“Stocks don’t move, they are moved.” Jack Cooper
Some of you may be familiar with my story. But it has been many years since the revised editions of my Hit & Run books…
So a little background is in order.
In the late 1950’s my father, Jack,had sold a textile business in the east for millions and our family moved to Beverly Hills.
In order to keep busy my dad invested in the stock market.
Brokers would call two three four ties a day with their investment ideas:
Jack, Bethlehem Steel looks good. Jack, I like the auto’s. Jack, Eastman Kodak is a steal. Jack I’ve got the next IBM.
After my father invested all his cash, the brokers introduced him to a new investment technique: margin.
Jack, we can buy twice the amount of companies using the stocks in your portfolio as margin. You’ll make double the amount of money when the stocks go up.
Remember, stocks always go up if you hold them long enough.
This made sense to my father and he went along.
In May 1962, my father went bankrupt. On the day my mother was being operated on for cancer, the market was crashing and the brokers who told my father that stocks always go up had no way of reaching my father and were mass liquidating his portfolio to meet margin calls.
Our family’s net worth was not only wiped out, but we owed the brokerage houses money.
This was my introduction to the buy and hold strategy that once again, has become more popular that ever: not only has the market survived two hear attacks ….in 2001 to 2002 and 2007 to 2009 this century, but recovered to new highs relatively quicly—unlike prior bear markets like the 1930’s when it took 25 years to eclipse the high made in 1929 or the bear that started in early 1973 that went on for almost 10 years.
My father had to sell our house and we were forced to move back east.
But fate was not done with the Cooper family; our moving van caught fire in Needles, Arizona and all our possessions were destroyed.
This was my first lesson with cycles in life.
My father could have been the poster child for the Vince Lombardi saying: “It’s not whether you get knocked down, it’s whether you get up.”
Within 5 years my dad sold another textile business for millions and in the early 1970’s we were on our way back to California.
There was a lingering matter to be settled: my father was going to make back the money he had lost in the stock market.
After selling a skateboard business I started, Dogtown Skates, I went to work for my dad who had started a small private hedge fund.
He retired and after a brief stint at Drexel Burnham I went out to replicate my fathers success. I was making great money until October 1987 when the buy and hold curse hit another member of the Cooper family.
Fortunately, I was not on margin and I did not go bankrupt, but I did get hurt and learned a bitter lesson.
I knew if I was going to stay in the game, I had to develop a method that was just as concerned with my return OF capital as my return on capital.
About the 13 Laws
I had learned two valuable rules: rule # 1, don’t lose money and rule #2 don’t forget rule # 1— and I had learned them the hard way.
In all seriousness, I had learned two valuable lessons: as in sports, the game is one by defense. The game is lost by unforced errors.
I had learned that being risk adverse was critical and that the amount of time exposed risk was an important factor in performance.
In other words, performance doesn’t exist in a vacuum, it must be measured by the amount of time exposed to risk…the amount of time in a trade, the amount of time in the market.
Something buy & hold does not account for.
As the saying goes Time Is Money.
I set out on a quest to develop a methodology to profit day by day, week by week both long and short in the stock market.
After all these years, I can confidently say that methodology has been successful and is still working for me and thousands of traders who have subscribed.
The 13 laws of trading is not about my strategies and tactics that make up the skeleton of my methods. This is about 13 conceptually correct laws for active trading.
Law #1 It’s okay to guess wrong. It’s a sin to stay wrong.
As George Soros says, “ I’m only rich because I know when I’m wrong… I basically have survived by recognizing my mistakes.”
In my experience emotional capital is as valuable as financial capital. My 13 laws will help you adhere to the discipline of taking a loss because you will have the confidence that just continuation the process of taking solid setups will lead to profitability.
Set ups are just set ups. The market can do anything at anytime.
My strategies have a proven consistent edge, but that is not a guarantee.
As traders, by nature we’re transactional. We like the action.
The market presents a log of opportunity to be validated, to be right…AND to be wrong.
We all get what we’re looking for in the market. If you’re looking for validation, you’re going to fight getting out of a losing trade.
I use time stops as well as price stops.
When we initiate a trade, there is a ruling reason. If the setup isn’t playing out, I get out.
If the setup revalidates itself you can get right back in.
Patience pays, but only to a point.
In my experience this is a game of balancing patience with taking action.
Using time stops along with price stops helps limit risk. And, risk must be measured by how much time exposure one has. In other words, obviously a 10% gain for example in one day is different than a 10% gain in 1 month.
You have to decide what’s more important: to be right or to make money. I know this was a challenge for me when I got into the game. I had opinions about things that made it hard to give up on a position.
