

If he bought a stock with a certain scenario in mind for what he
expected the stock to do and it did not follow through with the expected
scenario and go up immediately, he often just went ahead and
dumped it, sold it automatically. He also never looked back—he had
no self-recriminations after a bad trade or bitter thoughts if the stock
later took off. He did, however, often study the trade to see what he had
done wrong.

MONEY MANAGEMENT RULE 3: ALWAYS KEEP A CASH RESERVE

The successful speculator must always have cash in reserve, like a good
general who keeps troops in reserve for exactly the right moment, when
the odds are in his favor, and then moves with great conviction, and commits
his reserve armies for the final crushing victory.
There is a never-ending stream of opportunities in the stock market. If

you miss a good opportunity, wait a little while, be patient, and another
one will come along.

Livermore used the analogy of playing cards—for him it was highstakes
poker and bridge. He believed it was only human nature to want to
play every hand. This desire to always be in the game, is a common flaw
and one of the speculator’s greatest enemies in managing his money. It
will eventually bring about disaster, as it had brought bankruptcy and financial
disaster to Livermore several times in his early career. The observation
made below is a critical factor in understanding the Livermore
trading system.

There are times when playing the stock market that your money
should be inactive, waiting on the sidelines in cash to come into play in
the stock market. It was Livermore’s belief that in the stock market:

Time is not money
Time is time
And money is money.

Often money that is just sitting can later be moved into the right situation
at the right time and make a vast fortune—patience, patience, patience
is the key to success—not speed. Time is a cunning trader’s best
friend if he uses it right.

MONEY MANAGEMENT RULE 4: YOU NEED A GOOD REASON TO BUY A STOCK AND YOU NEED A GOOD REASON TO SELL

Stick with the winners—as long as the stock is acting right, do not be in
a hurry to take a profit. You must know you are right in your basic judgment,
or you would have no profit at all. If there is nothing basically
negative, well then, let it ride! It may grow into a very large profit. As
long as the action of the overall market and the stock does not give you
cause to worry, let it ride—have the courage of your convictions. Stay
with it!

When you are in profit on a trade, you never need to be nervous. Livermore
could have a line of a hundred thousand shares out on a single
stock play and sleep like a baby. Why? Because he was in profit on that
trade. He was simply using the track’s money—the stock market’s money.
His attitude was that if he lost all his profit—well then he had lost money
he never had in the first place, since he did not count the money as profit
until he sold the stock and converted it to cash.

Profits Take Care of Themselves—Losses Never Do

Never confuse this approach of letting the position ride with the “buy
and hold forever” strategy. How can any trader know what will occur
far into the future? Things change: Life changes, relationships change,
health changes, seasons change, your children change, your lover
changes, why shouldn’t the basic conditions that originally caused you
to buy a stock change? To buy and hold blindly on the basis that it is a
great company, or a strong industry, or that the economy’s generally
healthy was to Livermore the equivalent of stock-market suicide. He
said: “There are no good stocks—there are only stocks that make
you money.”

As already discussed, one of the most important points in buying a
stock was to try and buy as closely as possible to the Pivotal Point or the
Continuation Pivotal Point. It was from this point that the key decisions
are made. If the stock advanced from the Pivotal Points, you can hold it
and relax, because from then on you are playing with the house’s money,
not your own capital. If the stock pulls away from the Pivotal Point in the
opposite direction of the purchase, the experienced trader knows to automatically
sell his position. It therefore becomes the trader’s biggest job to
find the Reversal Pivotal Points and Continuation Pivotal Points. This is
the constant money management rule you must never break:

cut your losses, let your profits run.

Stick with the winners—let them ride until you have a clear reason
to sell.

MONEY MANAGEMENT RULE 5: PUT HALF THE PROFIT FROM A WINDFALL TRADE IN THE BANK

Livermore recommended parking 50 percent of your profits from a successful
trade, especially where you doubled your original capital. Set
this money aside, take it out of the stock market so you have to make a
conscious effort to put it back in. Put it in the bank, hold it in reserve,
lock it up in a safe deposit box, stuff it in your mattress—just put it
somewhere safe. Like winning in the casino, it’s a good idea, now and
then, to take your winnings off the table, and turn them into cash. There
is no better time then after a large win on a stock. Cash is your secret
bullet in the chamber.

