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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Summary of Livermore Trading RulesSummary of Livermore Trading Rules Dont concern yourself with why things are happening only observe what is happening. The reasons why will eventually be revealed to youby then it will be too late to make money! The move will be over. Learn from your mistakes, analyze them. The trick is not to repeat your mistakes, which meant to Livermore you had to first understand themfind out what went wrong with the trade and dont repeat the same mistake again. Place as many factors in your favor as possible. Livermore was successful when all the factors were in his favor, and he concluded that the more factors he could think of the more successful he would be. No trader can or should play the market all the time. There will be many times when you should be out of the market, sitting in cash, waiting patiently for the perfect trade. Determine the direction of the overall market. Livermore referred to this as the Line of Least Resistance. He did not use the terms bull or bear for a very specific reason: he felt these terms caused a mind set to form: the market is in a Bullish Trend or the market is in a Bearish Trend. This in turn caused the trader to have a mindset that would anticipate the direction of a trade or the direction of the marketa deadly and dangerous thing to do. Dont try and anticipate what the market will do nextsimply go with the evidence of what the market is telling youpresenting to you. Experience has proved to me that the real money made in speculating has been in commitments in a stock or commodity showing a profit right from the start. Profits always take care of themselves but losses never do. The speculator should insure himself against considerable losses by taking the first small loss. In so doing, he keeps his account in order so that at some future time, when he has a constructive idea, he will be in a position to go into another deal, taking on the same amount of stock as he had when he was wrong. As long as a stock is acting right, and the market is right, do not be in a hurry to take a profit. You know you are right, because if you were not, you would have no profit at all. Let it ride and ride along with it. It may grow into a very large profit, and as long as the action of the market does not give you any cause to worry, have the courage of your convictions and stay with it. Do not have an interest in too many stocks at one time. Remember that it is dangerous to start spreading out all over the market. It is much easier to watch a few than many. I made that mistake years ago and it cost me money. A successful speculator remains a constant student of three things: 1. Market timingWhen to enter and when to exit a market trade when to hold em when to fold em, as Livermores friend and Palm Beach Casino owner Ed Bradley used to say. 2. Money managementDont lose moneydont lose your stake, your line. A speculator without cash is like a store owner with no inventory. Cash is a speculators inventory, his lifeline, his best friend without it youre out of business. Dont lose your line! 3. Emotional controlBefore you can successfully play the market you must have a clear, concise strategy and stick to it. Every speculator must design an intelligent battle plan, customized to suit his emotional makeup, before speculating in the stock market. The biggest thing a speculator has to control are his emotions. Remember, the stock market is not driven by reason, logic, or pure economics, but by human nature which never changes. How can it change? Its our nature. You cant tell if your judgment is right until you put your money on the line. If you dont put your money on the table you can never test your judgment, because you can never test your emotions. And I believe it is emotion, not reason that dictates the direction of the stock market, just like most important things in life: love, marriage, children, war, sex, crime, passion, religion. It is rarely reason that drives people. This is not to say things like sales, profits, world conditions, politics, and technology do not play a part in the ultimate price of a stock. These factors eventually come to bear, and the price of the stock market and the individual stocks may reflect them, but it is always emotion that carries the extremes. The market moves in cycles. I believe in cycles, in life cycles and market cycles. They are often extreme, hardly ever balanced. Cycles come like a series of ocean waves, bringing the high tide when things are good and, as conditions recede, the low tide appears. These cycles come unexpectedly, unpredictably, and they have to be weathered with temperance, poise, and patience-good or bad. The stock market is a study in cycles, when it changes direction it remains in that new trend until the momentum weakensa body in motion tends to stay in motionremember, dont buck the trenddont fight the tape. The skillful speculator knows that money can be made no matter what the market conditions, if a speculator is willing to play both sides of the market, as I was. SHORT LIST OF LIVERMORE MARKET RULES I long ago realized that the stock market is never obvious. It is designed to fool most of the people, most of the time. My rules are often based on thinking against the grain, against human nature: Cut your losses quickly; Be sure to confirm your judgment before you take your full position; Let your profits ride if there is no good reason to close out the position; The action is with the leading stocks, these can change with every new market; Keep the number of stocks you follow limited in order to focus; New all-time highs are possible signals of valid break-outs; Cheap stocks often appear to be bargains after a large drop. They often continue to fall, or have little potential to rise in price. Leave them alone! Use Pivotal Points to identify trend changes and confirmations in trends; Dont fight the tape! Play both sides of the market. In a free market system, Prices fluctuate! They never go up all the time, and they never go down all the time. This is good for the alert speculator, since either side of the market can be played. The market goes up a third of the time, sideways a third of the time, and down a third of the time. If a trader only takes long positions he is out of the play two-thirds of the time. Going short of stocks can be very profitable for the astute trader. Cut Losses Quickly. Never sustain a loss of more than 10 percent of your invested capital. This Livermore learned in the bucket shops where he worked with 10 percent margin and was automatically sold out if the loss exceeded the 10 percent limit. This is also a money management