Thursday, December 10, 2015

Richard Smitten's Observations on Jesse Livermore

Don't try to buy at the bottom and sell at the top. It can't be done except by liars.
Bernard Baruch

In his book "How to Trade Stocks" Richard Smitten talks about Jesse Livermore the man and his trading techniques (Available from Traders Press). Here are some of his observations about the legend Jesse Livermore.

He quickly learned that it was never what the brokers, or the customers, or the newspapers said — the only thing that was important was what the tape said. The tape had a life of its own, and its was the most important life. Its verdict was final. 

He learned to be interested only in the change in price, not the reason for the change. He had no time to waste trying to rationalize the action of the stock. There could be a million reasons why the price had changed. These reasons would be revealed later, after the fact. 

He knew that unless he actually purchased a stock, he could never know how he would handle himself. When a trader made a bet everything changed, and he knew it. Then and only then did the trader enter the heated jungle of emotions.. .fear and greed. You either control them or they control you. 

He worked alone.. .never telling anyone what he was doing, never taking on a partner. The thrill came from the winning, not the money, though the money was nice. 

He never blamed the market. It was illogical to get angry at an inanimate object, like a gambler getting mad at a deck of cards. There was no arguing with the tape. The tape was always right; it was the players who were wrong. 

His first conclusion was that he won when all the factors were in his favor, when he was patient and waited for all the ducks to line up in a row. That led him to his second conclusion, that no one could or should trade the market all the time. There were times when a trader should be out of the market, in cash, waiting. 

To speculate, a trader had to be a player, not a theorist, or an economist, or an analyst. A speculator had to be a player with money down on the table. It was not the coach or the team's owner who won the game, it was the players on the field — just as it was not the generals who won the battle, it was the grunts on the ground. 

You had to lose, because it taught you what not to do... his conclusions were developing from actual trading, from hands-on participation in the market and constant analysis. 

He never used the words bull market or bear market because these terms tended to make too permanent a psychological mind-set. 

Livermore was looking for the difference between stock gambling and stock speculation. Livermore's final conclusion was clear: To anticipate the market is to gamble; to be patient and react only when the market gives the signal is to speculate. 

The first step was to concentrate on the overall market before making a trade. He would follow the line of least resistance— up in a bull market, buy long, down in a bear market, sell short. If the market went sideways, he would wait in cash for a clear direction to be established.... He would not anticipate the market by guessing its direction... .Livermore had come to realize that the big money was in the big swings... .it is the big moves that make the big money. 

Livermore believed that stocks are never too high to begin buying or too low to begin selling short. Livermore believed that there was only one side of the market to avoid. He could be on the bull side or the bear side — it made no difference to Livermore — just as long as he was not on the wrong side. 

From experience, Livermore knew that one of the hardest things to do as a trader was to sell out a position early if he was wrong on the initial purchase and the stock moved against him. 

He did not care why things happened in the market, he cared only what happened every day when the market opened.... He observed that the market always did what it wanted to do, not what it was expected to do. 

Livermore had a steadfast rule that if something serendipitous, an unplanned windfall, should occur, he must capitalize on it and not be greedy — accept his good fortune and close out his position. 

Livermore loved the fact that in trading the market there was no end to the learning process. The game was never over, and he could never know enough to beat the market all the time. The puzzle could never be solved...he never considered himself a market master. He always considered himself a market student who occasionally traded correctly. 

Livermore had long ago realized that the stock market was never obvious. It was designed to fool most of the people most of the time. His rules were based on thinking against the grain: cut your losses quickly; let your profits ride unless there's a good reason to close out the position; the action is with the leading stocks, which change with every new market; new highs are to be bought on breakouts; cheap stocks are often not a bargain, because they have little potential to rise in price. The stock market is a study in cycles. It never goes up forever, nor does it go down forever, but when it changes direction it remains in that new trend until it is stopped. 

He considered it necessary to act like a poker player in his business, to never tip his hand or to react emotionally. Because of this inability and unwillingness to express his emotions, the stress on him was permanent. 

Timing was everything to a speculator. It was never if a stock was going to move; it was when a stock was going to move up or down. 

Livermore always considered time as a real and essential trading element. He often would say it's not the thinking that makes the money — it's the sitting and waiting that makes the money... .This has been incorrectly interpreted by many people to mean that Livermore would buy a stock and then sit and wait for it to move. This is not so. There were many occasions where Livermore sat and waited in cash, holding little or no stock, until the right situation appeared. He was able to sit and wait patiently in cash until the perfect situation presented itself to him. When conditions came together, when as many of the odds as possible were in his favor, then and only then would he strike. 

Livermore let the market tell him what to do, he got his clues and his cues from what the market told him. He did not anticipate, he followed the message he received from the tape. 

