One of the stock market classics that should be on every speculator’s bookshelf is Edwin Lefevre’s Reminiscences of a Stock Operator. Written in 1923, you may assume its contents have scant application to the more sophisticated traders of today. That assumption could not be farther from the truth, for while technology may change and access to information may level the playing field in many respects, human nature hasn’t changed, especially when it comes to managing risk and the uncertainty associated with it.
While I could list many pertinent Lefevre quotes here, one that affects all of us in one way or another is the following.
Here are the 24 rules:
1. Amount of capital to use: Divide your capital into 10 equal parts and never risk more than one-tenth of your capital on any one trade.
2. Use stop loss orders. Always protect a trade.
3. Never overtrade. This would be violating your capital rules.
4. Never let a profit run into a loss. After you once have a profit raise your stop loss order so that you will have no loss of capital.
5. Do not buck the trend. Never buy or sell if you are not sure of the trend according to your charts and rules.
6. When in doubt, get out and don’t get in when in doubt.
7. Trade only in active markets. Keep out of slow, dead ones.
8. Equal distribution of risk. Trade in two or three different commodities if possible. Avoid tying up all your capital in any one commodity.
9. Never limit your orders or fix a buying or selling price.
10. Don’t close your trades without a good reason. Follow up with a stop loss order to protect your profits.
11. Accumulate a surplus. After you have made a series of successful trades, put some money into a surplus account to be used only in emergency or in times of panic.
- The potential of initial and temporary success only exists in trading. You can’t just call yourself a brain surgeon and get lucky while messing around in someone’s head. And just stepping on stage and trying to give a violin concert if you have never touched a violin before won’t end too well either.
- Right, wrong, win and lose are inappropriate terms for describing the participation in the markets. In 20/20 hindsight, decisions might be good or bad but not right or wrong. With regards to the markets, only expressed opinions can be right or wrong. Market positions are either profitable or unprofitable.
- There are as many ways to make money in the markets as there are participants. But there are only very few ways to lose.
- A light-bulb manufacturer understands that 2 out of 10 bulbs will not work; a fruit seller knows that some apples will be foul. Those losses are expected. In trading, we don’t expect to lose when we enter a trade. Unexpected losses are hard to deal with. Acknowledging that losses are part of the game and accepting the losses are two very different things.
- In trading, losses are treated as mistakes and from early on, we have been taught that mistakes are bad and have to be avoided.
- If you know exactly how much you are going to win, but don’t know how much you can lose, you are denying losses.
- Trading is an activity without a beginning and an end. In an activity without an end, you can always make decisions and change your decisions based on the current situation. A football game, a roulette spin or blackjack have defined beginnings and endings; after the game is over, you can’t change anything. You have to accept the outcome. It’s not open for interpretation; you (your team) have lost or won. In trading, the “game” (activity) never ends and your trade (potentially) never ends. Because your trade doesn’t end, your loss is never final and it could always turn around.
- Rules are hard and fast. Tools have some flexibility. Fools neither have rules nor tools.
- A scenario might have been an acceptable trade based on someone else’s rules. Profitable opportunities will occur that you won’t participate in. Your rules will only enable you to engage in some of the millions of opportunities.
- You can’t calculate the probability of having a winner. You can only calculate how much you are going to lose. All you can do is manage your losses and not predict your profits.
- People usually pick the exit point as a function of their entry point and it’s usually some arbitrary Dollar amount.
- People rationalize a trade idea by expressing the trade in terms of the money odd’s fallacy – “it’s a three to one reward-risk ratio! I’ll risk $500 to make $1500”. The reward-risk ratio gives no information about the likelihood of winning a trade.
- People who ask, “Why is the market up or down?” don’t want to know why. They only want to hear the reasons that justify their losing position.
- The last moment of objectivity for the roulette player is the moment before he places his bet and the wheels starts spinning. After that, he can’t do anything anymore to lose more money. For the market participant, the last moment of objectivity is the moment before he places his trade. But after that, he can still do a lot to lose more money. That’s why all your decisions and plans have to be made pre-trade.