Chapters IV-X

“It was an old trading theory of mine that when a stock crosses 100 or 200 or 300 for the first time the price does not stop at the even figure but goes a good deal higher, so that if you buy it as soon as it crosses the line it is almost certain to show you a profit. Timid people don’t like to buy a stock at a new high record. But I had the history of such movements to guide me.”

This observation is as true today as it was 100 years ago. New highs, especially when combined with a break of psychological barriers like large whole numbers, beget more new highs. The average investor or trader will see a break and only consider an entry once the market recedes to the original breakout zone, as though the market will gift them a perfect entry. Ironically, if the market does return to the breakout zone it’s likely because the original breakout was false and price will continue to fall. However, a break and hold at new highs has always been a strong indication to me that price is ready to run and an entry is warranted.

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“Tape reading was an important part of the game; so was beginning at the right time; so was sticking to your position. But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities.”

Here we get a succinct summary of the key lesson’s learned by Livingston at this stage in his career. It’s obvious why the final point is considered to be the most valuable. If you can accurately determine the long-term trend of the market, not much else matters. Sure, understanding setups, entering at a good point, and refraining from premature exits are all important disciplines. But to understand the direction of the market as a whole, and what conditions would warrant an end, implies the ability to make the big bucks and get out before those profits are eaten away by an inevitable downturn.

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“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.”

There is as much to learn from failure as there is from success, yet we often chose to avoid the pain and effort of adequate reflection, much to our own demise. Trading is particularly punishing should you choose to avoid reflection. Consider the repeated failure of deciding to hold a trade showing as paper loss. The conditions that justified it in the first place have been reversed, and yet hope keeps you in the trade. Should you never learn to cut these trades loose, you will eventually go broke or become so demoralized you quit for good. Upon reflection, it should become readily apparent that a loss should never bother you. But being wrong by avoiding proper risk management will kill your spirit as well as your wallet.

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“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 love this little tidbit of advice. Sometimes as a trader you end up with a position that is so large that it becomes difficult to sleep at night should the market move against you. Bad advice you hear is to place a stop loss. This is nonsensical. Why should a certain price point, should it be reached while you are asleep, take you out of a trade with slippage to boot when you have not had any time to assess the context from which the move occurred. I have been knocked out of so many great trades for this exact reason it makes my head spin. Instead, sell down your position until you can comfortably sleep at night. Sometimes this takes a few nights to get the right level, but it’s worth it. Otherwise, you risk making an easily avoidable mistake off the back of sleep deprivation and stress induced exhaustion.

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“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 break breaks through the limit in either direction.”

This is generally good advice that deserves some nuance. If one is able to assess the general conditions, then waiting for a breakout is not necessarily justified. An asset trading sideways in a strong bullish market is likely to breakout out to the upside sooner than later, and adding to your position nears the lows of the consolidation range implies asymmetric upside. If an assessment of general conditions, and therefore the likely breakout direction, is not possible with any real certainty, then the above quote rings true.

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“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 break breaks through the limit in either direction.” This is generally good advice that deserves some nuance. If one is able to assess the general conditions, then waiting for a breakout is not necessarily justified. An asset trading sideways in a strong bullish market is likely to breakout out to the upside sooner than later, and adding to your position nears the lows of the consolidation range implies asymmetric upside. If an assessment of general conditions, and therefore the likely breakout direction, is not possible with any real certainty, then the above quote rings true.