It's scary to think how much money Livermore would make if he traded today.. .his ability to read the tape when the tape wasn't even that reliable. He is in our opinion the best ever. Since the market is an extension of human psychology and human emotion and because people don't change, the market doesn't change. The players change; the underlying issues change; trading doesn't change, and that's why over 60 years after he committed suicide, Livermore's words of wisdom are still relevant.

Friday, December 4, 2015

Jesse Livermore Quotes

Don't try to buy at the bottom and sell at the top. It can't be done except by liars.
Bernard Baruch
Just prior to the Thanksgiving holiday I published Jesse Livermore's Money Management Rules Now let's carry that post forward and put together some of his best quotes from which we can all learn:
"...it is what people actually did in the stock market that counted — not what they said they were going to do." Livermore studied his mistakes objectively.. ."the only way you get a real education in the market is to invest cash, track your trade, and study your mistakes!"

It is emotionally difficult to review your mistakes, since the speculator must wade through his own bad trades and blunders. And these are not simple blunders; these are blunders that cost money. Anyone who has lost money by investing poorly knows how difficult it is to reexamine what occurred. The examination of a losing trade is tortuous but necessary to ensure that it will not happen again. Livermore was brutal in self-analysis. He told his sons his conclusions: "Successful trading is always an emotional battle for the speculator, not an intelligent battle."...  He knew that his biggest enemy was his own emotions. 

"We are the sum total of our experience." When asked what makes a good stock speculator, Livermore replied 
"...It's an aptitude for the game, a stomach for the ride, and the ability to see what is happening without emotion. The ability to make observations that others don't and a good memory... .Only speculate if you can make it a full-time job. don't take tips of any kind, no matter where they come from. don't worry about catching tops or bottoms, that's fools play. Keep the number of stocks you own to a controllable number. It's hard to herd cats, and it's hard to track a lot of securities. Take your losses quickly and don't brood about them. Try to learn from them but mistakes are as inevitable as death. And only make a big move, a real big plunge, when a majority of factors are in your favor....every once in a while you must go to cash, take a break, take a vacation. don't try to play the market all the time. It can't be done, too tough on the emotions."  
"The unsuccessful investor is best friends with hope, and hope skips along life's path hand in hand with greed when it comes to the stock market. Once a stock trade is entered, hope springs to life. It is human nature to be positive, to hope for the best. Hope is an important survival technique. But hope, like its stock market cousins ignorance, greed, and fear, distorts reason. See the stock market only deals in facts, in reality, in reason, and the stock market is never wrong. "
Traders are wrong. Like the spinning of a roulette wheel, the little black ball tells the final outcome, not greed, fear or hope. The result is objective and final, with no appeal. 
"I believe that the public wants to be led, to be instructed, to be told what to do. They want reassurance. They will 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 they want to be safely included within the herd, not to be the lone calf standing on the desolate, dangerous, wolf-patrolled prairie of contrary opinion." 
First, do not be invested in the market all the time. There are many times when I have been completely in cash, especially when I was unsure of the direction of the market and waiting for a confirmation of the next move....Second, it is the change in the major trend that hurts most speculators.
"The last gasp of heavy volume provides a great opportunity to sell out any illiquid large holdings. I knew it was foolish to ever catch the tops or the bottoms of the moves. It is always better to sell large holdings into an advancing market when there is plenty of volume. The same is true on the short side; you are best to cover the short position after a steep fast decline."...
the market will often go contrary to what speculators have predicted. At these times, successful speculators must abandon their predictions and follow the action of the market. Prudent speculators never argue with the tape. Markets are never wrong, but opinions often are.
"All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis." "Every stock is like a human being: it has a personality, a distinctive personality. Aggressive, reserved, hyper, high-strung, volatile, boring, direct, logical, predictable, unpredictable. I often studied stocks like I would study people; after a while their reactions to certain circumstances become more predictable." 
I believe that having the discipline to follow your rules is essential. Without specific, clear, and tested rules, speculators do not have any real chance of success. Why? 
"Because speculators without a plan are like a general without a strategy, and therefore without an actionable battle plan. Speculators without a single clear plan can only act and react, act and react, to the slings and arrows of stock market misfortune, until they are defeated." 
If you miss sleep at night because of your stock market position, then you have gone too far. If this is the case, then sell your position down to the sleeping level. 
"I believe that anyone who is intelligent, conscientious, and willing to put in the necessary time can be successful on Wall Street. As long as they realize the market is a business like any other business, they have a good chance to prosper." 
Remember, it [the market] is designed to fool most of the people most of the time. 
"...I have always fully understood that I am not the only one who knows that the stock market is the world's biggest gold mine, sitting at the foot of the island of Manhattan. A gold mine that opens its doors every day and invites anyone and everyone in to plum its depths and leave with wheelbarrows full of gold bars, if they can — and I have done it. The gold mine is there all right, and every day somebody plums it's depths, and when the bell rings at the end of the day they have gone from pauper to prince, or gone from prince to supreme potentate, or gone stony broke. And it's always there waiting." 
"I believe that uncontrolled basic emotions are the true and deadly enemy of the speculator; that hope, fear, and greed are always present, sitting on the edge of the psyche, waiting on the sidelines, waiting to jump into the action, plow into the game." 
These words [bullish, bearish] are not in my vocabulary because I believe they can create an emotional mind-set of a specific market direction in a speculator's mind. 
"I never try to predict or anticipate. I only try to react to what the market is telling me by its behavior." 
"I believe there are no good stocks or bad stocks; there are only money making stocks. So there is no good direction to trade, short or long; there is only the money-making way to trade." "Greed, fear, impatience, and hope will all fight for mental dominance over the speculator." 
"My satisfaction always came from beating the market, solving the puzzle. The money was the reward, but it was not the main reason I loved the market. The stock market is the greatest, most complex puzzle ever invented — and it pays the biggest jackpot... .it was never the money that drove me. It was the game, solving the puzzle, beating the market that had confused and confounded the greatest minds in history. For me, that passion, the juice, the exhilaration was in beating the game, a game that was a living dynamic riddle, a conundrum to everyone who speculated on Wall Street." 
Always remember; you can win a horse race, but you can't beat the races. You can win on a stock, but you cannot beat Wall Street all the time. Nobody can.

