“The recognition of our own mistakes should not benefit us any more than the study of our successes. But there is a natural tendency in all men to avoid punishment. When you associate certain mistakes with a licking, you do not hanker for a second dose, and, of course, all stock-market mistakes wound you in two tender spots - your pocketbook and your vanity.”
“But I will tell you something curious : A stock speculator sometimes makes mistakes and knows that he is making them. And after he makes them he will ask himself why he made them; and after thinking over it cold-bloodedly a long time after the pain of punishment is over he may learn how he came to make them, and when, and at what particular point of his trade ; but not why. And then he simply calls himself names and lets it go at that.”
It is really a shame that we can’t learn "from scratch" out of books but really from scars to our trading “book”. We have to take some hits and then must press on before there is even an opportunity to “hit it big” in so many things. That is the interesting thing about experience and the conditioning of our habits, routines and nervous systems: mistakes make the muscles of our memory.
Books, lectures and friendly advice can’t give a trader “instincts”. It can give a trader a kind of self-conscious awareness, where every dance step is a studied and perhaps nervous movement. “One-two-three-four, One-two-three-four. Left, left, right, left, left, right…” We stumble along as we are kept on our toes with the trepidation that comes from feeling. Only experience and continuous training provides an autonomous, natural and comfortable gait filled with lots of self-assurance.
“Of course, if a man is both wise and lucky, he will not make the same mistake twice. But he will make any one of the ten thousand brothers or cousins of the original. The Mistake family is so large that there is always one of them around when you want to see what you can do in the fool-play line.”
And it’s always the same rhythm of growth, there will be bumps and pretty soon you can do something “with your eyes closed”, once your body, mind and memory have made enough trips. And then you trip yet again and learn something new.
“...Money does not give a trader more comfort, because, rich or poor, he can make mistakes and it is never comfortable to be wrong. And when a millionaire is right his money is merely one of his several servants. Losing money is the least of my troubles. A loss never bothers me after I take it. I forget it Overnight. But being wrong - not taking the loss - that is what does the damage to the pocketbook and to the soul.
Livermore emphasizes process, less about staying put with profitable trades, and on leaving as soon as the losses show up. It’s not his money but his market memory, and psyche, which is important.
Risk of size, size of risk and The “SLEEPING POINT”:
“...You remember Dickson G. Watts' story about the man who was so nervous that a friend asked him what was the matter.”
"I can't sleep," answered the nervous one.
"Why not?" asked the friend.
"I am carrying so much cotton that I can't sleep thinking about it. It is wearing me out. What can I do?"
"Sell down to the sleeping point," answered the friend.
I think the phrase “new normal” is suitable to describe the paradox tucked within the phrase “living within your means”. What are we to do if we are blessed with profits and our “means” expands? Yes, that’s great but can you ratchet back if your "means" then contract again? Can you be comfortable with a new normal which keeps changing?
“As a rule a man adapts himself to conditions so quickly that he loses the perspective. He does not feel the difference much -that is, he does not vividly remember how it felt not to be a millionaire. He only remembers that there were things he could not do that he can do now. It does not take a reasonably young and normal man very long to lose the habit of being poor. It requires a little longer to forget that he used to be rich. I suppose that is because money creates needs or encourages their multiplication. I mean that after a man makes money in the stock market he very quickly loses the habit of not spending. But after he loses his money it takes him a long time to lose the habit of spending.”
This is relevant for both lifestyle and trading size. What if your account is larger - can you adjust to trading “larger” without stressing out? Perhaps you can’t swing a line like the prior week, month or year, after a huge drawdown, you didn’t change gears and as a result, you could be over-trading within a now smaller trading account. Soon enough you won’t be able to sleep.
Markets might change but similar events happen in markets. Hence the power of real memories from both both “right trading” (according to a planned process) and mistakes.
“Of course the same things happen in all speculative markets. The message of the tape is the same. That will be perfectly plain to anyone who will take the trouble to think. He will find if he asks himself questions and considers conditions, that the answers will supply themselves directly. But people never take the trouble to ask questions, leave alone seeking answers. The average American is from Missouri everywhere and at all times except when he goes to the brokers' offices and looks at the tape, whether it is stocks or commodities. The one game of all games that really requires study before making a play is the one he goes into without his usual highly intelligent preliminary and precautionary doubts. He will risk half his fortune in the stock market with less reflection than he devotes to the selection of a medium-priced automobile.”
