Jesse Livermore is a legendary trader who needs no introduction. He is the role model for traders. He gives the credit of his success to discipline. Over his trading career he made many rules and made millions by following these rules. His money management rules are excellent and can be adopted by traders.
1.Don’t Buy entire position all at one time
Livermore believed its dangerous to take full stock position at only one price. If you want to buy 1000 shares start with 200 shares, if the stock keeps rising buy another 200 shares. Then see how it reacts if it keeps rising or corrects and then rises, you can go ahead and purchase the final 400 shares.
A trade going in the expected direction is the proof that your judgement about the price movement is correct. Conversely, if it goes against it means the judgment was wrong and you will lose the minimum when you are wrong.
Livermore always made additional purchase at a higher price when on the long side and additional short selling at the lower price when on the short side.
2. Never lose more than 10% of your investment
He called this 10% rule his bucket shop rule because he learned it while trading in the bucket shops, when he worked all his trades with 10% margin. As soon as the stock falls 10% he exits. Capital protection is a very important for a trader to survive in the market. The consequences of big losses are drastic. You have gain back 100% to cover a loss of 50%. The more you lose the more you have to earn in the consecutive trades to recover it.
Livermore also recommends to sell out positions when your broker calls and ask for more money for margin requirement on a declining stock. A trader should never average losses and should not become an involuntary investor.
3. Always keep a cash reserve
Like a good general always keeps troops in reserve for right opportunity, a successful trader must always have some cash in reserve. Market keeps on providing new opportunities but you can take advantage of those opportunities only when you have money. If you miss a good opportunity, don’t worry another will come.
4. Don’t buy or sell without any reason
You should have some reasons for entering and exiting a trade. Just because the price has appreciated few points is not the reason to sell it. Continue with the winners as long as the stock is acting right. As long as the action of the overall market and the stock does not give you cause to worry have the courage to continue your positions. The golden money management rule is cut your losses, let your profits run.
5. Put half of your profit in bank
Livermore recommends to park 50% of your profits from successful trade, especially when your capital is doubled.Take out the cost put it in the bank or hold it in reserve. Cash is sometimes your secret bullet in the chamber.
6. Pay special attention to Risk/Reward Ratio
It doesn’t matters how good trader you are, you can’t avoid losses. Its the part of the game. I have written in detail how a better risk reward ratio can make you a more profitable trader.