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Newsletter March 18, 2006 Jesse Livermore's 5 Money Management Rules Market & Sector Review A Run for the Roses Largest Changes This Week This Week's Economic Reports Jesse Livermore's 5 Money Management Rules I recently copied down a message board posting about Jesse Livermore, arguably the greatest trader that has ever lived. Posted by an experienced trader who goes by the moniker - Chilidawgz. If you are an aspiring trader, even an experienced one, you must read about this man, he should be your hero. The next 3 weeks we will cover some of his wisdom in this section of the newsletter, hopefully it will entice you enough to want to read more. Reminiscences of a Stock Operator 1) Don't lose money. Don't lose your stake. A speculator without cash is like a store-owner with no inventory. Cash is your inventory, your lifeline, and your best friend. Without cash, you are out of business. Don't lose your line. There is no place in speculating for hoping, for guessing, for fear, for greed, for emotions. The tape tells the truth. 2) Always establish a stop. A successful speculator must set a firm stop before making a trade and must never sustain a loss of more than 10 percent of invested capital. I have also learned that when your broker calls you and tells you he needs more money for a margin requirement on a stock that is declining; tell him to sell out the position. When you buy a stock at 50 and it goes to 45, do not buy more in order to average out your price. The stock has not done what you predicted; that is enough of an indication that your judgment was wrong. Take sour losses quickly and get out. Remember, never meet a margin call, and never average losses. Many times I would close out a position before suffering a 10 percent loss. I did this simply because the stock was not acting right from the start. Often my instincts would whisper to me: "J.L., this stock has a malaise, it is a lagging dullard. It just does not feel right," and I would sell out of my position in the blink of an eye. I absolutely believe that price movement patterns are repeated and appear over and over with slight variations. This is because humans drive the stocks, and human nature never changes. Take your losses quickly. Easy to say, but hard to do. 3) Keep cash in reserve. The successful speculator must always have cash in reserve.. .for exactly the right moment. There is a never-ending stream of opportunities in the stock market and, if you miss a good opportunity, wait a little while, be patient, and another one will come along. J.P. reach for a trade, all the conditions for a good trade must be on your side. Remember, you do not have to be in the market all the time. The desire to always be in the game is one of the speculator's greatest hazards. When playing the stock market, there are times when your money should be waiting on the sidelines in cash.. .waiting to come into play. Time is not money — time is time, and money is money. Often money that is just sitting can later be moved into the right situation at the right time and make a fast fortune. Patience is the key to success, not speed. Time is a cunning speculator's best friend if it is used wisely. 4) Let the position ride. As long as the stock is behaving normally, do not be in a hurry to take a profit. You must know you are right in your basic judgment, or you would have no profit at all. If there is nothing basically negative, then let it ride. It may grow into a very large profit. As long as the action of the overall market and the stock do not give you cause to worry, have the courage of your convictions, and stay with it. When I was in a profit on a trade, I was never nervous. Of course the opposite is true as well. If I bought a stock and it went against me I would sell it immediately. You can't stop and try to figure out why a stock is going in the wrong direction. The fact is that it is going in the wrong direction, and that is enough evidence for an experienced speculator to close the trade. I do not and never have blindly bought and held a stock. To buy and hold blindly on the basis that a stock is in great company or a strong industry, or that the economy is generally healthy, is, to me the equivalent of stock market suicide. Stick with the winners. Let them ride until you have a clear reason to sell. 5) Take the profits in cash. I recommend parking 50 percent of the profits from a successful trade, especially when the trade doubled the original capital. Set the money aside, put it in the bank, hold it in reserve, or lock it up in a safe-deposit box. Like winning in the casino, it's a good idea, now and then to take your winnings off the table and turn them into cash... .the single largest regret I have ever had in my financial life was not paying enough attention to this rule. Market & Sector Review A Run for the Roses I am not sure how many of you are thoroughbred racing fans, I am. I borrowed the above title from what many call the greatest two minutes in sports, The Kentucky Derby - "The run for the roses". Who knows, with a little bit of luck, OK maybe a lot of luck, this rally may even last until that wonderful annual event May 6. This week many averages attained new all time highs and multi-year highs although there were notable laggards. The divergences the dichotomies continue to build and one day will come into play but for now let's just enjoy what the market is giving us. Toward the end of this letter I will give you some of the new index charts we are publishing twice weekly so you, as I, may watch the divergences continue to build until they become just too much for the market to handle. The charts below cover the entire bull market and may be a bit hard to read, however the ones posted on site cover about the last 8 or 9 months. The psychology of the market remains relatively strong as can be easily seen by the markets reaction to recent news. Last Friday (3/10) we enjoyed a very nice