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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Livermore felt that it is wrong and dangerous to establish your full stock position at only one pricePerfecting Money Management Money Management is one of the essential three pieces of the puzzle that fascinated Livermore: Timing, Money Management, and Emotional Control are the main headings of his trading system. Livermore had five main rules in managing his money. He attempted over the years to explain his entire trading theory to his sonsMoney Management was a big part of it. But the sons never responded to their father. They were not interested in the stock market. The excerpt below is from Jesse Livermore Worlds Greatest Stock Trader by Richard Smitten, published by John Wiley & Sons, Inc. One day Livermore called his two sons into the library at Evermore on Long Island. He sat behind the massive desk and the two boys sat down in front of him. He leaned forward and took a wad of cash out of his pocket. He peeled off ten one dollar bills. He did this twice, then folded the bills and handed each boy a pack of ten ones. The boys sat looking at him, each holding their money. Boys, always carry your money folded and in your left pocket. Go ahead do it. You can keep the money. The boys did as they were told and put the folded money in their left pockets. You see, pickpockets always go for a persons wallet, which is usually in the back pocket. Or they will come up behind you and go for your right front pocket, because most people are right handed. You all right with this so far, boys? he asked. The boys nodded. He continued. All right, thats why you keep your paper money folded in your left pocket. See, if a pickpocket gets into your left pocket, and he gets that close to your balls, youre going to know about it. The boys looked at each other. Their father continued. Dont ever lose your cash boysthats the moral of this story. Keep it close to your balls, and dont let anyone near it. MONEY MANAGEMENT RULE 1: DONT BUY YOUR ENTIRE POSITION ALL AT ONE TIME He liked to call this his probe system. Dont lose money, dont lose your stake, dont 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 youre out of business. Dont 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 Pointif 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 reactsif 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 directionand 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 Livermores 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 judgmentpay more for each lot you buydollar 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 Livermores 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 tradewhen 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 drasticyou must gain back 100 percent to cover a loss of 50 percent. 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 birds 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. Livermores advice: Dont 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 backhe 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 cardsfor 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 speculators 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 Livermores 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 fortunepatience, patience, patience is the key to successnot speed. Time is a cunning traders best friend if he uses it right. |
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