The single largest regret I have ever had in my financial life
was not paying enough attention to this rule.
—Jesse Livermore

Here is a summary of Jesse Livermore’s money management rules:

1. Use probes—don’t buy your entire position all at one time;
2. Never lose more than 10 percent of your investment;
3. Always keep a cash reserve;
4. You need a reason to buy a stock and you need a reason to sell;
5. Put half the profit from a windfall trade in the bank.

ADDITIONAL ADVICE

Stay Away from Cheap Stocks

One of the greatest mistakes that even experienced investors make is buying
cheap securities just because they are selling at a low price. Although
in some instances stock demand may push the stock from a small per share
price of say, $5 or $10 a share to over $100, many of these low-priced
stocks later sink into oblivion by going into receivership, or else they
struggle for years and years, with only the slightest prospect of ever returning
a profit to their shareholders.

In selecting securities, it is essential for an investor to determine
which industries or groups are in the strongest position, which are less
strong, and which groups are comparatively weak, very weak, etc. The
speculator should not plunge into cheap stocks in depressed industry
groups just because the stock may appear to be a bargain. Stay with the
powerful, healthy Industry Groups.

Keep Your Funds Liquid and Working for You

Perhaps nothing has contributed to the traditional poor success of the
public in the investment markets as much as this fact—the average market
investor does not keep his investment and speculative funds in proper
circulation. The public is usually in a permanent loaded-up or tied-up condition,
buried in a stock or a number of stocks with no cash or buying
power held in reserve.

If the public observes a certain stock that may advance a few points a
month, are they interested? No, they want something that moves more
quickly. Yet in a few months they will probably wake up to see the stocks
they refused to buy now selling for 20 points higher, while their cheap,
volatile stocks, which they actually purchased, are selling at less than the
prices they paid for them.

Disregard the Action of Insiders

Never pay any attention to the actions of insiders—this includes company
directors and management. Insiders are commonly the absolute worst
judges of their own stock. They usually know too much about their
stocks, and they are too close to observe the weaknesses. Key executives
also are usually ignorant about the stock market, especially market technical
indicators and group movement. They are often reluctant to admit
that the stock market is a specialty business and is an entirely different
business from their own. In other words, you can be an expert in radio
broadcasting or selling automobiles, or the manufacture of steel or pharmaceuticals,
and most likely not know anything about trading stocks, especially
in a volatile stock market as we had in the late 1990s and early in
the new millennium.

Disregard Any Statement Made by Key Executives

The chief executive officer of most companies is little more than a cheerleader
who has only one job with regard to the market. He must assure
and reassure the shareholders, including the mutual funds and potential
future shareholders, that everything is fine—if sales are down, he tells the
shareholders that the decline is nothing more than a slight problem due to
some temporary reason like seasonality, terrorism or competitors’ lowering
their prices. If profits are down, he assures the shareholders there is
nothing to worry about, since the company has already reacted and made
adequate plans to recapture their profitability.

Before Buying a Stock Establish Profit Target—Risk/Reward Ratio

The intelligent trader pays a lot of attention to the ratio of potential profit
and the size of his overall investment. If a stock was trading at $200 and
you are expecting a 20-point move or 10%, then you know you will have to
put up $200,000 to make $20,000. This was not appealing for Livermore,
because for him the risk/reward ratio was out of balance. No matter how
good a trader you are, stock market losses are inevitable and must be considered
as part of a trader’s operating expenses, along with interest, brokerage
fees, and capital gains tax. Few stock traders establish a
risk/reward ratio before they enter a trade. It is essential to try to do this
in order to have a specific money management plan.

Livermore was a lot less active in his trading than people thought. In
fact, in his later life he was only interested in the “essential move,” the important
swing in the stock price. This often took extra patience in waiting
for all the factors to come together to a focal point, where he felt as much
as possible that everything was in his favor: the direction of the overall
market, the industry group, the sister stock activity and, finally, an important
Pivotal Point.