Thursday, November 19, 2015

Jesse Livermore's 5 Money Management Rules

Money management has been a profession involving a lot of fakery - people saying they can beat the market, and they really can't.
Robert J. Shiller

A few years ago, maybe even a decade ago, I copied down a message board posting about Jesse Livermore, Posted by an experienced trader. If you are an aspiring trader, even an experienced one, you must read about this man, he should be your hero. 

1) Don't lose money. Don't lose your stake. A speculator without cash is like a store-owner with no inventory. Cash is your inventory, your lifeline, and your best friend. Without cash, you are out of business. Don't lose your line. There is no place in speculating for hoping, for guessing, for fear, for greed, for emotions. The tape tells the truth. 

2) Always establish a stop. A successful speculator must set a firm stop before making a trade and must never sustain a loss of more than 10 percent of invested capital. I have also learned that when your broker calls you and tells you he needs more money for a margin requirement on a stock that is declining; tell him to sell out the position. When you buy a stock at 50 and it goes to 45, do not buy more in order to average out your price. The stock has not done what you predicted; that is enough of an indication that your judgment was wrong. Take sour losses quickly and get out. Remember, never meet a margin call, and never average losses. Many times I would close out a position before suffering a 10 percent loss. I did this simply because the stock was not acting right from the start. Often my instincts would whisper to me: "J.L., this stock has a malaise, it is a lagging dullard. It just does not feel right," and I would sell out of my position in the blink of an eye. I absolutely believe that price movement patterns are repeated and appear over and over with slight variations. This is because humans drive the stocks, and human nature never changes. Take your losses quickly. Easy to say, but hard to do. 

3) Keep cash in reserve. The successful speculator must always have cash in reserve.. .for exactly the right moment. There is a never-ending stream of opportunities in the stock market and, if you miss a good opportunity, wait a little while, be patient, and another one will come along. J.P. reach for a trade, all the conditions for a good trade must be on your side. Remember, you do not have to be in the market all the time. The desire to always be in the game is one of the speculator's greatest hazards. When playing the stock market, there are times when your money should be waiting on the sidelines in cash.. .waiting to come into play. Time is not money — time is time, and money is money. Often money that is just sitting can later be moved into the right situation at the right time and make a fast fortune. Patience is the key to success, not speed. Time is a cunning speculator's best friend if it is used wisely. 

4) Let the position ride. As long as the stock is behaving normally, do not be in a hurry to take a profit. You must know you are right in your basic judgment, or you would have no profit at all. If there is nothing basically negative, then let it ride. It may grow into a very large profit. As long as the action of the overall market and the stock do not give you cause to worry, have the courage of your convictions, and stay with it. When I was in a profit on a trade, I was never nervous. Of course the opposite is true as well. If I bought a stock and it went against me I would sell it immediately. You can't stop and try to figure out why a stock is going in the wrong direction. The fact is that it is going in the wrong direction, and that is enough evidence for an experienced speculator to close the trade. I do not and never have blindly bought and held a stock. To buy and hold blindly on the basis that a stock is in great company or a strong industry, or that the economy is generally healthy, is, to me the equivalent of stock market suicide. Stick with the winners. Let them ride until you have a clear reason to sell. 

5) Take the profits in cash. I recommend parking 50 percent of the profits from a successful trade, especially when the trade doubled the original capital. Set the money aside, put it in the bank, hold it in reserve, or lock it up in a safe-deposit box. Like winning in the casino, it's a good idea, now and then to take your winnings off the table and turn them into cash... .the single largest regret I have ever had in my financial life was not paying enough attention to this rule.