rule. Wait until all the factors are in your favor before making a trade follow the Top Down Trading rules. The big money is made by the sittingthe waitinnot the thinking. Once a position is taken, the next difficult task is to be patient and wait for the move to play out. The temptation is strong to take fast profits or cover your trade solely out of fear of losing the profit on a correction. This error has cost millions of speculators millions of dollars. Be sure you have good clear reasons to enter a trade, and be sure you have good clear reasons to exit your position. It is the big swing that makes the big money for you. Play the market only when all factors are in your favor. No person can play the market all the time and win. There are times when you should be completely out of the market. Cover your losses quickly, without hesitation.The only thing to do when a person is wrong is to be right, by ceasing to be wrong. Dont waste time, when a stock moves below a mental-stop, sell it immediately. Study the stocks like you would study people. After a while their reactions to certain circumstances become predictable, and useful, in timing the stocks movement. Stocks often act like human beings, expressing different personalities: aggressive, reserved, hyper-high-strung, direct, logical, predictable, unpredictable. Stocks are never too high to begin buying or too low to begin selling short. Failure to take the opportunity to get out of large illiquid positions when the opportunity presents itself can cost. Failure to take advantage of a serendipitous act of good luck in the stock market is often a mistake. Dont anticipate! Wait for market confirmation! In a market moving sideways in a narrow channel where stock prices are essentially stagnant, there is a great danger in trying to predict or anticipate when, and in what direction the market will move. You must wait until the market or the stock breaks out of this sideways channel in either direction. Never argue with the tape. Follow the line of least resistance. Follow the evidence. The answer always lies in what the tape says, not trying to figure out the why. Do not spend a lot of time trying to figure out what moves the price of a particular stock. Rather, examine the tape. Behind all major movements in the stock market there is an irresistible force, which will most likely be revealed later. That is all the successful speculator needs to know. The stock market goes up, down and sideways. You can make money on the up side or the down side-you can buy long or sell short. It should not matter to you what side of the market you are on. You must be impersonal. When the market goes sideways and you are confused, take a vacation. Beware of the one-day reversal. When the high of the day is higher than the high of the previous day, but the close of the day is below the close or the low of the previous day and the volume of the current day is higher than the volume of the previous day, beware! If the stock you traded is going in the opposite direction than you expected, sell it quickly. It means your judgment was wrongcut your losses quickly. Study the action of a stock that has made a severe break in price, a precipitous drop. If the stock does not rebound quickly it will most likely fall away furtherthere is an inherent weakness in this stock, the reason will be revealed at a later time. The market is operating in future time. It has usually already factored in current events. A change in trend, if caught, yields the most rewards. It is the inception of a basic movement, the Pivotal Point, a change in trend, which indicates whether to buy or sell. Pivotal Points are an essential timing device, a trigger that reveals when to enter, and when to exit the market. There are two kinds of Pivotal Points: The Reversal Pivotal Point and the Continuation Pivotal Point. The Reversal Pivotal Point is defined as the perfect psychological time at the beginning of a major market move, a change in basic trend. It does not matter if it is at the bottom or top of a long-term trending move. It marks a definite change in direction. The Continuation Pivotal Point confirms the move is underwayit is a natural consolidation before the next move upward. Be alertmajor Pivotal Points can often be accompanied by a heavy increase in volume. At the end of a bull market, watch for wild capitalizations, good stocks selling at 30, 40, 50, 60 times their annual earnings. These will be the same stocks that had normally traded at 8 to 12 times earnings. Beware of wild speculative stocks that take off for no real reasons, except that they are trendy, in-favor stocks. New highs are very important for timing. A new all-time high can mean that the stock has broken through the overhead supply of stock and the line of least resistance will be strongly upward. The majority of people, when they see that a stock has made a new high, sell it immediately, then look for a cheaper stock. Top Down Tradingfollow the trendcheck the main market. The speculator must know the overall trend of the market before making a tradethe line of least resistance. Know if this line of least resistance is upward or downward. This applies to both the overall market and individual stocks. The basic thing you need to know before making a trade is which way the overall market is headed, up, down, or sideways. You have to decide this first before making a trade. If the overall trend of the market is not in your favor, you are playing at an extreme disadvantage, remember, go with the flow, bend with the trend, do not sail into a gale, and most of all . . . dont argue with the tape! Group action is a key to timing. Stocks do not move alone when they move. If U.S. Steel climbs in price, then sooner or later Bethlehem, Republic, and Crucible will follow. The premise is simple: If the basic reasons are sound why U.S. Steels business should come into favor in the stock market, then the rest of the steel group should also follow for those same reasons. Trade the leading stocks in the leading groupsas the leaders go so goes the entire market. Buy the strongest market leader in an industry group. Watch the market leaders, the stocks that have led the charge upwards in a bull market. When these stocks falter and fail to make new highs, it is often a signal that the market has turned. Confine your studies of stock market movements to the prominent issues of the day, the leaders. If you cannot make money out of the leading active issues, you are not going to make money out of the stock market. That is where the action is and where the money is to be made. It also keeps your universe of stocks limited, focused, and more easily controlled. |
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