jobs report and the markets rose because the economy is strong. Tuesday this week we had disappointing news on retail sales and the deficit although Goldman Sachs reported blow out earnings, and the market rose to new highs because the FED may be soon be finished raising rates. When bad news is good [retail sales, deficit] and good news [Jobs report] is even better, the psychology at least in the short term is very positive, go with the flow. When this market finally does top, be it next week or in the summer you will notice the psychology reverse; good news will be negative and bad news will be even worse. Last weekend I received a call from an old and very good friend who is also a trader. We talked awhile about the markets and agreed that over the short term at least the market looks like it wants to go higher. The question arose, should we spend some cash and buy here or just sit back and watch? Our time frames are similar and we both, expecting a reversal soon have shortened our time frames considerably. I made some notes during our conversation thinking it just might make a good newsletter. While on the phone we decided to combine our experience use what is available to everyone, visa-vie the Prudent Trader site, and see what we might come up with to buy. It's an interesting thought process and I hope you enjoy it. One of our biggest concerns was the lack of participation by the NASDAQ composite and the NASDAQ-100 and even more specifically the downtrends apparent in the Semiconductor stocks as measured by the Philadelphia Semiconductor Index (SOX) or the Exhcange Traded Fund SMH - Semiconductor Holders Trust. We also noted the apparent head and shoulders top forming in the NASDAQ 100 or QQQQ if you prefer. I suggested; is there any one that does not know of this head and shoulders formation? How many are shorting in anticipation of this formations break, which by the way would suggest a move to the October lows? Neither of us could imagine this formation breaking to the downside while the rest of the market moved higher. It suggested we perhaps have a low risk (I refer to that often, don't I) trade on the long side. He agreed. If the NASDAQ pulled the rest of the market lower we would have small losses, however if the rest of the market began to pull the NASDAQ with it we might just have a real nice trade. Monday's open price on QQQQ was $41.62 with a risk of $39.69 (Fridays low minus Fridays range). The action of the semi's however continued to bother us both. One of us (I really don't remember which) pointed out that there are 100 stocks in the NASDAQ 100 and they are not nearly all semiconductors. The next step was to go to the section on site, compare stocks within an index and clicked on the NASDAQ-100. We then made a list of those stocks with a relative strength rank of 90 or more. Here is that list, a + sign after the symbol indicates that the relative strength blinkers (linear regression direction of relative strength) were also positive: AMLN+; BRCM; CELG+; CHRW+; ESRX; EXPD+; GILD+; JOYG+; LRCX; NTLID; PIXR+; RHAT+; SNDK. We went slightly different ways but you can I hope get the gist of how we came to our conclusions. I point this out simply because it was, under the circumstances, a very quick way to find something good to trade and I hope it helps some in their future endeavors. Now on to some of the long-term index charts with a plethora of information pointing to the deteroration under way. You've probably heard before that about half if not more of the NYSE listed securities are non-operating companies so the data may be a bit skewed in favor of issues that are not economically but perhaps more interest rate sensitive. Nonetheless participation is narrowing on each push to new highs. Next let's take a look at another new high index, the Russell 2000. The Russell 2000 includes the smallest 2000 securities in the Russell 3000 (RUA). The Russell 3000 Index represents approximately 98% of the U.S. market. RUA made its high in March of '00 at approximately 855, its low in October of '02 at approximately 441 and is currently almost 100 points from that high sitting right on the Fibonacci 78.6% retracement point. But let's look at RUT; the Russell 2000 new high chart. As you can see from the above chart participation here is also narrowing, enough to turn the index down? There is still sufficient participation to carry this index higher but continue to watch these charts in our twice weekly postings for further deterioration to the point the average can no longer continue much higher. Now let's take our focus on the averages most traders like to follow the S&P -500 and the NASDAQ-100 (referred to above). Both are large capitalization indices and since the large cap stocks are apparently leading this latest advance these two should look promising, right? The data shown on the S&P and NDX are very similar to all the other charts, deterioration on each advance but not as yet enough to turn the indices down on an intermediate term basis. Over time if this deterioration continues these averages will no longer be able to advance but will begin to fall of their own weight. These charts are not flashing a sell signal on a short term basis but they are warning simply that change is in the wind, so when we finally do turn down regardless of the price level you should not be surprised. In addition to the data contained in the above charts if you took the time to read John Hussman's weekly commentary last Monday another ominous sign was given to you: "Meanwhile, Vickers notes that during the past week, corporate insiders (executives, directors, etc) in NYSE stocks sold 8.48 shares for every share purchased, with the 8-week average at 6.82 sales for every share purchased - figures that Vickers reasonably characterizes as ominous." Again, a sell today: No; a warning: Yes. Largest Changes This Week This Week's Economic Reports Have A Great Week! Bill Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.