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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Livermore believed that a stock trader is Always a student, never a masterLivermore Trading Discoveries The stock market is forever evolvingit is dynamic. Because of its complexity, Livermore believed that a stock trader is Always a student, never a master. As Livermore gained knowledge over his 45 years of trading, he modified his trading system accordingly. He always reviewed and studied each of his trades, good or bad. He went to school on his successes and his failures. They always had a lesson for him, sometimes hidden, sometimes painful. DISCOVERY 1: TRADE ONLY THE LEADERS Once he was sure he was correct in his conclusions, he would incorporate them into his trading system. One early Livermore lesson was trade only the leaders in any particular industry group. Dont play in the junkyard with the weaker stocks. Dont try to fish for the bargain stock, the as yet undiscovered stock in an industry group. Rather, go with the proven leaders! In the long run, you will be much better off. This single piece of advice can greatly assist a trader in the decision-making process. If you cannot make money with the leaders of a stock group, it is unlikely that you can make money at all in that group. He believed there is always the temptation in the stock market, particularly after a period of success, to become careless or excessively ambitious. Prudent trading requires the trader to use sound common sense and clear thinking to keep the profit that he has already made in the market. If you will hold fast to sound principles, you will not lose your money, once you have acquired it. Everyone knows that stock prices move up and down. They always have, and they always will. Livermore believed that behind these major movements is an irresistible force: a momentum like a wave of water, in some cases a tidal wave that once set in motion would remain in motion until it hit an obstacle and stopped or was reversedin stock trading this is know as the trend. Noticing and observing this power is all one needs to do. It is not profitable to be too curious about all the reasons behind the force of price movements. You risk the danger of clouding your mind with nonessentials. Just recognize that the movement, the power, the momentum is there, and take advantage of it by steering your speculative ship along with the tide. Use the power. Do not argue with the market you are observing, and most of all, do not try to combat it. Remember also that it is dangerous to start spreading out all over the market, carrying several positions. Do not have an interest in too many stocks at any one time. It is much easier to watch a few than many. Livermore made this mistake of owning too many stocks early in his career, and it cost him money. He believed the most stocks that can be handled at any one time was 10, but he felt much safer and in control if the number was smaller, say no more than 5 stocks. Another mistake he recognized and warned against was to turn completely bearish or bullish on the whole market. Because one stock in some particular group had clearly reversed its course from the general market trend, dont assume from this that the entire market is changing in trend. Rather, be patient, and wait until you see other groups turning to a new direction, particularly the leading industry groups within the market. The time to act is when these other groups corroborate the actions of the first group and indicate a decline or advance in the direction of the market, showing that a new trend is forming. If you use the Livermore trading system principles, you will have plenty of time to see the trend changing. In time, other stocks will clearly give you the same indication. Those are the cues you must wait for, and you must take them when they show themselves. These were the specific cues Livermore got in the Crash of 1907, when he made $3 million in a single day, and in the Crash of 1929, when he profited by more than $100 million by being on the short side. Back in the wild bull markets of the late 1920s (before the Crash of 1929), he saw clearly that the advance in the copper stocks had come to an end. Copper was a major commodity used as a bellwether in the 1920s to predict the market, because it was so widely used in the building industry. Many of todays traders still use copper in their calculations to predict market direction. In 1929, Livermore next noticed that the advance in the motor group had reached its zenith, stopped dead in its tracks, and rolled over. Because the bull market in those two industry groups had ended, he arrived at the faulty conclusion that he could safely sell everything and jump on the short side. He was wrong. The rest of the market kept moving in its upward spiral. Livermore lost his shirt on these trades. But at the same time he was piling up huge profits on his copper and motor short sales. Overall, he was about breaking even. He persisted in his short positions on the entire market and continued to lose on these trades. He spent the next six months of 1929 trying to find the top of the utility group, another key bellwether group. Eventually, this and other industry groups reached their peaks. By that time, Anaconda copper was selling 50 points below its previous high and the motor stocks were in close to the same ratio. So the profits on these short sales continued to climb, offsetting his losses, but not by much. The lesson to impress upon your mind is that when you clearly see a move coming in a particular industry group, act upon it. But do not let yourself automatically act in the same way in another industry group until you plainly see signs that the second group is in a position to follow the trend of the first group you are trading. The trader must have patience and wait until his judgment is confirmed by the market. In time, you will get the same tip-off in other groups that you received in the first group. Just dont spread out your positions and move to trade the entire market, until you have first received confirmation. Confine your studies of movements only to the prominent stocks of the day, the