Lessons from the Greatest Stock Traders of All Time Proven Strategies Active Traders Can Use Today to Beat the Markets by John Boik

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1 Lessons from the Greatest Stock Traders of All Time Proven Strategies Active Traders Can Use Today to Beat the Markets by John Boik "With persistence and hard work, anything is possible. You can do it, and your own determination to succeed is the most important element." These words from William J. O'Neil, one of the five most successful stock traders examined in Lessons from the Greatest Stock Traders of All Time, neatly encapsulates the essence of the book's lessons and strategies. These five men, whose lives span the last century, illustrate that while the stock market is neither a simple nor an easy place to find wealth, with both perseverance and diligence, it is possible to succeed over the long term. From Jesse Livermore's humble beginnings in the bucket shops of Boston in the late nineteenth century to William J. O'Neil's astronomical successes over recent decades, an investigation of these experts offers strategies and techniques to power trading profits while dramatically cutting losses. Author John Boik is best known for his popular column, The Stock Market Weekly Report, for Traders Press. An influential and active trader and former stockbroker, Boik is a controller and the owner of Stock Traders Management, Inc., a private money management firm. After examining the characteristics and strategies of these five stock traders whose trading days span from the early 1890s to the present, the author notes with interest how each of the traders adopted similar strategies and disciplines. Also, Boik found that some of the traders learned from those who came before them; O'Neil studied Loeb and Livermore, and Darvas apparently reread Loeb's classic treatise The Battle for Investment Survival every two weeks. Here is a brief biography of the five traders reviewed in Lessons from the Greatest Stock Traders of All Time. Jesse Livermore: Active in the markets for upwards of 48 years, Livermore started trading as a teenager in the late nineteenth century. Over nearly five decades, he repeatedly amassed and lost fortunes, and even declared bankruptcy more than once. He anticipated the crash of 1907 and made nearly $3 million in a single day. In 1939 he published How to Trade in Stocks, and is famous for the remark: "Wall Street never changes. The pockets change, the stocks change, but Wall Street never changes because human nature never changes." Bernard Baruch: Starting as an office boy and runner at a small brokerage firm in 1891, Baruch's Wall Street activity continued through the late 1950s and garnered him a reputation as both a successful speculator and a skilled financier. After a mere five years on Wall Street, at the age of 32, Baruch amassed $3.2 million; when he died at age 94, his estate was 1 The Business Source All Rights Reserved

2 worth $17 million and it was estimated that he had donated more than $20 million to charities over his lifetime. His remarkable dedication to research and study earned him the nickname "Dr. Facts." He also had a long stint in the public service as an advisor to six different presidents. Gerald M. Loeb: Loeb's career in stock trading began in the 1920s. Soon thereafter, he began writing about the markets in publications such as Barron's, The Wall Street Journal and Investor Magazine. Initially a stockbroker with E.F. Hutton & Co. in New York, Loeb eventually became partner and later Vice-Chairman of the board. In 1935, his highly successful book, The Battle for Investment Survival was published; interestingly, when Loeb updated the book in 1971, practically no changes were made to the basic strategies of the original. While Loeb's records do not contain information on specific trades, one spectacular example of his analytical prowess relates to The Great Crash of He foresaw the Crash and started selling his portfolio nearly two months before it happened. Nicolas Darvas: The only great trader of the group who was not a broker by profession was Darvas, a professional dancer who stumbled into a very successful penny stock that piqued a lifetime interest in the stock market. Through research and perseverance, he developed and practiced strategies that garnered him a fortune of over $2 million in just over six years and landed him on the cover of Time magazine in May William J. O'Neil: O'Neil made his first trade in 1958, and over the following decades generated some of the greatest published returns in stock trading history. With Pic'N Save he saw a twenty-fold increase over seven years; with Price Company, a tenfold increase over three years; and, with America Online and Charles Schwab & Co., he made 456% and 313% respectively. By the 1980s, O'Neil's personal stock investment account averaged returns of more than 40 percent annually, and in 1998 and 1999, he realized gains of 401% and 322% respectively. Best known as the Founder and Chairman of Investor's Business Daily, O'Neil continues to write books and give lectures on winning investment strategies. The similarities linking these successful men together are easy to see: They all began with little money, but grew their seed capital into enormous wealth. They all made mistakes early on in their investing lives and lost fortunes. They learned from their mistakes, analyzed their trades and established rules that enabled them to achieve overwhelming success. It is clear from their experiences, that success in the markets is not easy; it requires effort, perseverance and insight but is definitely attainable. Common Skills The successes of all five men are based on these six common skills, habits and traits: 2 The Business Source All Rights Reserved