A famous misunderstood quote of Livermore was: “It was the sittin’
and the waitin’ that made me the money.”

He did not mean the sitting and waiting after the stock was purchased—
he meant before he pulled the trigger—that’s when the trader
must have the patience to sit and wait for all factors to come together to
merge into the perfect trade, or as perfect as possible.
Remember, it is very difficult to work your way back from a devastating
loss—this is true no matter what anyone tells you. Don’t wind up without
cash, like the merchant with no inventory—that’s the same as a stock
trader with no cash—out of business.

Always Establish a Stop before Making a Trade

When you purchase a stock, you should always have a clear price target of
where to sell if the stock moves against you. And you must obey your
rules! Never sustain a loss of more than 10% of your invested capital.
Losses are twice as expensive to make up, as previously explained. This
point can not be made often enough.

Always establish your stop before making the trade. This is another
reason for buying on the Pivotal Point—it always gives the trader a clear
point of reference. The Pivotal Point acts as a place to establish the stop
loss point—the spot for the trader to close out the trade if things go
against him.

Before making a trade, most stock traders do not take the time to observe
the following rules:

• Decide on the potential of the trade versus the size of the investment—
if it is a large investment with a small potential return, then
pass. The trader should see a clear profit potential.

• Before you buy, make sure that you are buying at a crucial Pivotal
Point, and use this as the spot to establish your exit point—your stop
loss point if the trade goes bad. Write this number down and honor
it—cut your losses—this is the most important thing for the trader to
know, even if you get whipsawed and it rallies right back. It did not do
what you expected it to do at the time you pulled the trigger–this is
the most important thing to remember.

• Make sure all things are in your favor, market direction, group direction,
sister stock direction and the exact timing is in place.

• At this point, the trader must then assume the status of an automaton,
a robot, and he must then follow his rules.

Remember that no trader’s judgement is infallible; if it were always
correct, that person would soon be the richest on this planet. But it is not
the case—we all make mistakes, and we will continue to make mistakes
in our lives and in the stock market! The rewards can be enormous if we
can learn to “cut the losses quickly and let the profits ride.”

Points Are a Key to Money Management

Livermore wanted at least the opportunity of a 10 point gain in any stock
he invested in.

Potential profit points were key in his trading. He was well aware that
if a stock goes from $10 to $20 it is a 100 percent gain, whereas a stock
that goes from $100 to $200 is a hundred point gain, as well as a hundred
percent increase in value.

He always bought in round lots and used his probing technique to buy:

1. An initial position of 20 percent,
2. A second position of 20 percent,
3. A third at position of 20 percent, and
4. A final purchase of 40 percent, with all purchases being at a higher
price and therefore higher cost.

This proved to him that the stock was moving in the direction he wanted
it to.

As previously explained, the main challenge for the trader is to identify
the current market leaders and to spot the new market leaders who
are waiting to take over from the current ones. During major shifts and
changes in market direction, it is of paramount importance for the trader
to observe the leaders that are being driven out and identify the new
stocks that will assume leadership in the future.

It is usually always best to go with the strongest stock in the strongest
group—do not look for the cheapest or the laggard stock that has not yet
had his turn to move in the group—always go for the strongest most dominant
stock in the group.

Livermore’s Method of Pyramiding

The trader must learn: You never average down.

That is, if the stock you bought goes down in price—do not buy any
more and try to average your price—it hardly ever works. But what
does often work is “averaging up” in price—buying more as the stock
goes up in price. But this can be dangerous also, so try to establish your
main position at the beginning, at the initial Pivotal Point, and then increase
it at the Continuation Pivotal Point—providing the stock comes
out of the consolidation with strength. The trader must wait until the
stock has proven it is going to break out on the strong side of the Continuation
Pivotal Point; until the stock declares itself, it is always a risk. At
these junctures the trader must watch like a hawk and stay poised, but
not biased by hope.

