19 August 2013
JESSE LIVERMORE TRADING RULES
Excerpted from book "Trade Like Jesse Livermore"
Don’t concern yourself with why things are happening only observe
what is happening. The reasons why will eventually be
revealed to you—by 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
them—find out what went wrong with the trade and don’t 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 market—a deadly and dangerous
thing to do.
Don’t try and anticipate what the market will do next—simply go
with the evidence of what the market is telling you—presenting 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 timing — When to enter and when to exit a market trade–
when to hold ‘em when to fold ‘em, as Livermore’s friend and Palm
Beach Casino owner Ed Bradley used to say.
2. Money management — Don’t lose money—don’t lose your stake, your
line. A speculator without cash is like a store owner with no inventory.
Cash is a speculator’s inventory, his lifeline, his best friend—
without it you’re out of business. Don’t lose your line!
3. Emotional control — Before 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?
It’s our nature.
You can’t tell if your judgment is right until you put your money on
the line. If you don’t 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
weakens—a body in motion tends to stay in motion—remember,
don’t buck the trend—don’t 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
cheap stocks alone!
• Use Pivotal Points to identify trend changes and confirmations in trends;
• Don’t 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 sitting—
the waitin’—not 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. Don’t 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 stock’s 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.
Don’t 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 wrong—cut 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 further—there 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 underway—it is a natural consolidation before the next
move upward. Be alert—major Pivotal Points can often be accompanied
by a heavy increase in volume.
At the end of a bull market, watch for wild capitalization, 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 Trading—follow the trend—check the main market. The
speculator must know the overall trend of the market before making a
trade—the 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 . . . don’t 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. Steel’s 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 groups — as 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.
Before 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 time—use 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
don’t look back or hesitate—sell 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.
Livermore 10 Percent Loss Table
Starting Position Amount % to
Lost Remainder % Loss Recover Loss
$1000 $ 80 $920 8.0 8.7
100 900 10.0 11.1
200 800 20.0 25.0
300 700 30.0 42.8
400 600 40.0 66.6
500 500 50.0 100.0
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 was—is—and always will be—king.
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:
Don’t be in a hurry. 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, 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 judgment—then 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.
• Protect your capital—use probing system to buy
• Observe the 10 percent bucket shop rule
• Keep cash in reserve
• Stick with the winners—let your profits ride—cut 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 tape—the
tape is the truth . . . seek harmony with the tape.
Don’t 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. Don’t 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 importantly—
never 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 sources—from 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 dangerous—take 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 emotions—don’t 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 speculator—but it’s
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
method — stick 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 didn’t 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 Webster’s 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 outcome—
not 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 knowledgeable 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. Livermore’s 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 doesn’t 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 market
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.
CONCLUSION
“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
Don’t concern yourself with why things are happening only observe
what is happening. The reasons why will eventually be
revealed to you—by 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
them—find out what went wrong with the trade and don’t 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 market—a deadly and dangerous
thing to do.
Don’t try and anticipate what the market will do next—simply go
with the evidence of what the market is telling you—presenting 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 timing — When to enter and when to exit a market trade–
when to hold ‘em when to fold ‘em, as Livermore’s friend and Palm
Beach Casino owner Ed Bradley used to say.
2. Money management — Don’t lose money—don’t lose your stake, your
line. A speculator without cash is like a store owner with no inventory.
Cash is a speculator’s inventory, his lifeline, his best friend—
without it you’re out of business. Don’t lose your line!
3. Emotional control — Before 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?
It’s our nature.
You can’t tell if your judgment is right until you put your money on
the line. If you don’t 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
weakens—a body in motion tends to stay in motion—remember,
don’t buck the trend—don’t 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
cheap stocks alone!
• Use Pivotal Points to identify trend changes and confirmations in trends;
• Don’t 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 sitting—
the waitin’—not 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. Don’t 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 stock’s 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.
Don’t 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 wrong—cut 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 further—there 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 underway—it is a natural consolidation before the next
move upward. Be alert—major Pivotal Points can often be accompanied
by a heavy increase in volume.
At the end of a bull market, watch for wild capitalization, 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 Trading—follow the trend—check the main market. The
speculator must know the overall trend of the market before making a
trade—the 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 . . . don’t 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. Steel’s 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 groups — as 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.
Before 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 time—use 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
don’t look back or hesitate—sell 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.
Livermore 10 Percent Loss Table
Starting Position Amount % to
Lost Remainder % Loss Recover Loss
$1000 $ 80 $920 8.0 8.7
100 900 10.0 11.1
200 800 20.0 25.0
300 700 30.0 42.8
400 600 40.0 66.6
500 500 50.0 100.0
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 was—is—and always will be—king.
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:
Don’t be in a hurry. 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, 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 judgment—then 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.
• Protect your capital—use probing system to buy
• Observe the 10 percent bucket shop rule
• Keep cash in reserve
• Stick with the winners—let your profits ride—cut 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 tape—the
tape is the truth . . . seek harmony with the tape.
Don’t 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. Don’t 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 importantly—
never 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 sources—from 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 dangerous—take 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 emotions—don’t 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 speculator—but it’s
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
method — stick 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 didn’t 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 Webster’s 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 outcome—
not 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 knowledgeable 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. Livermore’s 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 doesn’t 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 market
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.
CONCLUSION
“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
Labels: Reference, Risk Management, Stock Trading System