You can control your actions, guided by your memory, but prediction is outside of this process:
“...To read the tape is not to have your fortune told. The tape does not tell you how much you will surely be worth next Thursday at 1:35 p.m. The object of reading the tape is to ascertain, first, how and, next, when to trade-that is, whether it is wiser to buy than to sell…”
And that is what I do along with many traders. We observe and make note of what we see:
“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.”
But what of the future? What good is memory then? Well, here is the answer:
“Nobody should be puzzled as to whether a market is a bull or a bear market after it fairly starts. The trend is evident to a man who has an open mind and reasonably clear sight, for it is never wise for a speculator to fit his facts to his theories. Such a man will, or ought to, know whether it is a bull or a bear market, and if he knows that he knows whether to buy or to sell. It is therefore at the very inception of the movement that a man needs to know whether to buy or to sell.”
The point for Livermore, about “tape reading” and observing “conditions”, is about finding and trading “the big swing”, not by small trades, or “tokens” as he puts it:
“...A man ought not to be led into trading by tokens. He should wait until the tape tells him that the time is ripe. As a matter of fact, millions upon millions of dollars have been lost by men who bought stocks because they looked cheap or sold them because they looked dear...Therefore the thing to determine is the speculative line of least resistance at the moment of trading; and what he should wait for is the moment when that line defines itself, because that is his signal to get busy.”
People think following price is following the crowd, and that there are limits to this approach, but here is the advantage. Livermore actually sees his approach as holding away from the crowd of traders who are eager to be in a trade, impatient and not watching for confirmation “to get busy”:
“Eventually something happens that increases the power of either the upward or the downward force and the point of greatest resistance moves up or down-that is... The price will break through the old barrier or movement-limit and go on. As a rule, there is always a crowd of traders who are short ...because it looked so weak, or long at ...because it looked so strong, and, when the market goes against them they are forced, after a while, either to change their minds and turn or to close out, In either event they help to define even more clearly the price line of least resistance….”
The idea is to keep watching, waiting, sitting on one’s hands, with accounts at the ready:
“ Thus the intelligent trader who has patiently waited to determine this line will enlist the aid of fundamental trade conditions and also of the force of the trading of that part of the community that happened to guess wrong and must now rectify mistakes. Such corrections tend to push prices along the line of least resistance.”
Nothing beats trading with the trend, like a endless summer surfer, and having that trend reinforced by the unwinding of positions caught wrong-footed, like over-leveraged longs or shorts-being squeezed.
“And right here I will say that, though I do not give it as a mathematical certainty or as an axiom of speculation, my experience has been that accidents - that is, the unexpected or unforeseen - have always helped me in my market position whenever the latter has been based upon my determination of the line of least resistance….”
The market and the tape makes the news, not the other way around. A lot of us have seen this in the form of sensationalist magazine and online post headlines, typified by a dismal field of bears or a limitless blue sky metaphor:
“You will find in actual practice that if you trade as I have indicated any important piece of news given out between the closing of one market and the opening of another is usually in harmony with the line of least resistance. The trend has been established before the news is published, and in bull markets bear items are ignored and bull news exaggerated, and vice versa.”
With an example of the “unforeseen” news favoring the Livermore’s particular short along a line of least resistance:
“Before the war broke out the market was in a very weak condition. There came the proclamation of Germany's submarine policy. I was short one hundred and fifty thousand shares of stock, not because I knew the news was coming, but because I was going along the line of least resistance. What happened came out of a clear sky, as far as my play was concerned. Of course I took advantage of the situation and I covered my shorts that day.”
Livermore realizes what others are thinking after reading his advice about “tape reading” for the line of “least resistance” and generally ignoring the news, unless it favored a trade after the fact, that he has oversimplified and makes it “sound easy”. He acknowledges that all human beings face one challenge. Themselves.
“It sounds very easy to say that all you have to do is to watch the tape, establish your resistance points and be ready to trade along the line of least resistance as soon as you have determined it. But in actual practice a man has to guard against many things, and most of all against himself-that is, against human nature. That is the reason why I say that the man who is right always has two forces working in his favor- basic conditions and the men who are wrong. In a bull market bear factors are ignored. That is human nature, and yet human beings profess astonishment at it.”