As long time readers have heard me say: speculation is observation pure and experiential. Thinking can just get in the way.
If you’re in the game to make money, then you just keep taking the setups and honoring the stops.
The validation, the satisfaction comes from adhering to the process.
After some years and some healthy drawdowns, I was able to put my ego in check. I was able to derive a sense of satisfaction and self-approval from being right in following the process—good, bad or indifferent.
It’s easy to get into a trade. It’s more difficult to get out emotionally. This is why I use time stops and price stops and why it is necessary to determine a stop BEFORE you enter…not once you’re in the trade.
If you try to define a stop after you have entered the trade, the temptation is to say let me give it a little more room, let me give it a little more time.
This is the kiss of death.
When a trade is not working out, get out. No one likes a divorce. That’s why I make it a point to date but not to marry positions.
Likewise, there is a time and a place to realize profits.
This can be much more difficult to determine than a good risk to reward entry.
This is why I typically always scale out or Scale & Trail.
In other words, I scale out by selling half a position and then use a trailing protective stop on the balance.
Great traders will not only not stay wrong but are flexible enough and secure enough to reverse their positions as they know that fast moves often come from false moves.
This underpins the saying that it’s ok to guess wrong but it’s a sin to stay wrong.
Trust me I’ve been there, it’s as if the market can smell when you’re wrong and trapped.
And it’s so easy to just get out when you’re uncomfortable.
As Jesse Livermore said, “Losing money is the least of my troubles. A loss never troubles me after I take it. I forget it overnight. But being wrong—not taking the loss—that is what does the damage to the pocket book and to the soul.”
#2) Never Confuse Your Position With Your Best Interest
“I’m always thinking about losing money as opposed to making money. Don’t focus on making money, focus on protecting what you have.”
The return of capital is more important than the return on capital.
“Sometimes failure is merely chasing you off the wrong road and onto the right one.” Paul Tudor Jones
Never confuse your position with your best interest.
This is really a corollary to the first law of trading.
Said another way, when in doubt, get out.
The back bone of my methodology is that you can survive small losses, but big ones are hard to overcome.
The analogy I like to use to describe my trading philosophy is like that of a small bird swooping down for a crumb of bread and flying off. If the small bird hangs around trying to eat the entire piece of bread (because the bread is too large to fly away with) a larger bird will snatch his whole dinner.
Small losses are part of the game. But a large loss is devastating because emotional capital is as important as trading capital.
Then there’s the Ant Hill Syndrome. After accumulating many small gains that amount to a tidy pile, it’s only natural that after a long stint of gains we may be enticed to play a little fast and loose with our profits—and our discipline.
We think we know something. We can become over confident in ourselves and our strategies.
This is when we are most vulnerable and the pile of winnings is subject to being stepped on by Mr. Market.
Like an ant hill.
Never play macho man with the market.
Mr. Market can smell ego as easily as he can smell fear.
This is grist for his mill.
There is nothing foolproof in the markets. As Elvis said “the only thing foolproof is a Coupe de Ville”—and even then, only if you use the brakes…the stops.
Always adhere to a stop and then always have an uncle point for when you don’t honor your stop.
Again, never confuse your position with your best interest. Never confuse your positon with a “story”.
Don’t listen to and look for narratives about why you should stay in your position.
Remember thinking isn’t necessary and often just gets us into trouble.
#3) The Second Mouse Gets the Cheese
“Michael Marcus taught me one other thing that is absolutely critical: You have to be willing to make mistakes regularly; there is nothing wrong with it. Michael taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.” Bruce Kovner
Part and parcel of not being married to a set up means having the flexibility to go back to a setup when it retriggers or revalidates.
Early in my career I heard a story from a friend of Paul Tudor Jones.
Tudor Jones was starting out in the cotton pits. He saw a nice looking setup, got long and his stop was hit.
The setup revalidated and he went long again.
Once again he was stopped out.
The set up triggered a 3rd time and Jones went long.
Cotton ran big and as the story goes he made his initial big capital kickstarting his career.
As I put it, the first mouse gets the squeeze, the second mouse gets the cheese.
In other words, the first signal often sees players get squeezed; but the second signal gets the cheese.
Keep in mind that there are thousands of traders that may recognize a potentially nice setup.
The market does not exist to accommodate.
Sometimes when many players jump on a setup all at once they get squeezed out— In the near term, markets revolve around “positioning”.
As well, stocks can be gamed and manipulated by big players and market makers.
As my dad used to say, stocks don’t move, they are moved.
