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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Before you buy a stock, you should have a clear target where to sell if the stock moves against you. Jesse LivermoreBefore you buy a stock, you should have a clear target where to sell if the stock moves against you, a firm stop. And you must obey your rules! Buy small positions, probe first, to test your judgment before you commit to a large position. A successful market trader must only bet on the course of highest probabilities. Do not establish your full position all at one timeuse probes to confirm your judgment and timing and to find the line of least resistance. The probe approach is also a major factor in Money Management. The trader must react quickly to the unexpected, which is never predictable. If it is a windfall, grab it. If it is bad news, hit the road, and dont look back or hesitatesell out the position. Beware after a long trend up when volume gets heavy, and stocks churn. This is a clue, a red-alert warning that the end of the move is near. This is also a possible indication of stocks going from strong hands to weak hands, from the professional to the public, from accumulation to distribution. The public often views this heavy volume as the mark of a vibrant, healthy market going through a normal correction, not a top or a bottom. Follow money management rules: Establish stops! The speculator should have a clear target where to sell if the stock moves against you. This is essential on the first buys trailing stops can also be used as the stock moves, although I always did these with trailing mental stops. And you must obey your rules! Never sustain a loss of more than 10 percent of your invested capital. Losses can be twice as expensive to make up. I learned this in the bucket shops working with 10 percent margin. You were automatically sold out by the bucket shops if the loss exceeded the 10 percent limit. Never sustain a loss of more than 10 percent of invested capital. The 10 percent loss rule is an important rule for managing money. As noted, this is also a key timing rule. If you lose 50 percent, you must gain 100 percent to break even. Never meet a margin call and never average down in your buying. Turn paper profits into real money periodically. Take a percent of your winnings and put them in a safe place, like the bank or bonds, or an annuity. Cash wasisand always will beking. Always have cash in reserve. Cash is the ammunition in your gun. My biggest mistake was not in following this rule more often. Examine and understand the dimension of time: Dont be in a hurry. The successful investor is not invested in the market all the timethere are many times when you should be completely in cash. If you are unsure of the direction of the market, then stay out and wait for a confirmation of the next move. Use probes to establish your full position. After an initial probe, do not make a second move until the first probe shows you a profit. Do not establish your full position all at once, wait until your first trades, your early probes, have shown you a profit, then go ahead and fill out your full position. To be precise: First establish 20 percent of your planned position on the first purchase, 20 percent on the second, 20 percent on the third. Wait for a confirmation of your judgmentthen make your final purchase of 40 percent. Consider each of these purchases, or probes, a crucial factor in establishing the overall position. If at any time the stock goes against you, then wait or close out all your positions, never sustaining more than a 10 percent loss of invested capital. Sell the losers, let the winners ride, provided all the factors are positive. SUMMARY OF FIVE KEY MONEY MANAGEMENT RULES Protect your capitaluse probing system to buy Observe the 10 percent bucket shop rule Keep cash in reserve Stick with the winnerslet your profits ridecut your losses Take 50 percent of your big winnings off the table EMOTIONAL CONTROL Emotional control is the most essential factor in playing the market. Never lose control of your emotions when the market moves against you. And never become elated with your successes to such a degree that you think the market is an easy way to make money. Never fight the tapethe tape is the truth . . . seek harmony with the tape. Dont anticipate! Wait until the market gives you the clues, the signals, the hints, before you move. Move only after you have confirmation. Anticipation is the killer. It is the brother to greed and hope. Dont make decisions based on anticipation. The market always gives you time. If you wait for the clues, there will be plenty of time to execute your moves. All stocks are like human beings, with different personalities: aggressive, reserved, hyper, high-strung, direct, dull, old fashioned, futuristic, logical, illogical. Study the stocks as you would study people; after a while, their reactions to certain circumstance become predicable. Some traders limit their trading to stocks in specific price ranges. Do not spend a lot of time trying to figure out why the price of a particular stock moves. Rather, examine the facts themselves. The answer lies in what the tape says, not trying to figure out why, and most importantlynever argue with the tape. A stock trader can be convinced to move away from his own convictions by listening to the advice of other traders, persuaded that his judgment may be faulty. Listening to others may cause indecision and bad judgment. This indecision may cause a loss of confidence, which may well mean a loss of money. Tips come from many sourcesfrom a relative, a