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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Livermore was an independent thinker, yet he always wanted to trade along the line of least resistance the trendEmotional Control 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 Systems approach to timing and money management. Were left with this most important sectionemotional 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 understoodsince 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, knowledgable way. Its 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 didnt 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, thats how it appears. Simply put, its 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 emotionswhen things go bad, theres 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 hopewhen it comes to the stock market, hope skips along the traders 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 outcomenot 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 opinionand 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 directionthat 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 timesthe question for a successful trader is not will they come...it is when will they come? Livermores conclusionusually when you least expect it, the trend will change. The change in trend is the most difficult time in a speculators 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 Livermores later life, whenever he deduced that a change was coming, and he wasnt 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 purchasethe signalprices are droppingtime to go short. The traders 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 juncturesrecognizing the Reversal Pivotal Pointsbeing able to identify them and not be confused by natural reactions or the appearance of Continuation Pivotal Pointsthat 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 overhe 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. Nobodyno single personcould 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. Livermores 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 momentumthe 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 Motorsthe stock has simply done what the trader deduced it would do. If the trader can now make a profit as General Motors declinesby going shorthe 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 traders 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 wasnt. 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. |
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