The final time a trader can pyramid is when a stock breaks out to a
clear new high, especially if it moves on heavy volume (see Figure 5.1);
this is a very good sign because it most likely means that there is no more
overhanging stock to stop the progress of the stock for a while.

All pyramiding in the stock market is a dangerous activity, and anyone
who tries it must be very agile and experienced, for the further a stock
moves in its rise or decline the more dangerous the situation becomes.

To offset the risk, Livermore tried to restrict any serious pyramiding to the
beginning of the move. He found it unwise to enter a pyramiding action if
the stock was far from the Pivotal Point base—better to wait for the next
Continuation Pivotal Point or the break-out to a new high.

The trader must always remember there are no ironclad rules to the
stock market, the main objective for the stock speculator is to try and
place as many factors in his favor as he can. And even with these in place,
the trader will still be wrong on many occasions, and he must react by cutting
his losses.

Here is a money management rule that cannot be stated often enough:
A trader should always keep some cash in reserve for those incredible
moments in trading the market when all the factors come together to form
the “Supreme Trade at the Perfect Moment” such as occur at the zenith of
bull markets and the nadir of panics. Many of these trading moments have
recently occurred in 2003, and more still remain for 2004. There is no better
feeling than having a strong army of cash standing by, waiting for your
command to move into action.

Profits: The Spine of Every Stock

There is no magic about achieving success in the stock market. The only
way for anyone to succeed in investments is to investigate before investing;
to look before he leaps; to stick to the fundamentals of his own personal
list of rules, and disregard everything else. But, of course, first he
must establish his list of trading rules. Jesse Livermore was one of the
most successful traders in history. In this section, the trader is getting a
look at his money management rules.

Livermore would say to today’s trader: “Take my rules and try them. I
established them after having made many mistakes and thousands of
hours of analysis and they work. If I can save you the pain and expense I
endured, I will be happy to have done so.”

Every trader must also understand that, in the end, in the final
analysis, when the dust settles on a stock, it is the earnings—profits,
and profit potential—that actually establish the final price of the stock.
This happens when the emotions are wrung out and reality finally does
settle in. But the trader must also understand that it is always hope and
greed that grease the skids, lubricate the wheels of volatility on the
stock’s journey. The promise of superior earnings may have driven the
stock in its history. But in the final analysis, it is real profits and real results
that eventually cause the price of stocks to settle. Reality will always
eventually set in to produce a final conclusion for the industry
group and any particular stock. This will be revealed to the skilled technical
trader as it occurs.

Don’t Give Your Money to Others to Trade

It has become apparent in today’s modern scandal-ridden markets that
there is no security or safety in trading in the shares of large blue-chip
companies or listening to highly accredited analysts, or trusting old, steadfast
mutual funds. Where big money is concerned, there is always the danger
of illegal activities lurking in the background. And there is no more
money at stake than in the American stock markets.

The gangsters, the con men, the thieves, the swindlers, the grifters, all
know where the money is and are always thinking of ways to help themselves
to the stock trader’s money. This comes as an additional burden in
the field of stock trading, which is a most difficult field to begin with—a
place where only the skillful, disciplined trader has a chance.
Here is one of Livermore’s famous sayings: “If I am going to lose my
money in the stock market, as so many people do . . . then I would prefer
to lose it myself. I do not need a broker to lose it for me.”
When you are handling surplus income, do not delegate the task to
anyone. Whether you are dealing in millions or in thousands, the same
principal lesson applies. It is your money. It will remain with you just so
long as you guard it. Faulty speculation is one of the most certain ways of
losing it.

Blunders by incompetent speculators and traders cover a wide scale.
Livermore warns strongly against averaging losses. That is a most common
practice. Great numbers of people will buy a stock, let us say at 50,
and 2 or 3 days later if they can buy it at 47 they are seized with the urge to
average down by buying another hundred shares, making an average price
of 48 on all.

Having bought at 50 and being concerned over a three-point loss on a
hundred shares, what rhyme or reason is there in adding another hundred
shares and having the double worry when the price hits 44? At that point,
there would be a $600 loss on the first hundred shares and a $300 loss on
the second hundred shares.

