How to Trade Stocks: Timing
The next three lessons summarize the previous chapters. Although in this version of the book, some extra points are delivered and hence are important to read as well.
The three important aspects of being a successful trader are:
- Money Management
- Emotional Control
In this chapter let’s elaborate on the first aspect i.e, Timing.
Livermore has always emphasized that “time is everything”. This is validated by his concept of waiting for the pivotal point from entry and being watchful of unusual movements in the stocks which contradict its normal movements. Hence, he had advised us to trade in only a few scripts that would enable us to have in-depth knowledge of its movements.
Before making any trade follow the process of Top Down Trading:
- Check the market: Before entering any trade, the first step is to be sure where the overall market (Nifty50) is heading. If your trade confirms with the direction of the Nifty, it has a higher chance of succeeding. For instance, Moving averages can be a useful tool for determining the trend of the index.
- Check the trend of industry groups. When you trade in a stock, it's not only following the general market (Nifty) but also the industry in which it is categorized. For e.g., If you want to trade in Maruti Suzuki Ltd, check the trend of the Nifty Auto index as well. This will provide more assurance if your trade is in sync with the trend of the industry group (Nifty Auto)
- Check the tandem of peer stocks. You should also check whether the “Top” peer group is also moving in a similar trend or not.
- Check all four: The market, the industry group, the tandem of peer stocks and the stock itself, your chances of hitting the correct trend becomes more probable.
- Do a final thorough analysis of the individual stock you have decided to trade. This is your responsibility, your obligatory “Due Diligence.”
“Wait until the Preponderance of Evidence is in your Favor. Use Top-Down Trading. Be patient!” —Jesse Livermore.
Industry tracking is very important as per Livermore. It happens that sometimes, a particular stock performs exceptionally better than the entire sector, however, be ready as the other stocks can follow suit very soon.
Another very interesting theory of Livermore was “Follow the leaders”. Here he meant the trending stocks. On a particular day, list out the most trending stocks and try to see where you can trade (of course, by looking at the pivotal points!). Secondly, keep the trading universe small and controllable.
An interesting quote on his trading style, which differentiates him from others: “Just because a stock has fallen in price does not mean that it won’t go lower. I never buy a stock on declines, and I never short a stock on rallies.” He never anticipated,Lets now shift focus to Tandem Trading discussed above. Tandem trading can also be called Sister Stock Trading Method. Livermore advised never to trade only one stock from a sector, look at two. Why? Because, stocks in the same group move together. If one has already moved, chances are that the other twin will move very soon.
Livermore always considered “TIME” as a real and essential trading element. He would often say: “It’s not the thinkin’ that makes the money—it’s the sittin’ and waitin’ that makes the money.” There were many occasions where Livermore kept cash until the right situation appeared. “Often, the market will go contrary to what a speculator has predicted. At these times the successful speculator must abandon his predictions, and follow the action of the market. A prudent speculator never argues with the tape, remember: MARKETS ARE NEVER WRONG—OPINIONS OFTEN ARE.
When to buy a stock is based on the trend as recognized by pivotal points. One of the most used pivotal points by Livermore was a new high. Whenever the stock crosses a new high, according to Livermore, there will be no overhang for traders to exit the position. On the contrary, with a falling stock, each rise is accompanied by a sale from the traders who want to exit even at breakeven. Hence, breakout to new highs is considered a good buying opportunity.
Do you remember Livermore stating Danger Signals as an exit point?
One of the Danger Signals that Livermore used was ‘One Day Reversal’. This happens when the current day's high is higher than the previous day's high, the current day's close is lower than the previous day's close, and the current day's volume is higher than the previous day's volume. When something similar happens, stop the trade. Additionally, if there is significant volume but prices stagnate, do not rise, do not reach new highs, and there is not a strong continuation of the current advance, this is frequently a big hint, a warning that the stock may have peaked out.
In the next chapter, we will discuss the importance of money management.