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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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To offset the risk, Livermore tried to restrict any serious pyramiding to the beginning of the movePoints 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 groupdo not look for the cheapest or the laggard stock that has not yet had his turn to move in the groupalways go for the strongest most dominant stock in the group. Livermores Method of Pyramiding The trader must learn: You never average down. That is, if the stock you bought goes down in pricedo not buy anymore and try to average your priceit hardly ever works. But what does often work is averaging up in pricebuying 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 Pointproviding 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 basebetter 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 todays 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 earningsprofits, and profit potentialthat 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 stocks 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. Dont Give Your Money to Others to Trade It has become apparent in todays 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 traders money. This comes as an additional burden in the field of stock trading, which is a most difficult field to begin witha place where only the skillful, disciplined trader has a chance. Here is one of Livermores 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 tradenever 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 profitsits 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 happenssomething 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 moneyand 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: Ive 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: Ive 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 wont draw it out when the markets are going against him because he needs all his capital for margin. He wont draw it out after closing a successful deal because he says to himself: Next time Ill 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 brokers 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 overtrading. The uninformed trader regards the broker as his friend and is soon overtrading. Now if the speculator were smart enough to know at just which time he should overtrade, the practice would be justified. He may know of times when he could or should overtrade. 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 rulesnever 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, Jesses younger son. I have written it down faithfully as it was told to me. Livermores Annual New Years 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 banks 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 watchit 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 whats 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 dont 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 weekendwhy 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. Huttons 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. Im 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 cashnothing 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 representedcash 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 choicewere 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. |
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