Thursday, November 12, 2015

Just Stand Aside Awhile or is it Time to Give Up?

Our greatest weakness lies in giving up. The most certain way to succeed is always to try just one more time.
Thomas A. Edison
Have you ever heard a market trader state: "It's all a sham; there's no way to make money in the markets. There are just too many roadblocks. The odds are against you all the way?" If you have stated this or something similar to yourself it is apparent you are ready to quit, find a new profession. However it is at times like this that you must be resilient, it is not a time to brood. 

If someone tells you that trading the markets is easy, they are kidding you or themselves or both.
Trading is not easy; there is no Holy Grail, no quick and dirty way to make profits. If there were everyone would be trading the markets, now wouldn't they?  Who would be left to do all the rest ofthe worlds work? If you want to become a successful trader it is going to take sacrifices, commitment,and just plain hard work. Until you have become skillful and experienced the odds are indeed against you. If you approach trading as an amateur hobbyist you will come to believe it is all a sham. You will begin to convince yourself that trading just is not worth it; you will be finding reasons to just give up. If this is the way you are approaching trading and you are experiencing setbacks; it's decision time. Are you going to commit to doing the work required? If not then it is probably wise to give up and walk away.

That said, it is often hard to stay upbeat. There are times when nothing seems to click. Your trading strategies are not working, or you may have trouble getting an accurate read on the markets. This is a very common ailment. Depending on your past experience, there are times when the market does not seem to behave in the way you anticipate. Market conditions change, and unless you have a wealth of experience, you may simply not be familiar with the factors that are driving market action. It may just be a matter of standing aside until market conditions change. It becomes necessary to weather the storm.

Winning traders view unfavorable market conditions as a learning opportunity, a time to gain even more market experience. They objectively study the markets, trying to understand how the market moves and why. It is a time to think creatively and hone trading skills. It is at times like these that it is time to stand up and cultivate a fighting spirit. Instead of quitting; why not just rest awhile. It is all right to take a break. Even the most successful trader feels a little burned out at times. By resting, relaxing, and rejuvenating, you will find the strength to muster enough enthusiasm to tackle the markets again. And this time, you may find that the obstacles that once seemed insurmountable are now just minor bumps in the road to success. 

After you have taken your rest, review your plan and your risk management techniques, build up enough trading capital: only then should you address the psychological side of accepting losses. Begin to refute assumptions about risk and loss. Make a list of justifications that you can read after you have lost: "Losses are a business expense. It is like a personal investment in your trading business. It is like paying tuition in order to learn important trading lessons." These sayings may not work at first. It is hard to change over night. Practice! That's why you should actually write down these sayings about losses, and read through the list when you feel guilty about a loss. 

Trading often is emotionally draining, and if you are not careful, you can feel beaten and ready to quit. But rather than search for a way out, remember the reasons to stay. If you persist, gain as much experience as possible, and hone your trading skills, you will achieve enduring financial success.

Thursday, November 5, 2015

The Power of Compounding (Developing Your Plan IV)

The time to save for the future is now. Thanks to compounding interest, the earlier you start putting money away for the future, the more you will save.
Alexa Von Tobel

Unfortunately many traders and investors do not understand the simple concept of compounding. Their plan is written with goals that are blatantly unrealistic. The plans and the goals are more of a hope than a plan. If I can make X dollars then I can tell my boss where to go and live the good life. Whatever they perceive that good life to be.

Realistically you should understand the power of compounding; this basic principle is
essential in helping you initially set your goals, and keep them realistic. You can now work backwards from your end game to your current situation and plan. For instance if you invested $10,000 today at X% returns ( here is a Calculator) what would that $10,000 would be worth 3,5,10 and 20 years hence?

It should not surprise you that the higher the return, the higher the potential risks. What is your risk tolerance (how much of that risk capital can you afford, not only financially, but psychologically as well) to risk in order to attain your financial goals? I cannot overestimate the psychological part. It’s very easy to say I am willing to risk X% to make Y, but are you really psychologically ready? As an example and a true story; I once had a client referred to me when I was a commodities trader. He listed his net worth at $50 million exclusive of his home (this is 1970s dollars). I had thought I explained everything involved to both our satisfactions I evidently did not. I purchased for him one contract of an agricultural commodity. The market closed that day and he had a loss, on paper, of $200.

The next morning I received a call from this individual only to find out he couldn’t sleep the
night before because of the paper loss. Luckily I suppose, that market opened higher the next morning eradicating that minor loss and the position was liquidated. While this is obviously an extreme example it illustrates the point; your psyche and risk tolerance can and will affect how you go about things as it should. If you are risk averse, admit that to yourself. It merely changes how you go about trading/investing it doesn’t eliminate your trading/investing plan.


