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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Livermore could have a line of a hundred thousand shares out on a single stock play and sleep like a babyMONEY MANAGEMENT RULE 4: YOU NEED A GOOD REASON TO BUY A STOCK AND YOU NEED A GOOD REASON TO SELL Stick with the winnersas 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 ridehave 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 tracks moneythe stock markets money. His attitude was that if he lost all his profitwell 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 ThemselvesLosses 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 shouldnt 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 economys generally healthy was to Livermore the equivalent of stock-market suicide. He said: There are no good stocksthere 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 houses 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 traders 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 winnerslet 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 mattressjust put it somewhere safe. Like winning in the casino, its 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. 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 Livermores money management rules: 1. Use probesdont 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 pershare 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 factthe 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 insidersthis 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 fineif 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 traders 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 purchasedhe meant before he pulled the triggerthats 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 lossthis is true no matter what anyone tells you. Dont wind up without cash, like the merchant with no inventorythats the same as a stock trader with no cashout 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 Pointit always gives the trader a clear point of reference. The Pivotal Point acts as a place to establish the stop loss pointthe 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 invest mentif 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 pointyour stop loss point if the trade goes bad. Write this number down and honor itcut your lossesthis 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 traders judgement is infallible; if it were always correct, that person would soon be the richest on this planet. But it is not the casewe 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. |
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