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Trading Psychology

  
  Education
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Your biggest enemy, when trading, is within yourself. Success will only  come when you learn to control your emotions. Edwin Lefevre’s

 Reminiscences of a Stock Operator (1923) offers advice that still applies  today.

 Caution
 Excitement (and fear of missing an opportunity) often persuade us to enter the market  before it is safe to do so. After a down-trend a number of rallies may fail before one  eventually carries through. Likewise, the emotional high of a profitable trade may blind  us to signs that the trend is reversing.

 Patience
 Wait for the right market conditions before trading. There are times when it is wise to  stay out of the market and observe from the sidelines.

 Conviction
 Have the courage of your convictions: Take steps to protect your profits when you see  that a trend is weakening, but sit tight and don’t let fear of losing part of your profit  cloud your judgment. There is a good chance that the trend will resume its upward  climb.

 Detachment
 Concentrate on the technical aspects rather than on the money. If your trades are  technically correct, the profits will follow.

 Stay emotionally detached from the market. Avoid getting caught up in the short-term  excitement. Screen-watching is a tell-tale sign: if you continually check prices or stare at  charts for hours it is a sign that you are unsure of your strategy and are likely to suffer  losses.

 Focus
 Focus on the longer time frames and do not try to catch every short-term fluctuation.  The most profitable trades are in catching the large trends.

 Expect the unexpected
 Investing involves dealing with probabilities ? not certainties. No one can predict the  market correctly every time. Avoid gamblers? logic.

 Average up – not down
 If you increase your position when price goes against you, you are liable to compound  your losses. When price starts to move it is likely to continue in that direction. Rather  increase your exposure when the market proves you right and moves in your favor.

 Limit your losses
 Use stop-losses to protect your funds. When the stop loss is triggered, act immediately  – don’t hesitate.

 The biggest mistake you can make is to hold on to falling stocks, hoping for a recovery.  Falling stocks have a habit of declining way below what you expected them to.  Eventually you are forced to sell, decimating your capital.

 Human nature being what it is, most traders and investors ignore these  rules when they first start out. It can be an expensive lesson.

 Control your emotions and avoid being swept along with the crowd. Make consistent  decisions based on sound technical analysis.

The Virtue of Patience

  
  Education
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patienceWaiting for the right opportunity increases the probability of success. You don’t always have to be in the market. As Edwin Lefevre put it in his classic Reminiscences of a Stock Operator, “There is the plain fool who does the wrong thing at all times anywhere, but there is the Wall Street fool who thinks he must trade all the time.”
One of the more colorful descriptions of patience in trading was offered by Jim Rogers in Market Wizards: “I just wait until there is money lying in the comer, and all I have to do is go over there and pick it up.” In other words, until he is so sure of a trade that it seems as easy as picking money off the floor, he does nothing.

Six trading lessons from speculator Jesse Livermore

  
  Education
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Stock operator’s reminiscences useful in today’s market

If you ask traders to choose the most influential trading book, more than likely, they’ll mention Reminiscences of a Stock Operator by Edwin LeFevre. This book describes the experiences of one of the world’s greatest stock speculators, Jesse Livermore.

Many of the anecdotal lessons included in the book are well known to experienced traders. For example: the market is always right; don’t over-trade; never argue with the tape; use stop losses, and always trade with the primary trend of the market.

Almost anyone can learn the mechanics of trading. It’s the psychological pitfalls that make trading one of the most challenging activities. No matter your skill level, it’s important to remember and obey the rules of engagement — another word for discipline.

With that in mind, this book contains dozens of important lessons. Here are a few of my favorites:

1. Learn how to lose

Livermore (speaking through the fictional character of Larry Livingston) complains how he’s made a series of trading mistakes that cost him a lot of money, although he wasn’t completely wiped out. The losses, he admits, were painful but educational:

“There is nothing like losing all you have in the world for teaching you what not to do,” he says. “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.”

After going broke three times in less than two years, Livermore has this advice: “Being broke is a very efficient educational agency.” He says that you learn little from your winners because they often take care of themselves. It’s the losers that will teach you lessons to last a lifetime. And as long as you don’t make the same mistake twice, you always have the opportunity to trade another day. (more…)

Two quotes from :REMINISCENCES OF A STOCK OPERATOR

  
  Education
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Doing The Right Thing

The professional concerns himself with doing the right thing rather than with making money, knowing that the profit takes care of itself if the other things are attended to. A trader gets to play the game as the professional billiard player does—that is, he looks far ahead instead of considering the particular shot before him. It gets to be an instinct to play for position.

Price Tendency

You watch the market—that is, the course of prices as recorded by the tape—with one object: to determine the direction—that is, the price tendency. Prices, we know, will move either up or down according to the resistance they encounter. For purposes of easy explanation we will say that prices, like everything else, move along the line of least resistance. They will do whatever comes easiest, therefore they will go up if there is less resistance to an advance than to a decline; and vice versa.

Ten Anecdotal/Historical Book Ideas for Investors

  
  Education
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About a month or so ago, I finally got around to reading Marty Schwartz’s classic, Pit Bull, which I can best describe as a colorful autobiography that uses the 1980s options world as a palette for many amusing anecdotes that are expertly conveyed. The book was such a fun read that I went through the whole thing in no more than 2-3 days, cobbling together bits and pieces of ‘free time’ in order to do so.

 

Schwartz’s book is pure entertainment and touches only briefly on methodologies and techniques, yet I was able to pull quite a few investment-related nuggets from it in a short period of time, with the added benefit that the learning process was all fun and no pain. The process got me thinking that perhaps the fastest way to effortlessly bombard the brain with useful investment ideas are those easy reads that provide a personal historical window into the markets.

