JeremyAlan:Horse,
What are some of the psychological traits that you think a trader should have? We know that the trader should be able to take a loss but minimize a loss. You have given that down 10% in the whole portfolio, one should cash their chips in. What are some of the barometers when trading individual stocks? How do you know when you are wrong in the sense of buying into the security?
First, on the 10% rule. What Livermore is talking about there is each trade, not the entire port. So, let me address that first. I don't risk 10% on each trade, I risk 5% on each trade. That doesn't mean, though, that I put my initial stop at 5%. It means, I use staged buys with calculated stops to make sure I don't go over 5% of the entire trade. So, let's assume I want to make a trade using 3 buys of $1000... total $3000. 5% risk on this trade is $150. At no point then do I want to risk more than $150. I make my first buy based on support. In reality, I can place my stop 15% below my first buy and still risk only 5% of my trade. Once I commit my second buy, then my stop has to be no more than 7.5% from my average cost. Finally, if I get to commit my 3rd buy, then I have to use a max 5% stop. If I need a larger initial stop, then I might drop down to 1/4 buys. My thought on it is this. If I limit my total loss to 5%, but I can get minimum of 10% gains, then I can tolerate 2 losses for every gain and I break even. Any thing better than this, I'm gaining. Any gains greater than 10% increase my gains.
Now, back on the 10% port rule. I don't think a trader should completely throw in the towel. No, not at all. If someone gets down on their port 10%, even in this market, then I think it's pretty obvious their current strategy is not working. It could be the market, it could be the strategy. Before they take their port down even further, making it that much more difficult to come back, I think they should cash out temporarily, to cool the streams, let things settle, and evaluate the situation. If it's the market, take a breather. If it's strategy, then look at the problems and fix them. The last thing I would want someone to do is keep doing the same thing that got them down 10% in the first place. HOPING the port comes back will just result in that 10% going to 15% down, then 20%. Soon, they will have to throw the towel in. So, it's a matter of surving to make the next trade. After their rest period, then I advise them to take it easy. Make small trades, don't throw a lot in until they see changes, positive momentum. Once they get back in gear, if they are sure everything is working, they will have a chance to get back in the game. Being down 10% is tough psychologically, we start making additional mistakes. Again, it's a matter of survival.
Psychological traits. I don't necessarily think a person's psychology matters per se. We are all individuals and think/act differently. I think people who are more willing to say "I'm wrong" have a better chance because they don't tie themselves to being "right". I think people who are more emotionally balanced have a better chance. They don't get excited about gains nor down about losses. They just accept the result and move on. But, given these "advantages", I don't think they are necessary. What is necessary is objective, unemotional trading, full stop. To achieve this, it's not necessary to have a "perfect" psychology, but to have an awareness of our own psychology. If a trader is a very emotionally charged person AND KNOWS IT, they can implement rules and measures to tame their emotions... don't watch prices for one; make all decisions outside market hours, stuff like that. In essence, it's less about the psychological makeup, more about self-awareness and what it takes for ourself to achieve an objective unemotional state of trading.
How do I know I'm wrong? The price has told me. I make these barometers before I make my first buy. I'm patient with my buys and make sure I have something to judge them buy. If a stock price is resting on top of a 50DMA, then a violation of the 50DMA will tell me I'm wrong. So, to minimize risk, I'll buy as close to that support as I can get. Consolidation ranges, a breakdown in the consolidation range. Now, I am well aware of what the pros do with flushes. They'll trip stops or buys by pushing the price down or up out of range. This is a hazard of doing business. But, if this happens to me, I'm aware of it and act. A flush of stops with the price return back into consolidation means it should move higher. I'll buy it back. A failed breakout means the price should move lower, sometimes significantly lower... it's a great short sell opportunity. How do I know if I'm wrong in these cases? Easy, the stock moves in the wrong direction. Just because I get flushed once doesn't mean I won't accept being stopped out again... just a business expense. But, it's much easier to jump back into a trade after a 2% stoppage versus a 20% loss!
I'll also offer at least one answer on your question to chrib.
1. If I get a 10% gain in less than 5 days, I take partial profits off the table. I don't care if it reverses the next day or continues up.
2. If a stock makes a big jump in one day, called a "dominate candle", it should not retrace more than half of that candle if it's going to continue moving up. Ideally, it retraces less than this. The "perfect" retracement is a 3 day withdraw that stays above the midpoint. So, if you get in on a big day, take partial profits, then place a stop on the rest just below the midpoint of the dominate candle.
3. If you watch prices intraday, you can often see the price double, tripple top at a certain price. If it doesn't break through this short term resistance, it's withdrawing. We may not necessarily know, but it's retreating.
4. There's a rule I follow called the "Three Day Rule". It means most stock moves occur over a 3 day period. Day 1, the smart money is buying, starting the move. Day 2, the more astute traders are buying because they observed the first days move. Day 3, the "dumb" money is buying because the move is now plainly obvious. Day 3 often ends in a retreat. Never buy on Day 3! So, if you see two UP days in a stock, wait it out, don't chase it. If you're in on Day 1 or 2, good job start looking to sell to the "dumb" money!