There’s advice which applies to ALL TRADING about being careful with opinions. It amounts to the power of having strong opinions, lightly held:
“When a man makes his play in a ... market he must not permit himself set opinions. He must have an open mind and flexibility. It is not wise to disregard the message of the tape, no matter what your opinion of crop conditions or of the probable demand may be. I recall how I missed a big play just by trying to anticipate the starting signal. I felt so sure of conditions that I thought it was not necessary to wait for the line of least resistance to define itself. I even thought I might help it arrive, because it looked as if it merely needed a little assistance.”
Many traders have known the frustration of trying to trade a narrowly moving market. Inexperienced traders learn the hard way the value of “sitting on hands”. Watching, waiting and being ready is not the same as “doing nothing”. Too many of us have lost money needlessly, but inevitably, thanks to the human need to “get things done”. And being “right” means the right process and perhaps being profitable as a result. The insistence of both the non-professional and the inexperienced to somehow insist that the expected outcome of a trade matches the actual result can lead to painful lessons, in a narrow market.
“In a narrow market, when prices are not getting anywhere to speak of but move within a narrow range, there is no sense in trying to anticipate what the next big movement is going to be-up or down. The thing to do is to watch the market, read the tape to determine the limits of the get-nowhere prices, and make up your mind that you will not take an interest until the price breaks through the limit in either direction. A speculator must concern himself with making money out of the market and not with insisting that the tape must agree with him. Never argue with it or ask it for reasons or explanations. Stock-market post-mortems don't pay dividends.”
"Do you wish to gamble blindly in the hope of getting a great big profit or do you wish to speculate intelligently and get a smaller but much more probable profit?"
“...I merely learn the way prices are most probably going to move. I check up my own trading by additional tests, to determine the psychological moment. I do that by watching the way the price acts after I begin.”
Many of us who buy the breakout, the MACD, or trade IBD type trades or trade like one of Richard Dennis’ “turtles”:
“It is surprising how many experienced traders there are who look incredulous when I tell them that when I buy stocks for a rise I like to pay top prices and when I sell I must sell low or not at all. It would not be so difficult to make money if a trader always stuck to his speculative guns-that is, waited for the line of least resistance to define itself and began buying only when the tape said up or selling only when it said down. He should accumulate his line on the way up.
AND remember “size of risk”? One does not go all in even after seeing a trade, but in steps before a gallop and then a sprint:
“ If [the first trade of one trade] ...does not show him a profit he must not increase his holdings because he has obviously begun wrong; he is wrong temporarily and there is no profit in being wrong at any time. The same tape that said UP did not necessarily lie merely because it is now saying NOT YET.”
“It is simple arithmetic to prove that it is a wise thing to have the big bet down only when you win, and when you lose to lose only a small exploratory bet, as it were. If a man trades in the way I have described, he will always be in the profitable position of being able to cash in on the big bet.
Livermore knows the future is unpredictable, and emphasized “sleeping size” risks, understanding that not all trades will work, despite identifying potentially successful trades through watching for “conditions”, “the line of least resistance”. Trading size isn’t just optimized to minimize distress but also danger from unpredictable losses. The idea is to trade, in a manner consistent with the trader’s inner life, outer material needs, while being available long enough to secure a profitable “big swing”.
“The speculator's chief enemies are always boring from within. It is inseparable from human nature to hope and to fear. In speculation when the market goes against you you hope that every day will be the last day-and you lose more than you should had you not listened to hope-to the same ally that is so potent a success-bringer to empire builders and pioneers, big and little. And when the market goes your way you become fearful that the next day will take away your profit, and you get out-too soon. Fear keeps you from making as much money as you ought to…”
The responsibility of every trader comes from managing both outer as well as inner challenges:
“The successful trader has to fight these two deep-seated instincts. He has to reverse what you might call his natural impulses. Instead of hoping he must fear; instead of fearing he must hope. He must fear that his loss may develop into a much bigger loss, and hope that his profit may become a big profit. It is absolutely wrong to gamble in stocks the way the average man does.”
The greatest challenge for every trader is NOT the market, it is with human desire to control reality:
“A man may beat a stock or a group at a certain time, but no man living can beat the stock market! ...It's like the track. A man may beat a horse race, but he cannot beat horse racing.”