 I am contrasting this process with the process I went through in trying to read and digest the ideas in Alan Farley’s The Master Swing Trader, which, despite the many interesting ideas, is about as fun to trudge through as Hegel.

 With this in mind, I offer the following ten books as relatively effortless ways to cross-pollinate your investment thinking with that of some of the better minds in the field, both past and present.

 Roughly in order of how quick and easy they are to read:

  • How I Made $2,000,000 in the Stock Market (Nicolas Darvas) – You can probably read this book in a little over an hour. There are only a few salient ideas, but these are destined to stick with you long after you have read the book. I also found that the path Darvas took along the way to developing his system bears a strong resemblance to my own.
  • Pit Bull (Marty Schwartz) – A fast-moving and superbly written account of a champion options trader. A great companion for a cross-country plane trip.
  • Reminiscences of a Stock Operator (Edwin Lefevre) – This is on almost everyone’s reading list, so I will say little about it, other than to point out that it is chock full of insight, yet still reads like a novel.
  • A Journey Through Economic Time (John Kenneth Galbraith) – A very different book from the others on this list, this is certainly one of the easiest economics reads out there, yet the survey of the economic landscape from WWI to after the fall of the Berlin Wall will give the reader a lot to think about.
  • My Life as a Quant (Emanuel Derman) – Another physicist who writes extremely well, Derman provides a thoughtful accounting of his personal journey through the (then) unlikely intersection of theoretical physics, finance and risk.
  • Investment Biker (Jim Rogers) and Adventure Capitalist (Jim Rogers) – These two books are probably best read back to back, in chronological order, starting with the Investment Biker’s 1990-1992 world tour, then using the 1999-2001 Adventure Capitalist jaunt to see how the world had changed over the course of a decade. This is first-person global macro analysis at its best, though you may not have the stamina to do your own world tour in one sitting…
  • Market Wizards (Jack Schwager), The New Market Wizards (Jack Schwager), and Stock Market Wizards (Jack Schwager) – I never thought I’d willingly place the Schwager wizards trilogy at the bottom of any list, but they end up here because they are more densely packed than the other books. Like the Jim Rogers duo, these are best consumed in small bites, on an empty stomach, leaving ample time for proper chewing and digestion. Schwager’s interview style and editing is such that he is able to deliver an astonishing amount of information in an easy to read fashion. The best news of all is that while the books are a great place for beginners to start, they somehow manage to improve with repeated reading.

Great Advice by Livermore in Reminiscences of a Stock Operator

  
  Education
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By far the most useful advice by Livermore in Reminiscences of a Stock Operator was to avoid tips like the plague. Similarly, Bacon warned:

DON’T look at anybody else’s selections of prices or handicaps before making your own selections and prices. That is a rule with no exceptions.

If you look at some other prices or selections first, the line you will come up with will be a sort of scrambling of his line and your line. Almost invariably, it will combine the weakest features of both. You’ll have the mistakes and trite opinions of his line and yours. But the possible ‘bright work’ and getting-away-from-the-public part of his figures and yours, will be discarded.

Jesse Livermore’s Money Management Rules

  
  Education
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If you haven’t read this book “Reminiscences of a Stock Operator” written in 1923, read it! It is purpordetly the unofficial biography of one of the greates traders ever; Jesse Livermore.  The rules Jesse followed back at the turn of the last century are still very much applicable today.

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. (more…)

The Virtue of Patience

  
  Education
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The Virtue of PatienceWaiting for the right opportunity increases the probability of success. You don’t always have to be in the market. As Edwin Lefevre put it in his classic Reminiscences of a Stock Operator, “There is the plain fool who does the wrong thing at all times anywhere, but there is the Wall Street fool who thinks he must trade all the time.”
One of the more colorful descriptions of patience in trading was offered by Jim Rogers in Market Wizards: “I just wait until there is money lying in the comer, and all I have to do is go over there and pick it up.” In other words, until he is so sure of a trade that it seems as easy as picking money off the floor, he does nothing.

Mark Weinstein (also interviewed in Market Wizards) provided the following apt analogy: “Although the cheetah is the fastest animal in the world and can catch any animal on the plains, it will wait until it is absolutely sure it can catch its prey. It may hide in the bush for a week, waiting for Just the right moment. It will wait for a baby antelope, and not Just any baby antelope, but preferably one that is also sick or lame. Only then, when there is no chance it can lose its prey, does it attack. That, to me, is the epitome of professional trading.” (more…)

Speculation Defined

  
  Education
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Graham and Dodd’s Definition of Speculation

In their 1934 classic text, Security Analysis, Benjamin Graham and David Dodd provided a general definition of speculation: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

By this definition, most people who buy stocks are speculators. We can attempt to sharpen Graham and Dodd’s definition by including time-scale. Speculators are not interested in putting their money into a stock or commodity for a long time. They want to see a good profit quickly – on a time scale of minutes to months. If their money does not quickly perform well in a situation, they move it into another situation.

In pursuit of greater gain, speculators take greater risks with their capital than people who put their money into Savings & CD Accounts.

Jesse Livermore’s Definition of Speculation

Jesse Livermore, the 20th century’s most (in)famous speculator provided his own definition of speculation – preceding Graham and Dodd’s by several years. In Reminiscences of a Stock Operator, under his pseudonym of Lawrence Livingston, he said: “The speculator is not an investor. His object is not to secure a steady return on his money at a good rate of interest, but to profit by either a rise or a fall in the price of whatever he may be speculating in.” (more…)

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