THE MILLION DOLLAR BLUNDER
It is my purpose in these chapters to lay down some general trading principles. Later on there will be specific explanation of my formula for combining time element and price.
In consideration of these general trading principles it should be said that too many speculators buy or sell impulsively, acquiring their entire line at almost one price. That is wrong and dangerous.
Let us suppose that you want to buy 500 shares of a stock. Start by buying 100 shares. Then if the market advances buy another 100 shares and so on. But each succeeding purchase must be at a higher price than the previous one.
That same rule should be applied in selling short. Never make an additional sale unless it is at a lower price than the previous sale. By following this rule you will come nearer being on the right side than by any other method with which I am familiar. The reason for this procedure is that your trades have at all times shown you a profit. The fact that your trades do show you a profit is proof you are right.
Under my trading practice you first would size up the situation in regard to a particular stock. Next it is important to determine at what price you should allow yourself to enter the market. Study your book of price records, study carefully the movements of the past few weeks. When your chosen stock reaches the point you had previously decided it should reach if the move is going to start in earnest, that is the time to make your first commitment.
Having made that commitment, decide definitely the amount of money you are willing to risk should your calculations be wrong. You may make one or two commitments on this theory and lose. But by being consistent and never failing to re-enter the market again whenever your Pivotal Point is reached, you cannot help but be in when the real move does occur. You simply cannot be out of it.
But careful timing is essential … impatience costly.
Let me tell you how I once missed a million dollar profit through impatience and careless timing. I almost want to turn my face away in embarrassment when I tell this.
Many years ago I became strongly bullish on Cotton. I had formed a definite opinion that Cotton was in for a big rise. But as frequently happens the market itself was not ready to start. No sooner had I reached my conclusion, however, than I had to poke my nose into Cotton.
My initial play was for 20,000 bales, purchased at the market. This order ran the dull market up fifteen points. Then, after my last 100 bales had been bought, the market proceeded to slip back in twenty-four hours to the price at which it had been selling when I started buying. There it slept for a number of days. Finally, in disgust, I sold out, taking a loss of around $30,000, including commissions. Naturally my last 100 bales were sold at the lowest price of the reaction.
A few days later the market appealed to me again. I could not dismiss it from my mind, nor could I revise my original belief that it was in for a big move. So I re-bought my 20,000 bales. The same thing happened. Up jumped the market on my buying order and, after that, right back down it came with a thud. Waiting irked me, so once more I sold my holdings, the last lot at the lowest price again.
This costly operation I repeated five times in six weeks, losing on each operation between $25,000 to $30,000. I became disgusted with myself. Here I had chipped away almost $200,000 with not even a semblance of satisfaction. So I gave my manager an order to have the Cotton ticker removed before my arrival next morning. I did not want to be tempted to look at the Cotton market any more. It was too depressing, a mood not conducive to the clear thinking which is required at all times in the field of speculation.
And what happened? Two days after I had the ticker removed and had lost all interest in Cotton, the market started up, and it never stopped until it had risen 500 points. In that remarkable rise it had but one reaction as great as 40 points.
I had thus lost one of the most attractive and soundest plays I had ever figured out. There were two basic reasons. First, I lacked the patience to wait until the psychological time had arrived, pricewise, to begin my operation. I had known that if Cotton ever sold up to 12.50 cents a pound it would be on its way to much higher prices. But no, I did not have the will power to wait. I thought I must make a few extra dollars quickly, before Cotton reached the buying point, and I acted before the market was ripe. Not only did I lose around $200,000 in actual money, but a profit of $1,000,000. For my original plan, well fixed in mind, contemplated the accumulation of 100,000 bales after the Pivotal Point had been passed. I could not have missed making a profit of 200 points or more on that move.
Secondly, to allow myself to become angry and disgusted with the Cotton market just because I had used bad judgment was not consistent with good speculative procedure. My loss was due wholly to lack of patience in awaiting the proper time to back up a preconceived opinion and plan.
I have long since learned, as all should learn, not to make excuses when wrong. Just admit it and try to profit by it. We all know when we ire wrong. The market will tell the speculator when he is wrong, because he is losing money. When he first realizes he is wrong is the time to clear out, take his losses, try to keep smiling, study the record to determine the cause of his error, and await the next big opportunity. It is the net result over a period of time in which he is interested.
This sense of knowing when you are wrong even before the market tells you becomes, in time, rather highly developed. It is a subconscious tip-off. It is a signal from within that is based on knowledge of past market performances. Sometimes it is an advance agent of the trading formula. Let me explain more fully.