Before continuing; take the time to do some self-analysis. This is not an easy task; self- analysis rarely is. It will be time well spent. Keep a log, and in it write where you wish to be financially 3, 5, 10, and 20 years hence. How much capital do you have now, how much of it is risk capital, and how much can you contribute to the goal on a monthly or annual basis?

Your trading capital should be capital that you can afford to lose. I did not say be happy to lose, but if you lost it or a majority of it, your current lifestyle would not be affected, and in your opinion, the capital can be replaced within a reasonable period of time 

Thursday, October 29, 2015

The How, Why, & What (Developing Your Plan III)

We must all suffer one of two things: the pain of discipline or the pain of regret or disappointment.
Jim Rohn

Now that you have your life and financial goals written out, the how to attain them begins. There are numerous ways to go about attaining these financial goals. It would be impossible to list them all, in these short dissertations. I will talk today of your investment and/or trading plan, which may be but one part of your overall plan. Other parts might be furthering your education to get a better job, or starting your own business.

If your intention is to trade the markets try and remember; investing/trading is a business, no different than if you were to start any new business, such as opening a store front or
other business on your own, to attain those goals.

Write out a Statement of purpose....

  • Why do you want to trade and invest in the stock market? • What do you hope to gain
    from trading?

  • What are your trading goals?
  • How do you plan on becoming a better trader?
  • How are you going to use your trading plan?
  • Clearly define your purpose for trading and investing.
State your goals and what you hope to gain and achieve through trading.

These questions might contain statements such as: I believe the markets to be the best place to utilize my speculative capital. I can attain a return on capital that is superior to other forms of investment, i.e. starting a business, investing in a business or just fixed income securities. I’m sure I can reach my goals sooner utilizing the markets.

List everything that you can think of at the moment that will help you achieve those financial goals. Then cull that list after it’s written down. Take your time, this is not something you should rush, opportunities will always be around. If you focus your attention you will spot them with more ease than if you ignore these steps.
I know it sounds like a lot of work and it is, however once completed it will pay enormous dividends over time 

Thursday, October 22, 2015

Developing Your Plan II

When it is obvious that the goals cannot be reached, don't adjust the goals, adjust the action steps.
Confucius
Financial Goals

Goal setting is a standard methodology used by business-people, top-level athletes, and achievers in all fields. It gives you long-term vision and short-term motivation. Goals will focus you on your acquisition of knowledge and help you organize your resources.
  • Goals help you decide what is important for you to achieve in life / as well as in your
    investments.


  • Goals separate what is important from what is not. Goals once crystallized in your mind, motivate you to achieve them. • Goals help build self-confidence based on measured achievement.

  • Goals need to be complete and focused, much like a road map. Remember the difference between a dream and a goal is the written word, the map to get there
    .
  • Make sure the goals you are working for are things that you really want, not just something that sounds good.

  • Develop goals in all areas of life. Be precise; set precise goals, that you can measure your achievement against. • State each goal as a positive statement.

  • Set priorities: where you have several goals, give each a priority.

  • Write your goals down; this crystallizes them and gives them more meaning and force.

    Without financial goals and specific plans for meeting them, you will drift along, leaving your future to chance. The first step in determining financial goals is to determine your long term goals first.

    Identify and write down your longer term financial goals, these goals could be such things as saving to send your kids to college, buying a new car, saving for a down payment on a house, going on vacation, paying off credit card debt, planning for retirement or anything else that will probably take years to accomplish. 

    Most people have fewer long-term goals but they are lofty in size and require disciplined commitment. These goals are often achieved by:

  • Adopting a practical lifestyle that stays within your means

  • Investing cash from your earnings each month, quarter, or year • Investment
    education to instill the confidence

  • The discipline to continue investing regularly 

Break each financial goal down into several short-term (less than 1 year), medium-term (1 to 3 years) and long-term (5 years or more) goals. Work on formulating these goals (for you...not what someone else may think). 

Thursday, October 15, 2015

Developing Your Plan

If you don't design your own life plan, chances are you'll fall into someone else's plan. And guess what they have planned for you? Not much. 
Jim Rohn
While it seems that every investing and trading web site or blog thinks they have all or many of the answers necessary, for you to make money, nothing could be further from the truth. And that includes this site “The Prudent Trader” Why do I say that? Simply, because we are all different, we all have different time frames upon which we operate, we are at

different stages of emotional development for the markets, differing financial conditions, different risk tolerances, different methods of operation, and different trading psyche’s to mention just a few.

If you believe that to be true, then there is no one method or system, pundit or guru recommendation, that is suitable for all. You as an individual must put together a plan suitable to you and you alone. Fail to make a plan and you plan to fail. You are not reading this because you are planning to fail.

I hope you enjoy and perhaps pick up a thing or two that will aid you’re investing and trading in the future. A trading plan should be unique to you and no one else. My trading plan or the plan of some well-known investor/trader is in all probability not suitable for you.Before developing a trading plan you must have an overall “Life plan” of which trading/ investing is but a part.

