This is Part 2 of my Lessons From Livermore: Part 1 can be found here:
Psychology plays a pivotal role in the market. People don’t like being wrong and since taking losses is an inevitable part of this business it behooves each of us to develop a sound plan for handling a setback. A very important investment lesson is: “always keep your losses small and never argue with the tape!” Since most people do not like being wrong, they spend their entire lives trying to be right, even when the facts are against them.
Unfortunately, subscribing to this mindset will force you into a money losing strategy. So do what the smart investors do: they cut their losers and let their winners run! Livermore addressed just this topic in the early 1900’s:
“They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation. Speculation is a hard and trying business, and a speculator must be on the job all the time or he’ll soon have no job to be on.”
Lesson 1 stressed the importance of developing “a sound market-tested trading plan, then trade your plan.” Lesson 2 discusses the importance of handling losses. Remember, losses are inevitable so don’t set them aside. Instead, prepare for them by integrating them into your trading plan. That way you can recognize when you are wrong, and instead of battling it out in the psychological warzone, you can cut your losses and get back to winning.
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