If one is to apply such an unsound principle, he should keep on averaging
by buying 200 shares at 44, then 400 at 41, 800 at 38, 1600 at 35,
3200 at 32, 6400 at 29, and so on. How many speculators could stand
such pressure? Yet if the policy is sound, it should not be abandoned. Of
course, abnormal moves such as the one indicated do not happen often.
But it is just such abnormal moves against which the speculator must
guard to avoid disaster.

So, at the risk of repetition and preaching, avoid averaging down. Livermore
received one sure tip from a broker concerning a margin call:

When the margin call reaches you, close your trade—never meet a margin
call. This proves you are on the wrong side of the market. Why send good

money after bad? Keep that good money for another day. Risk it on something
more attractive than an obviously losing deal.

A successful businessman extends credit to various customers, but
typically would not sell his entire output to one customer. The larger the
number of customers, the more widely the risk is spread. Just so, a person
engaged in the business of speculation should risk only a limited amount
of capital on any one venture. As stated, cash to the speculator is like merchandise
on the shelves of the merchant.

One major mistake of all speculators is the urge to enrich themselves
in too short a time. Instead of taking 2 or 3 years to make 500 percent on
their capital, they try to do it in 2 or 3 months. Now and then they succeed.
But do such daring traders keep it?

They do not. Why? They do not take some money off the table from
time to time.

This one rule haunted Livermore because he did not always adhere to
it. In fact, he consistently broke it. When he made a large profit in a trade,
he did not take some of the profit off the table, out of the market and put it
in the bank. It was one of the major regrets of his trading years.
Most people do not think they earned the money they make in the
market because all they have done is make a phone call and shuffle some
paper. There is no actual work involved in trading, no service being offered
such as a doctor, mechanic, carpenter, plumber provides, nothing
being manufactured like a lawn mower, a car, a suit of clothes. As a result,
a lot of people have trouble psychologically, it appears to them as unhealthy
money, rolling in rapidly, and stopping for but a short visit. The
speculator in such instances loses his sense of balance. The uninitiated
public investor says: “If I can make 500 percent on my capital in 2 months,
think what I will do in the next 2! I will make a fortune with basically no
work. I call, place my order with the broker, and collect my profits—it’s no
wonder rich people play the stock market.”

Such speculators are never satisfied. They continue to shoot the
works until somewhere a cog slips, something happens—something drastic,
unforeseen, and devastating. At length comes that final margin call
from the broker, the call that cannot be met, and this type of plunger goes
out like a lamp. He may plead with the broker for a little more time, or if
he is not too unfortunate, he may have saved a nest egg permitting a modest
new start.

Businessmen opening a shop or a store would not expect to make
over 25 percent on their investment the first year. But to people who enter
the speculative field 25 percent is nothing. They are looking for 100 percent.
And their calculations are faulty; they fail to make trading a business
and run it on business principles. In the end, Livermore believed that the

only money that is ever taken out of Wall Street by speculators is the
money they draw out of their accounts after closing a successful trade.
Livermore used to tell this story to his friends:

“I recall one day in Palm Beach. I left New York with a fairly large
short position open. A few days after my arrival in Palm Beach the market
had a severe break. That was an opportunity to cash paper profits into real
money—and I did.

“After the market closed I gave a message to the telegraph operator to
tell the New York office to send immediately to my bank one million dollars
to be deposited to my credit. The telegraph operator almost passed
out. After sending the message, he asked if he might keep that slip. I inquired
why.

“He said: I’ve been an operator here in Palm Beach for twenty years
and that was the first message I ever sent asking a broker to deposit in a
bank money for the account of a customer.

“He went on: I’ve seen thousands and thousands of messages passing
over the wire from brokers demanding margins from customers. But
never before one like yours. I want to show it to the boys.”

The only time the average trader can draw money from his brokerage
account is when he has no position open or when he has an excessive equity.
He won’t draw it out when the markets are going against him because
he needs all his capital for margin.

He won’t draw it out after closing a successful deal because he says to
himself: “Next time I’ll make twice as much.”