There is an old saying in business: "Fail to plan and you plan to fail." That may sound like just a slick saying however, if you are serious about being successful you should follow those eight words as if they were written in stone. Ask any successful trader and they will tell you, "You have two choices: you can either methodically follow a written plan, or fail."If you have a written trading or investment plan, congratulations! You are in the minority.

It should be understood that having a plan is not a guarantee of success. What a plan does is eliminate one of the major roadblocks. Even if you have a plan, if it utilizes flawed techniques or lacks preparation, your success will not come immediately, however you will be able to modify your course by documenting, learning what works and perhaps most importantly avoid repeating costly mistakes.

While no one has all the answers, and volumes could be written on the subject, I hope this short series will guide you and I also hope you will begin thinking for yourself.
Initially, most novice investors, perhaps unknowingly, adopt a "seat of the pants" approach.
They act in a variety of ways; a hot tip; a magazine or newspaper article; a recommendation from a friend; or perhaps TV commentaries or analyst recommendations. Often they are most anxious to buy after stocks have already risen substantially and the economic outlook is the rosiest. However, quite often this is the time to be selling your stocks and not buying them.

Why a management plan? A plan is simply a road map that will take you where you are looking to go. If you do not know where you are going, ask yourself, "How are you possibly going to get there?" Every business has a plan. Every professional has a plan. An investor or trader needs a plan too. Imagine for a moment building your house without a plan ---- I am sure people would come from miles away, just to see!

Thursday, October 1, 2015

Always Manage Risk

I have learned that nothing is certain except for the need to have strong risk management, a lot of cash, the willingness to invest even when the future is unclear, and great people.
Jeffrey R. Immelt
As traders there is probably nothing more thrilling than correctly anticipating the markets or a particular stock and making a huge profit off the trade. You feel on top of the world. After a good winning streak it is very tempting to let lose and start making some big trades, after all, you are invincible, at least for now. Although you should take advantage of a hot streak when you hit upon one, you must avoid acting recklessly, it can destroy you. I have
personally seen it too many times, the "BIG idea". Because we are hot and we sense a big move coming, instead of following our plan, our proper position size, we decide to risk it all. We buy as many shares or contracts, as we have dollars in our account, and margin it to boot. The market goes against us, but we feel OK because we are hot, and we know we are right. The market will soon realize that we are right. I don't have to finish this because you know where it leads, at least I hope you do. Even when on a hot streak, you must, for long-term survival maintain discipline and manage risk. 

After making a series of winning trades, you want to celebrate; you should. However, you must avoid thinking, "What do I have to lose? I'm far ahead of the game. I can take a little more risk." What is the harm of taking big risks I'm way ahead? The problem is you really do not know that your next set of trades will be wins, and when you take unnecessary chances, it is as if you are working under the assumption that you will tend to win in the future. No one has a crystal ball! Trading is about taking advantage of probabilities. From the perspective of probability theory, it is possible that you will continue to win, and by making larger trades and lowering your limits, you will reap big rewards. But in all likelihood, the next series of trades may be losers. If you don't continue to manage your risk, you'll tend to give back all your profits and more. 

One may not fully consider the realistic possibility that a losing trade is on the horizon. It is important that you maintain a little skepticism, though. It is nice to feel you are running hot, but remember that your hot streak may end as quickly as it started. Never let your guard down. Always be prepared for your luck to change. An unexpected defeat is often more devastating than an expected probable setback, always be ready for a potential loss. By remembering that a loss is always possible, and that it is not a big deal, you will be prepared, and won't be fazed when it happens. 

Managing risk is a trader's secret weapon. Do not take unnecessary chances. Trading is a game of survival. Sure, you must make big profits while you are running hot, but you must avoid mounting huge losses when you are running cold. Do not be caught off guard. Consider every possibility. Continue to manage risk. It can go a long way in helping you stay profitable in the long run.

Thursday, September 24, 2015

Don't Quit

Quitting is the easiest thing to do.
Robert Kiyosaki
A few years ago I copied down a poem called "Don't Quit". One of the lines; "stick to the fight when you're hardest hit - It's when things seem worst that you mustn't quit.

Most often when plans go awry, all we can think of is our conditions worsening. However, it is usually at this time that our greatest growth can occur, if we see the moment as a growth opportunity. If we see it as a time to learn how to control our thoughts towards the ends we desire.

With the market volatility and whipsawing accounts many are experiencing these days I thought it apropos: 


Don't Quite

When things go wrong as they sometimes will, 
When the road you're trudging seems all uphill. 
When the funds are low and the debts are high, 
And you want to smile, but you have to sigh. 
When care is pressing you down a bit, 
Rest if you must, but don't you quit.