loved one, a pal who has just made a serious investment himself and wants to pass on his expected good fortune. They also come from hucksters and criminals. Remember: All tips are dangeroustake no tips! Remove hope from your trading lexicon. Hoping a stock will do something is the true form of gambling. If you do not have good solid reasons to hold stock positions, then move on to another more logical trade. Wishing a stock up, or down, has caused the downfall of many stock market speculators. Hope walks along hand in hand with greed. Always be aware of your emotionsdont get too confident over your wins or too despondent over your losses. You must achieve poise, a balance in your actions. Nothing ever changes in the market. The only thing that changes are the players, and the new players have no financial memory of the previous major cycles, like the Crash of 1907, or the Crash of 1929, because they have not experienced them. It may be new to the speculatorbut its not new to the market. Always have a method of speculating, a plan of attack. And always stick to your plan. Do not constantly change your plan. Find a method that works emotionally and intellectually for you, and stick to that methodstick to your own customized rules. The speculator is not an investor. His object is not to secure a steady return on his money over a long period of time. The speculator must profit by either a rise or fall in the price of whatever he has decided to speculate in. Play a lone hand. Make your decisions about your own money by yourself. Be secretive and silent in your stock trading. Do not disclose your winners or your losers. The successful investor is not invested in the market all the time there are many times when you should be completely in cash. If you are unsure of the direction of the market, wait. It takes four strong mental characteristics to be a superior market trader: Observation: the ability to observe the facts without prejudice; Memory: the ability to remember key events correctly, objectively; Mathematics: an easy facility with numbers, at home with digits; Experience: to retain and learn from your experiences. Livermore believed that subliminal messages, apparent impulses, were nothing more than the subconscious mind talking to him; calling up his experiences, his years of trading. On occasion, Livermore would let his inner-mind lead him, even if he didnt know exactly why at the time. Livermore believed Aristotle, who said, We are the sum total of our experience. Emotions must be understood and harnessed before successful speculation is possible: Greed is a human emotion defined by Websters dictionary as the excessive desire for acquiring or possessing, a desire for more than one needs or deserves. We do not know the origin of greed, all we know is that it exists in every person. Fear lays ready to appear in a single heartbeat, and when it does, it twists and distorts reason. Reasonable people act unreasonably when they are afraid. And they get afraid every time they start to lose money. Their judgment becomes impaired. Hope lives hand in hand with greed when it comes to the stock market. Once a trade is made, hope springs alive. It is human nature to be hopeful, to be positive, to hope for the best. Hope is important to the survival of the human race. But hope, like its stock market cousins, ignorance, greed, and fear, distorts reason. Hope clouds facts, and the stock market only deals in facts. Like the spinning of a roulette wheel, the little black ball tells the outcomenot greed, fear, or hope. The result is objective and final with no appeal . . . like nature. Ignorance. The market must be studied and learned, not in a casual way, but in a deep knowledgable way. Like no other entity, the stock market, with its allure of easy money and fast action, induces people into the foolish mishandling of their money. The reverse of ignorance is knowledge, and knowledge is power. The stock market is never obvious. It is designed to fool most of the people, most of the time. Livermores rules are often based on thinking against the grain. You should not be in the market all the time. There are times you should be out of the market, for emotional as well as economic reasons. When the tape doesnt agree with your decision to buy or sell, wait until it does. Never try to rationalize your position with what the tape is saying. Do not give or receive stock tips, just remember: In a bull market stocks go up-in a bear market they go down. That is all anyone needs to know, or for you to tell them. Do not break your rules. A stock speculator sometimes makes mistakes, and knows that he is making them, but proceeds anyway, only to berate himself later for breaking his own rules. Never become an involuntary investor by holding a declining stock. Never buy a stock on reactions, and never short a stock on rallies. Do not use the words bullish or bearish. These words fix a firm mar ket direction in the mind for an extended period of time. Instead, use Upward Trend and Downward Trend when asked the direction you think the market is headed. Simply say: The line of least resistance is either upward, or downward at this time, as I did. Speculation is a business, and like any other business it takes hard work and diligence to succeed. There is nothing new on Wall Street or in stock speculation. What has happened in the past will happen again, and again, and again. This is because human nature does not change, and it is human emotion that always gets in the way of human intelligence. Of this I am sure. Jesse Livermore |
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