We can divide people’s stock market activities neatly into two separate disciplines – trading and investing.
Starting with a few dollars, Jesse Livermore became one of the world’s richest men by trading. He bought stocks with a view to selling them for a capital profit. He had no intention of obtaining an income from dividends or holding on to stocks for the long term: this is investing.
One of the big dangers in stock trading, he said, is when a trade goes wrong and the trader decides to hold a stock until things “come right.” In doing so, the trader breaks one of the cardinal rules of successful trading, which is:
“How often have you heard an investor say: ‘I don’t have to worry about fluctuations or margin calls? I never speculate. When I buy stocks, I buy them for an investment, and if they go down, eventually they will come back.'”
However, Livermore says, “It would be simple to run down the list of hundreds of stocks which, in my time, have been considered gilt-edge investments, and which today are worth little or nothing. Thus, great investments tumble, and with them the fortunes of so-called investors…”
Livermore liked to remind people that there is nothing new in Wall Street. Whatever happens in the stock market today has happened before and will happen again. A large number of modern-day investors will certainly nod their heads ruefully when reading his thoughts from the 1920s on great investments tumbling.
In Livermore’s opinion, investing using a buy and hold strategy was a bigger gamble than trading.
Buy and hold investors, he said, “make a bet, stay with it, and if it goes wrong, they lose it all.”
A trader, on the other hand, might buy the same stock at the same time as the investor. “But if he is an intelligent speculator, he will recognize – if he keeps records – the danger signal warning him all is not well. He will, by acting promptly, hold his losses to a minimum and await a more favourable opportunity to re-enter the market.”
Of course, a stubborn-minded buy and hold investor might sleep more easily in bed at night than a more active trader. Even though his stocks are performing poorly, he has an (often misplaced) unshakeable certainly that they will one day make him a good profit.
Traders, however, are under no such illusions and take a more active interest in their holdings. They are therefore at greater risk of being attacked by what Livermore described as the trader’s natural foes – no, not faith, hope and charity – but greed, hope and fear.
Livermore’s views on hope and fear lie at the heart of successful trading. He describes how traders fail when they allow hope of recovery to prevent them cutting their losses. They fail when fear of losing a small profit causes them to sell prematurely, when more profit would have been available if only they had the nerve to stick with the trend.
“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…
“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 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.”
Is Trading for You?
If you can trade intelligently and control your emotions during trades, you have a good chance of success. If you can’t, you’ll almost certainly fail and you would be advised to avoid trading altogether.