#4) Crocodile Rock— Focus on Behavior AND Levels
“It’s critical for the crocodile to understand its prey and to know where to look for it and remain calm and patient until it arrives. As traders, we have to know what our trading edge looks like and where to look for it and then control ourselves enough to not over-trade before it arrives.” Nial Fuiler
This game is as much art as it is science. By that I mean it that while I’m a technician and my entries are based on price action, and we have to mechanically take the setups as they trigger, that does not ensure a profitable outcome. It is the ensuing behavior after a setup is triggered that tells the tale.
For example, it is not just the break of a well-defined trendline that telegraphs a new upleg or down leg, it is the ensuing behavior.
It is the behavior after a signal bar that tells the tale.
I key off price as opposed to indicators because all indicators are derived from price and price or volume.
Indicators are second degree derivatives…why not go right to the horses mouth: PRICE.
Price is the point of the sword. Price is the final arbiter.
I typically never use indicators such as oscillators or MACD’s: In my experience indicators are more descriptive than they are predictive.
It is the price behavior at particular levels that put the odds in your favor.
For example, stocks like to test. In so doing a reversal may play out at a W Bottom formation or a Double Top pattern.
Likewise I look for price signals at important moving averages such as the 20, 50 and 200 day and the 50 period on the hourlies for intraday pivots.
It is important to watch the price behavior at key levels on tests of well-watched moving averages or prior important swing highs and lows or at 50% retracements.
At the end of the day my job is to track patterns of accumulation and distribution and report superior risk to reward setups to you.
This is why I say that speculation is observation, pure and experiential.
Thinking isn’t necessary and often just gets us into trouble.
#5) Markets have a tendency to play out in threes.
Triple tops and bottoms. Head & Shoulders patterns and my 1 2 3 Pullback buy strategy and my 1 2 3 Snapback short strategy.
Then there’s the 3 Day Rule. After 9/11 when the market was closed, after it reopened it went down 3 consecutive days before finding bottom.
The crash in 1987 was a bad Thursday and an uglier Friday with Monday being Black Monday, the crash day was followed by a Turnaround Tuesday.
There seems to be a cycle of 3 in the markets, be it 3 days, 3 weeks or 3 months.
This was one of the keys to forecasting in W.D. Gann’s coded novel The Tunnel Thru the Air.
As legendary investor Seth Klarman says, “The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.
3 Day spikes, up or down, often define Buying and Selling Climaxes for the near term at least.
When a stock runs up for 3 days and then gaps up and reverses to fill the gap, you may be looking at short term exhaustion (and vice versa).
Our swing method keys off the important W.D. Gann 3 Day Chart and 3 Week Chart which do a good job determining the short term and intermediate tern trends.
The 3 Day Chart turns up on 3 consecutive higher daily highs. The 3 Day Chart turns down on 3 consecutive lower daily lows.
I developed my daily and weekly Plus One/Minus Two Buy Method using this three period time frame.
#6) I use the 20 and 50 and 200 day moving averages and the 20 week moving average as guidance.
Whether the reason they work is because they are self-fulfilling as so many traders use them is irrelevant. They work.
If there is any one tool that can help one survive the peculiar nature of the market it is moving averages.
As Bruce Lee stated, “Adapt what is useful, reject what is useless. I fear not the man who has practiced 10,00 kicks once, but I fear the man who has practiced one kick 10,000 times.”
Fast moves come from false moves
Range precedes price. Volatility precedes price
#7) Even if you are a day trader or intraday trader, you must be aware of all time frames. Multiple time frame analysis will help you make profitable short term trades.
The dailies don’t exist in a vacuum. They exist within the context of the weeklies and monthlies.
Analyzing market time frames will stack the odds in your favor to make a profitable short-term trade.
Not all setups are created equal. All trading is contextual, that is setups occur within the context of the primary and secondary trends.
The market is a matrix of wheels within wheels: the weekly trend sets up the backdrop for daily setups just as the daily trend sets up intraday trends.
I like to buy pullbacks in a strongly up trending stock as long opportunities until proven otherwise.
The key word is ‘proven otherwise’. When the character of the trend changes, the stock talks.
Likewise I like to use bounces in strongly downtrending stocks as selling opportunities.
In other words, I am looking to buy strong stocks as they crouch and I am looking to short weak stocks as they try to stand on their tip toes.
Multiple time frame analysis using my 3 Week Chart and 3 Day Chart Method in tandem with the Monthly Swing Chart does a good job of defining and determining the primary and secondary trends.
Knowing your time frames keeps you in synch with the main trend and the secondary trend.
Map a trade using multiple time frame analysis.