Consequently most speculators rarely see the money. To them, the
money is nothing real, nothing tangible. For years, after a successful deal
was closed, Livermore made it a habit to draw out cash. He would draw it
out of the market at the rate of $200,000 or $300,000 a clip. It had a psychological
value for Livermore. He made it a policy to count the money
over again. It was then that he knew he had something in his hand. He felt
it. He spent a little. He knew his hard work was producing real money.
For Livermore, money in a broker’s account or in a bank account was
not the same as if you felt it in your own fingers once in a while. Then it
meant something. There is a sense of possession that makes you just a little
bit less inclined to take headstrong chances of losing your gains. So
every trader should have a look at his real money once in a while, particularly
between market deals.

Livermore was unable to make any money outside of Wall Street. In
fact, he lost many millions of dollars, which he took from Wall Street and
invested in other ventures, such as real estate in the Florida boom, oil
wells, airplane manufacturing, and the perfecting and marketing of products
based on new inventions. He always lost every cent.

In one of these outside ventures that had whipped up his enthusiasm,
he sought to interest a friend of his in investing $50,000. His friend listened
to his story very attentively. When Livermore finished, the friend
said: “Livermore, you will never make a success in any business outside of
your own. Now if you want $50,000 with which to speculate it is yours for
the asking. But please trade stocks and stay away from business.” The
next morning, to his surprise, the mail brought a check for that amount,
which Livermore did not need and sent back.

The lesson here again is that trading stocks is itself a specialty business
like any other, and should be so viewed by all who wish to trade in
the market. Do not permit yourself to be influenced by excitement, flattery,
or temptation. Keep in mind that brokers sometimes innocently
become the undoing of many traders. Brokers are in the business to
make commissions. They cannot make commissions unless customers
trade. The more trading, the more commissions. The speculator wants
to trade, and the broker not only is willing, but too often encourages
over trading. The uninformed trader regards the broker as his friend and
is soon over trading.

Now if the speculator were smart enough to know at just which time
he should over trade, the practice would be justified. He may know of
times when he could or should over trade. But once acquiring the habit,
very few traders are smart enough to stop. They are easily carried away
emotionally, and they lose that peculiar sense of balance so essential to
success. They never think of the day when they will be wrong. But that
day always arrives. The easy money they might have made takes wing, and
another trader goes broke.

Follow the rules—never make any trade unless you know you can do
so with financial safety.

POSTSCRIPT

Many legends about Jesse Livermore have persisted over the years. In my
research on Livermore, the following story was told to me by Patricia Livermore,
his daughter-in-law, married to Jesse Jr., and then again by Paul
Livermore, Jesse’s younger son. I have written it down faithfully as it was
told to me.

Livermore’s Annual New Year’s Ritual

“Good afternoon, Mr. Livermore.”

“Hello, Alfred.”

It was the Friday before the New Year of 1923. Livermore walked into
the Chase Manhattan Bank, late in the afternoon. He was warmly greeted
by Alfred Pierce, the bank manager. Livermore was one of the bank’s best
customers, keeping a balance of at least two million dollars in reserve for
his special “stock situations,” when he needed extra cash to establish one
of his famous stock purchases or perhaps engage in a raid or activate a
commodity corner.

“We have everything ready for you, J.L.,” Alfred said. (People who
knew Livermore well called him J.L.)

Livermore looked at his watch—it was almost 5:15. The bank was already
closed. They had let him enter the bank through the employees’
door. “Yes, J.L., the closing bank vault time-lock is set for 5:30, as always.”
They walked in silence across the great vaulted room of the main
branch through the door that separated the tellers’ cages from the public
and entered the back of the bank.

“And Monday morning?” Livermore asked.

“Monday, the timer on the vault is set to open at 8:00 sharp, like
always.”

“I just like to be sure.” Livermore added with a smile.

“I understand, J.L.—by that time you will have had enough solitude.”

“Yes Alfred, of that I am sure.” Livermore said. He was carrying a
leather briefcase. Alfred looked at the briefcase. “Do you mind me asking
what’s in the briefcase?”

