In the fourth chapter of How To Trade In Stocks, famous speculator Jesse Livermore addresses some of his money management rules and principles. Many of these concepts have become almost second nature to me after years of reading and rereading this book and many others like it. However, I do find it helpful to continually remind myself that these pitfalls exist and are just waiting for me to slip into them. I also find it helpful to remind myself of these principles when I have no position in the market because it is much harder to think clearly when I have open positions.
Never Allow Yourself To Average Down
“You are on the wrong side of the market. Why send good money after bad? Keep that good money for another day. Risk it on something more attractive than an obviously losing deal.” – Livermore
I have never seen a successful trader argue that it is a good idea to average down the cost of a position. Ever.
I have seen many unsuccessful traders argue the idea in an attempt to rationalize their choice to stay with a position that is showing them a loss.
Livermore presents the simple argument that once you start averaging down your position, there is never a place to stop. If you buy a stock at 30, and it drops to 26, if it is a good idea to average down there, then why not at 22 or 16? Why not at 6 or 2? Where do you draw the line?
Livermore also makes the classic argument that a disciplined speculator has no business ever throwing good money after bad money.
Do Not Expect Too Much Success Too Soon
“Businessmen opening a shop or a store would not expect to make over 25% on their investment the first year.” – Livermore
Livermore makes this point to address all the people who get into the markets hoping to make quick, easy money. They expect to start trading and have money just flow into their accounts without much effort. As anyone who has ever traded knows, this is never the case.
Any potential speculator needs to come into the market with reasonable expectations just as any businessman needs to approach his work with the same reasonable expectations.
Withdraw Part Of Your Profits
“A speculator should make it a rule each time he closes out a successful deal to take one-half of his profits and lock this sum up in a safe deposit box.” – Livermore
In this section, Livermore points out that money in your trading account doesn’t feel as REAL as money physically held in your hands. Because it doesn’t feel as real, it is much easier to be reckless with it. This is a pitfall that all speculators should avoid at all costs.
Dave Ramsey is famous for taking a similar stance against credit cards. He teaches that buying things with cash hurts more because you physically feel the money changing hands and that will stop you from frivolous purchases more often than a credit card will.
Guard Against Overtrading
“But once acquiring the habit, very few speculators are smart enough to stop.” – Livermore
Livermore spends most of this section warnings against letting your broker convince you to overtrade. Since most of us don’t use an actual person as a broker anymore, our first reaction would be to completely dismiss this section. However, we can interact with thousands of brokers every week on cable TV networks if we want. These networks can do a very compelling job of convincing you that RIGHT NOW is the time that you HAVE to be trading….and they do it every day.
The same concept can apply to social networks depending on how you use them. Trade on your own terms according to your own system.