Probe and test your actions, as if they were alive

The most common mistake traders make is that they approach trading as a one-time transaction. They make a purchase and then hope to make a profit with just one sale. If the trade doesn’t work then they take their losses and move on. They make little effort to use strategies or tactics to increase their potential for success. They just hope their timing is right and it will pay off.

This loss reduction approach can work, but you can dramatically increase your chances of making a profit if you treat a transaction as a living, breathing thing that evolves as conditions change. Your confidence level should start to build up if the price action is favorable and allows you to put more capital to work in a preferred stock. When the first few purchases don’t work, your risk is limited and you can reduce your exposure and avoid substantial losses.

The goal of “probing purchases” is to gain confidence in a transaction as we observe the development of a situation. It also allows us to consider other issues such as the overall health of the market and new fundamental developments. Conditions are constantly changing, so it makes sense to constantly change your level of exposure as the trade grows.

Jesse Livermore is considered one of the greatest traders of all time, but he still went bankrupt three times before he was 30. He was known on Wall Street as the “Boy Plunger” because he “dived” into a situation and took huge positions. When they worked, he made a fortune. When they weren’t working, he was devastated.

What was particularly frustrating for Livermore was that many of his top losing trades would have worked out really well if his timing had been a bit different. He built his position too big and too fast and couldn’t stay with them when they weren’t running immediately.

Ultimately, Livermore solved this timing problem by developing a method he called “polling”. Rather than jump in immediately, he would probe the market by making small purchases that would help him get a feel for the price movement. If he liked what he saw, he would add to the position and start pyramiding it as it moved in his favor.

He likened this approach to a military officer sending a reconnaissance patrol to spy on the enemy and gather intelligence. The knowledge gained from this survey would allow him to attack aggressively at the right time.

The survey method has several advantages. Firstly, it helps keep your emotions in check when you start out small and limits your risks. You will find that your outlook on a stock will often change very quickly once you actually own it. I often find that I will avoid a chart that at first glance seems too technically expansive, but after making a small initial buy and then watching the stock, my attitude about it will change as I follow the price movement of closer and get a feel for the personality of the action. Rather than just dismissing it as a missed trade, my focus is now on finding an opportunity to press as the chart grows.

A second advantage of the polling approach is that it allows for a much higher level of aggressiveness when you trade incrementally. Since you can manage the risk more closely, it is possible to take on larger conditions as you monitor the situation.

Livermore had two key conditions for its survey purchases. First, he made sure to determine the size he intended to hold, if the stock grew as he wanted. He had a plan in advance and didn’t just add random actions. His initial survey purchase would typically be around 20% of the total. The idea here is to have a plan and not be tempted to change it as your emotions kick in as the price action grows.

This first rule goes hand in hand with the second which is that you only add to the trade if it acts in a positive way. You are not trying to lower your base because you are hoping the market will eventually appreciate the positive fundamentals of that stock. What you are doing is adding to your position because the price action proves that the market is finding out about the merits of the situation. This is what helps you improve your timing. You are not trying to guess when a stock is going to move. You kiss him while he moves and does what he’s supposed to do.

Much of the movement of an action is just random and doesn’t make much sense. You can take this opportunity to observe the situation and consider it in the context of general market conditions.

A variation I add to the poll approach is to trade part of the position with shorter time frames. Rather than treating it as a big business that gradually builds up, I will think of it as multiple trades with different time frames. This has many of the same benefits as the survey approach, but helps mitigate the risk when there are quick reversals when you are building a position.

It can be quite easy to let inertia set in when looking for the perfect profession. There will always be negatives and uncertainties, but if you don’t put money into the work, you won’t have a chance to profit from it. Taking small initial “poll” positions forces you to take action and keeps you focused on finding good opportunities. Your insight into a trade will increase rapidly once you have a stake and learn its behavior. All it takes is a very small purchase to turn theory into practice.

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