Trading for a Living Read online

  Discussion: Once in a trend, your business is to stay in it, until you believe the trend has ended, the conditions have changed, and the market has turned. Yes, this means you will not be catching the last eight (or so) of the move, but there is no such thing as the perfect exit. The important thing is to get on board in strong trends, and get out only when they are over. You cannot catch every fluctuation, and you don’t have to.

  When to Exit a Trend

  “Never try to sell at the top. It isn't wise. Sell after a reaction if there is no rally.”

  Discussion: Here is how mature Livermore exited his position at the end of a trend (up trend, this case).

  He did not try to pick the top. He waited for a reaction in order to see if the trend resumed with a rally. If not, he got out. In other words, if the market made a lower low in an up trend, he sold.

  The Four Foundations of Successful Trading

  “Observation, experience, memory, and mathematics. These are what the successful trader must depend on. He must not only observe accurately but remember at all times what he has observed. He cannot bet on the unreasonable or on the unexpected, however strong his personal convictions may be about man's unreasonableness or however certain he may feel that the unexpected happens very frequently. He must bet always on probabilities that is, try to anticipate them. Years of practice at the game, of constant study, of always remembering, enable the trader to act on the instant when the unexpected happens as well as when the expected comes to pass.

  A man can have great mathematical ability and an unusual power of accurate observation and yet fail in speculation unless he also possesses the experience and the memory. And then, like the physician who keeps up with the advances of science, the wise trader never ceases to study general conditions, to keep track of developments everywhere that are likely to affect or influence the course of the various markets. After years at the game it becomes a habit to keep posted. He acts almost automatically. He acquires the invaluable professional attitude and that enables him to beat the game at times! This difference between the professional and the amateur or occasional trader cannot be over emphasised. I find, for instance, that memory and mathematics help me very much. Wall Street makes its money on a mathematical basis. I mean, it makes its money by dealing with facts and figures.”

  Discussion: The four foundations of successful trading, from the technical perspective, are observation, experience, memory, and mathematics. If any of these are absent, the trader has handicapped himself. They all contribute to trader’s ability to evaluate the market conditions accurately, and thus to make good trading decisions.

  Which of these is your strongest area? Which of these is the weakest? Where do you need to improve?

  Trade Probabilities

  “...the real joy was in the consciousness that as a trader I was at last on the right track. I still had much to learn but I knew what to do. No more floundering, no more half-right methods. Tape reading was an important part of the game; so was beginning at the right time; so was sticking to your position. But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities. In short, I had learned that I had to work for my money. I was no longer betting blindly or concerned with mastering the techniques of the game, but with earning my successes by hard study and clear thinking. I also had found out that nobody was immune from the danger of making sucker plays. And for a sucker play a man gets sucker pay; for the paymaster is on the job and never loses the pay envelope that is coming to you.”

  Discussion: Trading must be based on probabilities, and yes, it is hard work. Making ‘lazy trades’ will not make you rich. Success is earned.

  On Charting

  “I should say that a chart helps those who can read it or rather who can assimilate what they read. The average chart reader, however, is apt to become obsessed with the notion that the dips and peaks and primary and secondary movements are all there is to stock speculation. If he pushes his confidence to its logical limit he is bound to go broke. There is an extremely able man, a former partner of a well-known Stock Exchange house, who is really a trained mathematician. He is a graduate of a famous technical school. He devised charts based upon a very careful and minute study of the behaviour of prices in many markets stocks, bonds, grain, cotton, money, and so on. He went back years and years and traced the correlations and seasonal movements oh, everything. He used his charts in his stock trading for years. What he really did was to take advantage of some highly intelligent averaging. They tell me he won regularly until the World War knocked all precedents into a cocked hat. I heard that he and his large following lost millions before they desisted. But not even a world war can keep the stock market from being a bull market when conditions are bullish, or a bear market when conditions are bearish. And all a man needs to know to make money is to appraise conditions.”

  Discussion: A relevant quote in an age where most traders are addicted to charts and feel that’s all there is to trading. Livermore does not dismiss charting, but he criticizes reductionistic trading that considers nothing but the chart.

  To Livermore, the most important thing was what he called ‘the general market conditions’. In other words, being long in a bullish market, and short in a bearish one, and standing aside when the direction is not clear.