As Jesse Livermore said, “Speculators without a plan are like a general without a strategy, and therefore without an actionable battle plan. Speculators without a single clear plan can only act and react, act and react, to the slings and arrows of stock market misfortune, until they are defeated.
My plan is accessing patterns of accumulation and distribution across the various time frames.
#8) Don’t rush to trade the open like a Pavlovian dog reacting to the dinner bell.
There are a lot of misdirection moves out of the gate.
Recently we had SHOP as a short idea in our nightly report the day before it plunged 16 points the next day.
Pre-market SHOP was actually up 2 points.
Stocks often make first half hour to first hour highs or lows.
After the first half hour to hour one can often get a sense of whether a trend day, a continuation day or a reversal day is on the table.
Don’t rush into stocks on the open unless there’s a very good reason to do so combined with market tone.
As Warren Buffet says, “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.”
#9) Part and parcel of the not rushing in on the open is my Opening Range Breakout (ORB) strategy.
I often use the range of the first 30 minutes to define my entry points…whether long or short.
In other words I bracket the first 30 mins range. A push above the high of the range triggers an Opening Range Breakout or ORB which often signals a trend day higher.
However, it is always important to remember that fast moves come from false moves and that follow through is key.
For example if a stock triggers an up ORB and then later declines below the first 30 minutes range this is Reverse ORB which often can lead to a powerful move.
We use this method every day to enter long and short setups from our Nightly Stock Report.
#10) Although I believe there is an underlying natural synergy that the market adheres to, that is an intellectual conjecture.
Be flexible with targets.
Don’t be a shtick for a tick.
In other words most of the time the correct posture is to enter and exit at the market.
Market’s tend to go farther than anyone anticipates—in both directions.
To deal with this tendency, I usually scale in and scale out of positions.
With my swing trades we sell half at/near a designated target and then then trail a protective stop on the balance.
I do this because there is nothing more frustrating than watching a gain completely evaporate.
This method builds emotional capital which is just as important as dry powder.
The cardinal sin is letting a profit go to a loss.
No matter what your opinion is be flexible. In this game only the humble survive.
#11) Another cardinal sin is trying to get even.
This is lethal
The market owes us nothing.
It has no idea where we are in position from or that we are even in a position.
The market has a second sense of where the bodies are buried and seldom returns to the scene of the crime to let players get even.
Outside of the markets we are taught never to give up.
As Winston Churchill, one of my heroes, said, “Never give up, never give up, never give up.”
In the markets this can be the kiss of death.
As Linda Raschke says, “When the ship starts to sink, don’t pray—jump!”
A great surgeon never gives up. They can almost will a patient back to life.
In the markets, trying to rescue a trade and get even will have you fighting an uphill and losing battle.
Wait to play in league with the line of least resistance as surprises happen in the direction of the trend.
When you find yourself fighting a losing position, more often than not another surprise will happen in the direction contrary to your position.
#12) As I said earlier, although I believe there is an innate natural order underlying the market, when it comes to actual trades the best posture to operate from is that the market is not a fine Swiss watch.
While I have targets, they are not carved in stone. Rather they are to provide a frame of reference.
While it may feel emotionally and intellectually gratifying to try to nail a top or bottom produces losses and gets one too invested in what a stock should do rather than what it is doing.
More important than trying to nail a top or bottom is to be in synch with the line of least resistance.
This is a dangerous area to try to prove how smart you are. We’re just trying to make cash flow.
If understanding the market was purely about intelligence James Grant would be richer than Bill Gates.
As Victor Sperandeo says, “The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading. I know this will sound like a cliché, but the single most important reason people lose money in the financial markets is that they don’t cut their losses short.”
Said another way emotional IQ is more important than intelligence when it comes to trading.
The most elusive element in the market is time.
Timing is everything.
Your conjecture may be right but your timing may be wrong.
The market can disregard things for a lot longer than one can imagine.
#13) As Warren Buffet says “There seems to be some perverse human characteristic that likes to make easy things difficult.”
It’s easy to get overwhelmed in the markets. There’s a ton of information…both technical and fundamental.
The more you try to see, often the less you see.
Keeping it simple means following a universe of stocks that you track in order to get to know their personality…like an old friend.
While I am always adjusting my watch list, I always follow a core group of stocks.
There are too many moving parts in the market to get an unequivocal picture.
My way of keeping things simple is to allow price to be the final arbiter.
I don’t use indicators. They are derived from price and or price and volume so why not go right to the horses mouth: price itself.
In my experience, indicators are more descriptive than predicative.
Price and its tapestry: pattern.
As Jesse Livermore said, “The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you can familiarize yourself with the actions of the past, you will be able o anticipate and act correctly and profitably upon forthcoming movements.”