Here are seven lessons from Jesse Livermore who is considered by many as one of the greatest traders who ever lived.
Lesson Number One: Cut your losses quickly.
As soon as a trade is contemplated, a trader must know at what point in time he’ll be proven wrong and exit a position. Risk management should dictate the size of the trade and how much you can lose. Deciding where to exit when a position is going against you is not a winning strategy.
Lesson Number Two: Confirm your judgment before trading a larger than average position.
Livermore was famous for throwing out a small position and waiting for his thesis to be confirmed by it going in his favor. Once the stock was traveling in the direction he desired, Livermore would maximize his trading size for out sized wins.
There are many ways to add to a winning position — pyramiding up at key pivot points, building a position as the trade goes in your favor, being 100% in no more than 5% above the initial entry — but the take home is to buy in the direction of your winning trade – never when it goes against you. Never add to a losing position.
Lesson Number Three: Watch leading stocks for the best action.
Livermore knew that trending issues were where the big money would be made, and to fight this reality was a loser’s game. Shorting monster stocks is a very dangerous undertaking when they are under accumulation by large funds.
Lesson Number Four: Let profits ride until price action dictates otherwise.
“It never was my thinking that made the big money for me. It always was my sitting.”
One method that satisfies the desire for profit and subdues the fear of a losing trade is to take one half of your profit off at a predetermined level, put a stop at breakeven on the rest, and let it play out without micromanaging the position. All my biggest wins were in trades where I had no price target I simply let a winner run until it reversed back through my trailing stop. This is how the big money is made in trending markets.
Lesson Number Five: Buy all-time new highs.
The psychological merits of buying all-time or 52-week highs are immense and shouldn’t be discounted as a part of your overall strategy. Buying a break out to all time highs out of a long term consolidation of a price range in a high growth stock is one of the best ways to make money in the stock market.
Lesson Number Six: Use pivot points to determine trends.
When going long, traders are continually looking for confirmation by assessing the strength of a move. Higher highs and higher lows are a solid indicator that a current uptrend is merely taking a slight pause, and the odds of higher prices are in their favor. These same pivot points are integral to drawing support and resistance lines to give traders their line in the sand. Taken together, trend lines and pivot points can enlighten a trader to a change in momentum, which may change the character of a trade. Also be on the look out for key century marks in prices like $100, $500, $700, these are psychological areas where many traders have made the decision to buy or sell. Few traders decide “if it gets to $497.23 I will sell, they think $500.
Lesson Number Seven: Control your emotions.
Great trading is done with the mind not the emotions. Following trends and robust systems not your own fear and greed is what makes money in the markets.