  Charting is great, but don’t limit yourself. Understand the context of price moves.

  Calling

  “I always had to or felt that I had to make my daily bread out of the stock market.”

  Discussion: Livermore felt that being a trader is a matter of an absolute conviction, one might even say a ‘calling’.

  Importance of Memory

  “That is how I first came to be interested in the behaviour of prices. I had a very good memory for figures. I could remember in detail how the prices had acted on the previous day, just before they went up or down. My fondness for mental arithmetic came in very handy.”

  Discussion: Being a good trader presupposes having a good memory. Whatever one’s favorite trading instrument may be, one should be able to ‘go back’ and think about price behavior in the past.

  Look for Parallel Cases

  “I noticed that in advances as well as declines, stock prices were apt to show certain habits, so to speak. There was no end of parallel cases and these made precedents to guide me. I was only fourteen, but after I had taken hundreds of observations in my mind I found myself testing their accuracy, comparing the behaviour of stocks to-day with other days. It was not long before I was anticipating movements in prices. My only guide, as I say, was their past performances. I carried the "dope sheets" in my mind. I looked for stock prices to run on form. I had "clocked" them. You know what I mean. You can spot, for instance, where the buying is only a trifle better than the selling. A battle goes on in the stock market and the tape is your telescope. You can depend upon it seven out of ten cases.”

  Discussion: Trading is about pattern recognition. Livermore read the patterns through the ‘tape’. In his day, the tape meant the price quotes. NO INDICATORS REQUIRED.

  Expect Nothing New

  “Another lesson I learned early is that there is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market to-day has happened before and will happen again. I've never forgotten that. I suppose I really manage to remember when and how it happened. The fact that I remember that way is my way of capitalizing experience.”

  Discussion: High-frequency trading, dark pools, co-location, and flash crashes. These make it hard to believe that there is ‘nothing new’. To use an oxymoron, ‘the only constant is change’. Markets evolve, however, and as they do, similar scenarios repeat.

  There are booms and busts, inside manipulation, and everyone is trying to gain an advantage over everyone else. Our tools have evolved, but the essence of the market has remained the same. The money of the weak is transferred to the accounts o
f the strong. In this sense, little has changed.

  Record Your Observations

  “I got so interested in my game and so anxious to anticipate advances and declines in all the active stocks that I got a little book. I put down my observations in it. It was not a record of imaginary transactions such as so many people keep merely to make or lose millions of dollars without getting the swelled head or going to the poorhouse. It was rather a sort of record of my hits and misses, and next to the determination of probable movements I was most interested in verifying whether I had observed accurately; in other words, whether I was right. Say that after studying every fluctuation of the day in an active stock I would conclude that it was behaving as it always did before it broke eight or ten points. Well, I would jot down the stock and the price on Monday, and remembering past performances I would write down what it ought to do on Tuesday and Wednesday. Later I would check up with actual transcriptions from the tape.”

  Discussion: Even with a good memory, it is good to track one’s observations about the market by writing them down. One of the most instructive exercises is to go back through your past records and see how you traded and thought about price action.

  Forget the Why

  “Of course there is always a reason for fluctuations, but the tape does not concern itself with the why and wherefore. It doesn't go into explanations. I didn't ask the tape why when I was fourteen, and I don't ask it to-day, at forty. The reason for what a certain stock does to-day may not be known for two or three days, or weeks, or months. But what the dickens does that matter? Your business with the tape is now not tomorrow. The reason can wait. But you must act instantly or be left. Time and again I see this happen.”

  Discussion: The reasons why the price moves the way it does are immaterial. As a trader, you are not paid to understand the reasons beyond price movements, but to trade when the conditions are favorable to your strategy.

  Stick to Your Plan

  “I didn't always win. My plan of trading was sound enough and won oftener than it lost. If I had stuck to it I'd have been right perhaps as often as seven out of ten times. In fact, I always made money when I was sure I was right before I began. What beat me was not having brains enough to stick to my own game that is, to play the market only when I was satisfied that precedents favored my play. There is a time for all things, but I didn't know it. And that is precisely what beats so many men in Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.”

  Discussion: Your plan is only as good as its execution. If you cannot stick to your plan, you are trading your feelings. Thus, discipline is the most crucial trading virtue.