“Not at all. It is my entire trading history for 1923. I will review every
trade I made and refer to my notes. I keep good notes on all my trades that
explain why I bought or went short and why I closed my positions.”

“So you don’t win every time?” Alfred said facetiously.

“Alfred, there are many rumors about me; of course, you know that I
lose. I am only human. The idea is to get out fast when a trade goes
against you. I often lose, that is what I am trying to figure out this weekend—
why did I lose on certain trades over the year.”

They approached the main vault. It was huge with a giant solid steel
door. Two armed security men stood on either side of the door. They nodded
at Alfred and Jesse Livermore. They knew what was going on.

The two men crossed over the threshold and entered the cavernous
vault. There was a large amount of cash in a series of open chests. Most of
the bills were hundreds with one chest full of twenties and fifties. There
was a desk, a chair, a cot, and an easy chair in the middle of the cash.

There was a special light above the desk and a second light above the easy
chair. Livermore went over to the cash in the open chests and looked
down at the uncovered bills. “There is almost fifty million here. The exact
amount is written on the pad on your desk. The last of it came over from
E. F. Hutton’s this afternoon.”

Jesse Livermore had sold out almost every position he had in both
stocks and commodities, as he did at the beginning of every new year. He
stared down at the cash.

“I would like to have the commission on just these sales, J.L.,” Alfred
said.

“This is not all of it. In some cases the market was too thin to take the
hit, so that stock will be sold slowly over the next few weeks or so, and
will be sent here for safekeeping.”

“When will you resume trading?”

“Most likely in February, after I get to Palm Beach.”

The red light on the ceiling started to flash and a low-level bell rang at
20-second intervals. The bank manager looked at his watch.

“Five minutes before the vault closes, J.L. The food is over here.”
The bank manager went to an icebox in the corner. “We got everything
that your office manager Harry Dache ordered for you. He actually
brought the food over himself about an hour ago, and we had an ice delivery
around noon. Bread, cold cuts, vegetables, water, milk, juices and
the makings for some old fashioneds.” Alfred pointed into the open icebox
door.

“Thanks, those old fashioneds will come in handy.”

“Right you are, J.L. I’m going to leave now, I suffer from claustrophobia
and all this money scares me.”

Livermore walked the bank manager to the vault door. They shook
hands. “J.L. if anyone ever knew about this . . . well . . . they might think
that you were eccentric.”

“Eccentric is a kind word, Alfred.” Jesse Livermore smiled as the
door started to swing shut, pushed by the two armed guards. “You see, Alfred,
all year long all I see is and endless stream of paper. This weekend
makes it real for me . . . real cash—nothing like it.

Livermore stood at the door as it clanged shut. The lights above the
desk and the easy chair now provided an eerie but adequate light. Livermore
surmised that no one had ever actually tested them with the door
shut; no one would volunteer to be locked inside the vault.

He turned and walked to the desk surrounded by almost fifty million
dollars in cash. For the next two days and three nights this would be his
home. Inside the cavernous vault he would retreat into deep solitude and
review his entire trading year from every aspect . . . just as he had done
every year since he had started trading.

When it was time to leave on Monday morning he would go to the
chest that held the twenties and the fifties and stuff his pockets with
as much cash as he desired, and over the next two weeks he would
spend it.

He had not locked himself up with his cash as a miser might lock himself
up to count his money in the counting house. No, Livermore, because
his world was a world of paper transactions all year long, believed that by
the end of the year he had lost his perception of what the paper slips really
represented—cash money, and ultimately, power.

By the end of the year, he was just shuffling paper. Livermore
needed to touch the money and feel the power of cash. It also made him
reappraise his stock and commodity positions and determine: Were
these positions he would keep if he had the choice—were there better opportunities?
Selling everything out forced him to appraise whether or not
he would buy these positions back.

When he walked out of the vault on the Monday morning with pockets
full of cash, he would start his shopping spree, a spree that usually lasted
for at least a week and included spending on many human pleasures as
well as material items.

Labels: Reference, Risk Management, Stock Trading System