leaders. If you cannot make money out of the leading active issues in the leading industry groups, you are not going to make money out of the stock market as a whole. If a trader had followed Livermores advice in the last crash (1999), he would have seen history repeat itself as the leading stocks and groups such as Amazon, Yahoo, America Online, Lucent, Cisco Systems, Sun Microsystems, and even the great Microsoft reached their highs and rolled over, leading the entire market with them. The signals from these stocks came three to six months before the entire market followed suit. Livermore knew well that the market leaders in a strong bull market are the first to go up and the first to roll over and go down. Rarely are the market leaders of one bull market the same as the leaders of the new bull market, when it finally rallies and begins its new cycle. The same will be true in this market of the new millennium. Livermore always identified the market leaders and tracked them very closely. He also spent a lot of time deducing who would be the new leaders in a new market. If he were alive today, he would have already figured out what stocks will be the leaders of this new millennium market. A prudent trader of today would be wise to do the same. Find the new markets, the new products, and the new market leaders before the crowd. Just as styles in womens clothing are forever changing, the old stock market leaders drop out, and new ones rise up to take their places. In the 1920s, the chief leaders were the railroads, American sugar, and tobacco. Then along came the steels, and sugar and tobacco were nudged into the background. Every new market cycle has new market leaders, with few if any of the old leaders remaining in the picture. Livermore believed it would always be that way as long as there was a stock market. Note this Livermore trading rule: New leaders emerge with each new market. At this current moment, new leaders are moving into positions of leadership. Also note another Livermore rule: It is not prudent for a trader to try and keep account of too many stocks at one time. You will become entangled and confused. Try to analyze comparatively few groups and few stocks. You will find it is much easier to obtain a true picture that way than if you tried to dissect the entire market. If you analyze correctly the course of two stocks in the four or five prominent groups, you need not worry about what the rest are going to do. It becomes the old story of follow the leader . . . keep mentally flexible. Remember the leaders of today may not be the leaders two years from now. The skilled trader will study only a limited number of groups and the leading stocks in each of those groups. He will learn to look carefully before he leaps. In other words, he will be patient. After 1920, a new age of markets was ushered inone that offered safer opportunities for the reasonable, studious, competent investor and speculator. There were technology improvements for that age with the invention of the widely used ticker tape, the telephone, and newspapers that provided a current record of the stock trades and activity posted every day along with headlines and editorials. This all helped traders and investors make intelligent decisions on what to buy. DISCOVERY 2: UNDERSTAND INDUSTRY GROUP MOVEMENTS Livermore found that industry group movement was the key to individual stock movement. In the 1920s, he made a very important discovery that he applied to his trading system: Stocks did not move alone. When they moved, they moved in sectors and industry groups. For Livermore, this was a huge breakthrough. If U.S. Steel rose, then sooner or later Bethlehem, Republic, and Crucible would follow. Livermore observed this time and time again, and it became one of the most important trading weapons in his arsenal. As a result, Livermore never tracked a single stock. He first tracked the industry group movements. Livermore decided that a legitimate group movement had to include at least the two leaders of the group, and eventually all the stocks in the group would follow. It is a commonplace mistake for traders of today to confuse Industry Groups and Industry Sectors. In fact the media and traders often use these terms interchangeably. It is very important to know the difference. Sector means all the industry groups within a particular section or area. As examples, the Financial Sector includes a number of Groups, as do the Computer, Communications, and Medical Sectors. In the Financial Sector, for example, there are national banks, regional banks, savings and loan banks, financial service groups, stock brokers, and others. The Computer Sector includes, among others, box makers, software providers, makers of peripherals such as printers, monitors, and hand-held devices. Livermore believed that the most intelligent way to get ones mind attuned to market conditions and to be successful in trading was to make a deep and through study of industry groups in order to differentiate the good groups from the bad. The action result was this: Buy groups in a promising position and short Industry Groups that are not. It has been shown time and time again that on Wall Street people very often fail to see the thing that is right in front of them. Jesse Livermore Currently there are more than 87 million Americans invested in the stock market in one form or another. It cannot be emphasized too strongly the importance of first understanding the Industry Group action before the purchase of any single security. It was a key to Livermores incredible success in trading the market. This key factor is understood by some of todays market participants, but seemingly ignored by a large number traders and investors. Stay away from weak groups! Conversely, just as Livermore would have avoided the weak stocks in the weak industry groups, he favored the strongest stocks in the strongest industries. The trader must, of course, be able and willing to revise any forecasts and positions in the light of developments that occur from day to day and to move quickly, if factors have moved against him. This is just good common sense. |
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