“Tversky and Kahneman originally described “Prospect Theory” in 1979. They found that contrary to expected utility theory, people placed different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains. Some economists have concluded that investors typically consider the loss of $1 dollar twice as painful as the pleasure received from a $1 gain. They also found that individuals will respond differently to equivalent situations depending on whether it is presented in the context of losses or gains. Researchers have also found that people are willing to take more risks to avoid losses than to realize gains. Faced with sure gain, most investors are risk-averse, but faced with sure loss, investors become risk-takers.”
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Jesse Livermore continues to offer timeless lessons:
All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical (technical) formations and patterns recur on a constant basis. The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor.Don’t take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don’t be an impatient trader.
It is foolhardy to make a second trade, if your first trade shows you a loss. Never average losses. Let this thought be written indelibly upon your mind. Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes. When a margin call reaches you, close your account. Never meet a margin call. You are on the wrong side of a market. Why send good money after bad? Keep that good money for another day.
Successful traders always follow the line of least resistance. Follow the trend. The trend is your friend. A prudent speculator never argues with the tape. Markets are never wrong opinions often are. Few people succeed in the market because they have no patience. They have a strong desire to get rich quickly. I absolutely believe that price movement patterns are being repeated. They are recurring patterns that appear over and over, with slight variations. This is because markets are driven by humans and human nature never changes. When you make a trade, you should have a clear target where to sell if the market moves against you. And you must obey your rules! Never sustain a loss of more than 10% of your capital. Losses are twice as expensive to make up. I always established a stop before making a trade. I am fully aware that of the millions of people who speculate in the markets, few people spend full time involved in the art of speculation. Yet, as far as I’m concerned it is a full-time job perhaps even more than a job. Perhaps it is a vocation, where many are called but few are singled out for success. The big money is made by the sittin’ and the waitin’ not the thinking. Wait until all the factors are in your favor before making the trade.
It was never my thinking that made big money for me. It was my sitting…Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after this that a stock operator can make big money. it is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of ignorance. Give up trying to catch the last eighth – or the first. These two are the most expensive eighths in the world. Without faith in his own judgment no man can go very far in this game. That is about all I have learned – to study general conditions, to take a position and stick to it. Remember that stocks are never to high for you to begin buying or too low to begin selling.
That is where the tape comes in – to enable you to decide as to the proper time for beginning. Much depends upon beginning at exactly the right time. If you begin right you will not see your profitable position seriously menaced; and then you will find no trouble in sitting tight. The public, with their eyes fixed on the stock market, saw little – that week. The wise stock operators saw much – that year. That was the difference. A speculator must not merely be a student, he must be both a student and a speculator.
Tape reading was an important part of the game; so was beginning at the right time; so was sticking to your position. But my greatest discovery was that a man must study general conditions, to size them up so as to be able to anticipate probabilities. I knew that some day I would find out what was wrong and I would stop being wrong. I would then have not alone the will to be right but the knowledge to insure my being right. And that would mean power. A loss never bothers me after I take it. I forget it overnight. But being wrong – not taking a loss – that is what does damage to the pocketbook and to the soul.
The speculator is not an investor. His object is not to secure a steady return on his money at a good rate of interest, but to profit by either a rise or fall in the price of whatever he is speculating in. Therefore the thing to do is to determine the line of least resistance at the moment of trading; and what he should wait for is the right moment when the line defines itself, because that is his signal to get busy. In a narrow market, when prices are not getting anywhere to speak of but move in a narrow range, there is no sense in trying to anticipate what next big movement is going to be – up or down. Instead of hoping he must fear and instead of fearing he must hope.He must fear that his loss may develop into a much bigger loss, and hope that his profit may become a big profit.
A man may beat a stock or group at a certain time, but no man living can beat the stock market. A man must know himself thoroughly if he is going to make a good job out of trading in the speculative markets. I learned that the weaknesses to which a speculator is prone are almost numberless. Among the hazards of speculation the happening of the unexpected – I might even say of the unexpectable – ranks high. Observation, experience, memory and mathematics – these are what the successful trader must depend on. There is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. Of course there is always a reason for fluctuations, but what the tape does not concern itself with the why and wherefore. It doesn’t go into explanations. The reason for what a certain stock does today may not be known for two or three days, or weeks, or months. But what the dickens does that matter? Your business with the tape is now – not tomorrow. The reason can wait. But you must act instantly or be left.
There is a time for all things, but I didn’t know it. And that is precisely what beats so many men on Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time. No man can always have adequate reasons for buying and selling stocks daily – or sufficient knowledge to make his play an intelligent play. The desire for constant action irrespective of underlying conditions is responsible for many losses on Wall Street even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages.
I never argue with the tape. Getting sore at the market doesn’t get you anywhere. Much more to the game of speculation than to play for fluctuations for a few points. There is one side to the stock market; and it is not the bull side or bear side, but the right side. A man must believe in himself and his judgement if he expects to make a living at this game. 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. It seems so obvious now that tape reading is not enough, irrespective of broker execution, that I wonder why I didn’t then see both my trouble and the remedy for it.
I can’t tell you how it came to take me so many years to learn that instead of placing piking bets on what the next few quotations were going to be, my game was to anticipate what was going to happen in a big way. Since suckers always lose money when they gamble on stocks – they never really speculate. There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn! The game of speculation isn’t all mathematics or set rules, however rigid the main laws may be.
If a stock doesn’t act right don’t touch it; because being unable to tell precisely what is wrong; you cannot tell which way it is going. I should say that a chart helps those who can read it or rather who can assimilate what they read. The average chart reader, however, is apt to become obsessed with the notion that the dips and peaks and primary and secondary movements are all there is to stock speculation. If he pushes his confidence to its logical limit he is bound to go broke. I can see now that my main trouble was my failure to grasp the fundamental difference between stock gambling and stock speculation. I had to study what was going to happen; to anticipate stock movements.
It was the change in my own attitude that was of supreme importance to me. It taught me little by little, the essential difference between betting on fluctuations and anticipating inevitable advances and declines, between gambling and speculating. I made up my mind to be wise and play carefully, conservatively. Everybody knew that the way to do that was to take profits and buy back your stocks on reactions. And that is precisely what I did, or rather what I tried to do.
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