  Livermore, though not a perfect example of a disciplined man, did his best to arrange his life in a way that was conducive to success. He went to bed at the same time every day. He followed a schedule. He disciplined himself. That’s what it takes to win.

  Don’t Trade for Excitement

  “Whenever I read the tape by the light of experience I made money, but when I made a plain fool play I had to lose. I was no exception, was I? There was the huge quotation board staring me in the face, and the ticker going on, and people trading and watching their tickets turn into cash or into waste paper. Of course I let the craving for excitement get the better of my judgment. In a bucket shop where your margin is shoestring you don't play for long pulls. You are wiped too easily and quickly. The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages."

  Discussion: To become a trader because ‘it is exciting’ is a recipe for disaster. Good trading is at times hard, other times boring, but not ‘exciting’.

  If you want excitement, go to Vegas and blow $100 on slots. It will be cheaper.

  Inner Game

  “A stock operator has to fight a lot of expensive enemies within himself.”

  Discussion: The enemies are within, not ‘out there’. They are your greed and fear. If you don’t eliminate them (more about that later), you have to pay them off. And that’s an expensive proposition.

  The Right Side

  “They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation.”

  Discussion: Don’t be attached to ‘long’ or ‘short’. Your opinion must be flexible.

  Most traders have a natural preference for either buying or selling. This a dangerous bias. For instance, if you prefer buying to selling, you should be careful not to keep buying when the market is bearish.

  Learn from Every Mistake

  “With me I must back my opinions with my money. My losses have taught me that I must not begin to advance until I am sure I shall not have to retreat. But if I cannot advance I do not move at all. I do not mean by this that a man should not limit his losses when he is wrong. He should. But that should not breed indecision. All my life I have made mistakes, but in losing money I have gained experience and accumulated a lot of valuable don'ts. I have been flat broke several times, but my loss has never been a total loss. Otherwise, I wouldn't be here now. I always knew I would have another chance and that I would not make the same mistake a second time. I believed in myself. A man must believe in himself and his judgment if he expects to make a living at this game.”

  Discussion: Mistakes are a part of the learning process. The key is not repeating the same one twice. Livermore liked to iterate this piece of advice because it is so crucial.

  Make a Strong Commitment

  “I went broke several times, and that is never pleasant, but the way I lost money is the way everybody loses money who loses money in Wall Street. Speculation is a hard and trying business, and a speculator must be on the job all the time or he'll soon have no job to be on.”

  Discussion: So much for ‘easy money’. It cannot be had in trading. Make a complete commitment or forget it. Nobody would dream of being a ‘casual surgeon’. Trading requires no less dedication.

  Expect the Unexpected

  “Everything happened as I had foreseen. I was dead right and I lost every cent I had! I was wiped out by something that was unusual. If the unusual never happened there would be no difference in people and then there wouldn't be any fun in life. The game would become merely a matter of addition and subtraction. It would make of us a race of bookkeepers with plodding minds. It's the guessing that develops a man's brain power. Just consider what you have to do to guess right.”

  Discussion: The unexpected is an essential part of the game. Notice that Livermore takes it in good humor.

  The only way to avoid the unexpected is not to trade. So make friends with it.

  Watch the Slippage

  “The ticker beat me by lagging so far behind the market. I was accustomed to regarding the tape as the best little friend I had because I bet according to what it told me. But this time the tape double-crossed me. The divergence between the printed and the actual prices undid me. It was the sublimation of my previous unsuccess, the selfsame thing that had beaten me before. It seems so obvious now that tape reading is not enough, irrespective of the brokers' execution, that I wonder why I didn't then see both my trouble and the remedy for it.”

  Discussion: Slippage (and accurate information) was an issue in Livermore’s time and it is today.

  What slippage are you getting on your orders? How accurate is the information on your screen? The beginner never asks this.

  The accuracy of information and minimum slippage are especially crucial if you day trade, as every tick matters a great deal. Long term, it can be the difference between success a
nd failure.

  Learn What Not to Do

  “There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!”

  Discussion: Is this a mere logical conundrum or a gem of wisdom?

  The truth is that the process of losing money is sometimes the best teacher at your disposal. Slowly, we eliminate habits and actions that make us lose. What remains is closer and closer to a viable and a profitable trading strategy.