During the big Bull Market in the late twenties, there were times when I owned fairly large amounts of different stocks, which I held for a considerable period of time. During this period I never felt uneasy over my position whenever Natural Reactions occurred from time to time.
But sooner or later there would be a time when, after the market closed, I would become restive. That night I would find sound sleep difficult. Something would jog me into consciousness and I would awaken and begin thinking about the market. Next morning I would be afraid, almost, to look at the newspapers. Something sinister would seem impending. But perhaps I would find everything rosy and my strange feelings apparently unjustified. The market might open higher. Its action would be perfect. It would be right at the peak of its movement. One could almost laugh at his restless night. But I have learned to suppress such laughter.
For next day the story would be strikingly different. No disastrous news, but simply one of those sudden market turning points after a prolonged movement in one direction. On that day I would be genuinely disturbed. I would be faced with the rapid liquidation of a large line. The day before, I could have liquidated my entire position within two points of the extreme movement. But today, what a vast difference.
I believe many operators have had similar experiences with that curious inner mind which frequently flashes the danger signal when everything marketwise is aglow with hope. It is just one of those peculiar quirks that develops from long study and association with the market.
Frankly, I am always suspicious of the inner mind tip-off and usually prefer to apply the cold scientific formula. But the fact remains that on many occasions I have benefited to a high degree by giving attention to a feeling of great uneasiness at a time when I seemed to be sailing smooth seas.
This curious sidelight on trading is interesting because the feeling of danger ahead seems to be pronounced only among those sensitive to market action, those whose thoughts have followed a scientific pattern in seeking to determine price movements. To the rank and file of persons who speculate the bullish or bearish feeling is simply based on something overheard or some published comment.
Bear in mind that of the millions who speculate in all markets only a few devote their entire time to speculation. With an overwhelming majority it is only a hit-and-miss affair, and a costly one. Even among intelligent business and professional men and retired men it is a sideline to which they give small attention. Most of them would not be trading in stocks if at some time a good tip had not been passed along by a broker or customers’ man.
Now and then someone begins trading because he has a hot inside tip from a friend in the inner councils of a large corporation. Let me here relate a hypothetical case.
You meet your corporation friend at luncheon or at a dinner party. You talk general business for a time. Then you ask about Great Shakes Corporation. Well, business is fine. It is just turning the corner and the future outlook is brilliant. Yes, the stock is attractive at this time.
“A very good buy, indeed,” he will say and perhaps in all sincerity. “Our earnings are going to be excellent, in fact better than for a number of years past. Of course you recall, Jim, what the stock sold for the last time we had a boom.”
You are enthused and lose little time in acquiring shares.
Each statement shows better business than during the last quarter. Extra dividends are declared. The stock moves up and up. And you drift into pleasant paper profit dreams. But in the course of time the company’s business begins slipping dreadfully. You are not apprised of the fact. You only know the price of the stock has tobogganed. You hasten to call your friend.
“Yes” he will say, “the stock has had quite a break. But it seems to be only temporary. Volume of business is down somewhat. Having learned that fact the bears are attacking the stock. It’s mostly short selling.”
He may follow along with a lot of other platitudes, concealing the true reason. For he and his associates doubtless own a lot of the stock and have been selling as much and as rapidly as the market would take it since those first definite signs of a serious slump in their business appeared. To tell you the truth would simply invite your competition and perhaps the competition of your mutual friends in his selling campaign. It becomes almost a case of self-preservation.
So it is plain to see why your friend, the industrialist on the inside, can easily tell you when to buy. But he cannot and will not tell you when to sell. That would be equivalent almost to treason to his associates.
I urge you always to keep a little notebook with you. Jot down interesting market information: thoughts that may be helpful in the future; ideas that may be re-read from time to time; little personal observations you have made on price movements. On the first page of this little book I suggest you write—no, better print—it in ink: “Beware of inside information - all inside information.”
It cannot be said too often that in speculation and investment, success comes only to those who work for it. No one is going to hand you a lot of easy money. It is like the story of the penniless tramp. His hunger gave him the audacity to enter a restaurant and order “a big, luscious, thick, juicy steak,” and, he added to the colored waiter, “tell your boss to make it snappy.” In a moment the waiter ambled back and whined: “De boss say if he had dat steak here he’d eat it hisself.”
And if there was any easy money lying around, no one would be forcing it into your pocket.
Part of “How to Trade in Stocks” by Jesse Livermore.