Life is queer with its twists and turns,
As everyone of us sometimes learns. 
And many a fellow turns about, 
When he might have won had he stuck it out.
Don't give up though the pace seems slow, 
You may succeed with another blow. 


Often the goal is nearer than 
It seems to a faint and faltering man. 
Often the struggler has given up, 
When he might have captured the victor’s cup. 
And he learned too late when the night came down, 
How close he was to the golden crown. 
Success is failure turned inside out, 
The silver tint of the clouds of doubt. 
And you never can tell how close you are, 
It may be near when it seems afar. 
So stick to the fight when you're hardest hit, 
It is when things seem worst that you mustn’t quit. 

Thursday, September 17, 2015

Concentrate On The Big Picture

Details create the big picture.
Sanford I. Weill
When you're having a tough time of it, it is easy to get bogged down. You find yourself thinking totally about the current trade you are about to make; you desperately want it to be a winner. Instead concentrate on the big picture. Especially at times like this it's important to remember that this is merely one trade among the many you will make, and the outcome of a single trade is not relevant to the total picture of your trading account. All that is important is at the end of your accounting period, across a series of trades that you come out ahead. When you are in a slump looking at the big picture can do a lot to make you feel better, and when you're feeling better your better apt to make that trade.

BigPictureWhen you are looking at the big picture, think in terms of probabilities. Across a series of trades, if you are following a sound trading plan with sound money management and risk parameters you will need only one in three to be successful in order to be successful overall. Unfortunately when we trade we do not win one and lose two then win again. In the real world we may lose 5 in a row, then profit on 3 of the next four, then 4 of the next eight and so on. But if we are overall winning one in three we should be just fine (Review Money & Risk Management ). So maybe you've lost four in a row and the next will be number 5, but in the big picture we find we are doing just fine. In fact a very good friend of mine, we were brokers together, used to cheer out loud when he took a loss, he would say hey I'm getting closer to a big win 
In a purely mathematical sense, it isn't possible to estimate the odds that a trading strategy
is expected to produce a win, since the strategy cannot be repeated an infinite number of times under the exact same conditions. The best we can do is use historical data to see how well the trading strategy worked in the past, and assume it will work in the future when similar market conditions occur. 

Ideally, historical data should provide evidence that your strategy will give you enough of an "edge" to come out ahead. Since you never really know how well a trading strategy will work until you try it under current market conditions, it is extremely important to control risk.
Unless you control risk, then a single trade may actually be quite significant. It's a good idea however, to minimize the significance of a single trade in terms of your overall capital so that it won't hurt very badly should it go sour. By managing risk and trading high quality setups, you can more easily think in terms of probabilities. That is, a single trading outcome will actually be minimal compared to a large set of outcomes. From a purely psychological sense, think of outcomes as just one among a series. It will take some of the pressure off of you. You will not tend to think that every trade needs to be a winner, which can be very stressful, and you will be more relaxed if you look at the bigger picture.

Thursday, September 10, 2015

Dealing With The Unexpected

To expect the unexpected shows a thoroughly modern intellect.
Oscar Wilde

Experienced, winning traders try to stay in control by not letting their emotions influence their decisions even when the unexpected crops up. It is quite normal when we are caught off guard to react emotionally, that is human nature, however, one of the best ways to handle getting caught off guard is to remain calm and logical, which in turn will reduce our psychological stress. 

Trading in and of itself is stressful. With each trade your money is on the line and you are aware that you may have to deal with a loss and perhaps a blow to your ego. You have to take it all in stride and not allow yourself to be overwhelmed by it all. Feeling flustered is very natural but you need to reduce as much background stress as is humanly possible. When background stress is great, even a minor setback can set you off. Instead of flying off the handle prematurely, it is better to reduce background stress, and thus, increase your ability to handle unanticipated events. 

In addition to managing background stress, it is also important to anticipate as many possible adverse events as possible. It is impossible to anticipate everything that can go wrong, but the more you can specify what can go wrong, and have a plan to deal with it, the more you'll be able to handle the event when it happens. For example, be aware that earnings reports, rate hikes, or major political events can impact the markets and play havoc with your trading plan. If you get caught off guard, you may not handle the situation very well. You may get overly angry or frustrated, and act on impulse, rather than calmly and rationally. But if you decide beforehand how you will deal with the event, you'll react more decisively. 

Being on-guard and ready to take action, and you will get through unanticipated adverse events without getting bogged down by them. The more you can reduce background stress and react to unanticipated events decisively, the more profitably you will trade in the long run.

Thursday, August 20, 2015

When You're Hot You're Hot

Almost everyone's instinct is to be overconfident and read way too much into a hot or cold streak.
Nate Silver

No matter who you are, there are times when you just aren't functioning at the top of your game. You try and put on a trade, but your heart just isn't in it. What do you do? Do you continue on and hope for the best or stand aside and wait before tackling the markets again? As a general rule it's usually a good idea to stand aside.