3 1. Strong work ethic and drive to attain high goals and success. Like any profession, it takes hard work to get to the top. With the exception of Darvas, these men devoted their full attention to stock trading; and even Darvas put in at least eight hours a day studying the market. 2. Observation and study. Identifying opportunities in the market requires dedicated and diligent observation and study. All of these great traders spent a huge amount of time analyzing the market's actions and reactions. 3. Experience. Our five experts all found real trading experience to be invaluable. Learning lessons from books is one thing, but living the highs and the lows of the market is a much more powerful teacher. One of the insights all of the traders gleaned, concerns the recurring nature of market cycles. Patterns repeat themselves in stocks and market behavior year after year and cycle after cycle. After experiencing the effects of these patterns first hand, they all came to the conclusion that watching for patterns provides excellent trading opportunities. 4. Keep emotions under control. By establishing and following strict rules, these men controlled the emotional aspect of trading that often causes intelligent traders to behave irrationally. In his early years, Livermore, like the others, discovered that being impatient in the market is one of the biggest mistakes one could make: his initial experiences in New York saw him go broke within six months because he acted impulsively and succumbed to the emotional need to trade. 5. Sound judgment and thought, common sense and humility. These traits can be overshadowed by ego and overconfidence; their value to successfully participating in the ever-challenging environment of the stock market is immeasurable. 6. Ability to react quickly and adapt to change. Markets adapt to new companies, new business practices, economics and world events, and so must successful traders. Shared Disciplines Several of the key disciplines practiced by these great traders rail up against many commonly held investment principles; however, they proved enormously worthwhile for the likes of Livermore, Baruch, Darvas, Loeb and O'Neil. For example, many people believe that the easiest money can be made with access to privileged information. However, our traders didn't act on tips or the analysis of others to make their fortunes. Each one held firmly to the practice of reading, making decisions and reaching conclusions based on their own study of the market. All five believed that tips and inside information were very hazardous. The source of the information must always be questioned. Baruch, for example, early in his speculation business, bought a railroad venture on a tip and ended up losing every dollar he invested it was a mistake he would never repeat. 3 The Business Source All Rights Reserved

4 Another shared discipline practiced by these five men was their commitment to analysis. Each and every trade they made was analyzed. Darvas, for example, kept a "cause-of-errors" table, where he tracked the reasons why he bought and sold each stock, and if he took a loss, he would write down the reason he thought it had contributed to the loss. Although this is a hard discipline to adhere to, it proved to be a critical learning tool. Setting up a reserve account, that is, taking some profits and putting them away in a separate account is another shared discipline that allowed these great traders to take advantage of market opportunities. Just as the ability to react quickly when the market changes is important, so too is having resources at hand to invest in new and better investment opportunities as they arise. Common Trading Rules Livermore, Baruch, Darvas, Loeb and O'Neil all adhered to a set of strict trading rules. Their rules were created, adjusted and refined as they kept learning, analyzing and innovating. Despite the fact that each had their own unique set of experiences in the market, they each discovered and used a number of similar practices. Rule #1 Limit losses The ability to cut your losses quickly is what separates the best traders from everyone else: There is simply no better "risk control" trading rule than to accept a small loss when you have one and move on to the next opportunity when it presents itself. With experience, all these great traders chose to set limits on how much they would risk on a stock. O'Neil's number one trading rule advocates cutting all losses at seven to eight percent below the price you paid for the stock this is his insurance policy against catastrophic losses. Livermore and Baruch would limit their initial losses to ten percent, while Loeb and Darvas cut their losses under ten percent. Rule #2 Know general market behavior Understanding what the general market is doing when entering and exiting trades is just as important as limiting losses. All of these great traders discovered, through their analysis, how most stocks act in relationship to the direction of the general market, and how difficult it can be to try to go against the momentum of the market. Darvas, for example, found that trading in only bull markets provided the best chance for profits. For O'Neil, the "M" in his CAN SLIM strategy is watching the market. His studies show that about 75 percent of all stocks follow the direction of the general market, so it simply doesn't make sense to try to make stock purchases when the trend of the market as a whole is down. Rule #3 Buy stocks when they reach a new high in price Bucking the conventional wisdom of "buy low, sell high," these traders worked 4 The Business Source All Rights Reserved

5 from the premise "buy high, sell a lot higher." They all thought that cheap stocks were cheap for a reason, and that they would usually get even cheaper. One of Livermore's main strategies was to buy stocks hitting new price highs as they pass through resistance areas. For example, he noticed that when a stock rose to a round number like $100 or $200, it would more than likely keep increasing in price as it cleared this resistance level. In 1915, he bought Bethlehem Steel at $98, watched it pass through $100 and keep rising, bought more at $114, and the next day sold at $145. Rule #4 Practice pyramiding Pyramiding is the process of buying more and more shares in a company as the stock price increases. Pyramiding allowed all these men to leverage their winning stocks, and to compound their gains by purchasing more of a strong stock as it kept getting stronger. Together, their track records of pyramiding proves for over 100 years that if done correctly, pyramiding one's strong stocks is a key to realizing large profits. For example, Loeb believed that smart traders would pyramid their buys on new highs and he would pyramid up in increments. If he decided to buy 1000 shares in a particular company, he would buy 100 shares initially, and follow with 200 more if the stock moved up, and would continue in this manner as the stock continued to move in the right direction. Rule #5 Hold onto winners; don't sell them too quickly This rule is a major contributor to the largest gains these men experienced. After realizing in their early trading that they were missing the lion's share of large price moves, each of our great traders developed the discipline of holding their winning positions longer. O'Neil, for example, would sell when he had 20-25% gains in his stocks, but would try to hold fast-rising stocks longer because he believed that the biggest profits didn't happen overnight and for decades his patience has paid off. For example, in June 1963, he purchased Syntex at $100 per share which went up 40% in eight weeks but he didn't sell to reap the quick windfall, he held onto his position for another six months accumulating a much greater profit. In fact, this trade significantly contributed to the financial success that allowed O'Neil to become one of the youngest ever (at 30) to purchase a seat on The New York Stock Exchange. Conclusion The most amazing discovery found within the pages of Lessons from the Greatest Stock Traders of All Time is that even though these great traders conducted their activities in many different time periods on Wall Street, they would ultimately discover many of the same skills, disciplines and trading rules to achieve their success. 5 The Business Source All Rights Reserved

6 Livermore, Baruch, Darvas, Loeb and O'Neil all found success by using similar strategies and these strategies can be used by any trader. So, armed with their rules, knowledge, disciplines and skills, we have powerful insights into what it takes to be a truly successful investor. 6 The Business Source All Rights Reserved