If you are a music fan you may remember the 1971 song by Jerry Reed "When you're hot you're hot". The verse of the song is: "When you're hot, you're hot. And when you're not, you're not". My father (one of my hero's) loved that song and used to tell me remember those words for that is how life is! He was a salesman much of his life and used to tell me most sales people do it backwards, they make a sale in the morning, then take the rest of the day off to go fishing, play golf, whatever. He told me no, no, this is when you work harder than ever because you're hot, so try and pile up the sales for when things go bad and go bad they will. It is when things are not going well that you take a day or two off, go fishing or play golf, or whatever to clear your head of the cob webs, then begin again. Sage advice!

At first glance, this advice may seem counterintuitive. Throughout our lives, we've been told over and over, "At first if you don't succeed, try again." It may be necessary to try again, but it may not be a good idea to try again when you aren't ready. Give yourself a break. Your body and mind have limits. When you are feeling low, a lot of your mental energy is spent so that no one will suspect you're in a slump. If you broke your leg, you wouldn't try to jog two miles a day. You would stay off your feet until you recovered. If you had a high fever, you wouldn't jump in a cold pool and swim a few laps. When physically ill, your body can't take it. You would end up feeling worse when it was all over. It is vital that you rest and recover Similarly, when you're not feeling up to par, and have wavering confidence, it's wise to say out of the markets until you are feeling better.


A common mistake is to ignore your feelings and just push yourself to keep going. When you are a seasoned trader who is not feeling very badly, this may work. But if you are relatively new to the trading profession and are feeling down, you will find that the harder you push yourself, the more you'll feel let down and frustrated. Instead of pushing yourself beyond your limits, calm down, rest and cultivate a fighting spirit.


It may seem unproductive to take a break when feeling in a slump. But it works. Don't fall for the conventional view of success as making huge profits even when you aren't psychologically fit. It's better to work at your own pace, and focus on the process of trading. If you hone your skills in a calm yet deliberate manner, and take breaks when your psychological energy or confidence is depleted, you come back with a tough, fighting spirit that will help you achieve lasting success.

Articles will resume after Labor Day!
Reprint from PrudentTrader Archives 2006

Thursday, August 13, 2015

Emotional Influences on Trading Decisions

I'm not emotional about investments. Investing is something where you have to be purely rational and not let emotion affect your decision making - just the facts.
Bill Ackman

Greed and fear, do they play a roll in your market decisions? When we fear a potential loss, we sell. When we are greedy, we buy or buy too much. It is a little more complicated though. Regret and hope also play a roll. People may trade in or out to avoid feelings of regret or may hold on to losing positions out of denial and a hope that the loser will turn around. Emotions play a powerful role in decision making.


Dr. Jennifer Lerner of Carnegie Mellon University conducted a series of studies on how emotional states influence trading decisions. In one study it was shown that people who experience intense levels of anger tend to be willing to accept greater risks. Anger is experienced when we feel unfairly treated or we have been slighted. If you take things too personally it's easy to feel slighted by the markets when they don't go our way. To gain control we get angry. We fight back and enact our revenge. When this occurs we act out of desperation and often take on risks that we shouldn't.


In another study reported in "Psychological Science," Dr. Lerner and her colleagues showed that emotional states that have nothing to do with a financial issue might have a subtle impact on a subsequent economic decision. Participants watched films that made them feel one of two emotions, sadness or disgust. The movies had absolutely nothing to do with business or decision-making. The first film was about a loved one passing away, while a second film was about a man using an unsanitary public toilet. Participants were subsequently asked to estimate the value of a possession while in either a sad or disgusted emotional state. At the start of the experiment, participants were given a pen and asked to hold on to it. After the emotional states were elicited, participants were asked to estimate the value of the pen if they were to sell it. In some ways, you might see how this is analogous to holding a position and determining how much the price of the stock needs to move before you would be willing to sell. In contrast to participants in a neutral mood, participants who were incidentally disgusted or sad greatly underestimated the value of the pen; neutral participants estimated its value as about $4.50, while sad and disgusted participants put its value at about $3.00. The interesting aspect of this study is that there was no obvious connection between the emotional state and the financial decision to sell. It would be as if you watched a sad television show right before the open, and for no good reason whatsoever, under-valued a position and immediately sold too early. One event should have nothing to do with the other, yet in Dr. Lerner's study feeling sad or disgusted influenced a subsequent economic decision.


Ideally, it would be nice if we could trade with a totally objective, disconnected and purely logical mindset, but we are merely humans. The impact of common emotions of fear, greed, hope, and regret may seem obvious to many. Realize, it's possible that incidental emotions that have nothing to do with the markets may have an influence on our decisions. It just goes to show that trading is in many respects a pure psychological endeavor. The more you can stay logical and objective, the more you'll trade profitably.


Reprint from PrudentTrader archives 2005