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3 Jesse Livermore Rules for a Fed Taper

NEW YORK ( TheStreet) -- Before I discuss the current market outlook, I'd like to summarize a few investment rules made famous by American stock trader Jesse Livermore that are especially pertinent this week:

  1. Pivotal Points. The core of Livermore's timing strategy was built upon two categories of pivotal points. The first he called a reversal pivotal point and the second he called a continuation pivotal point. Optimum buy and sell opportunities occur when an investor is able to identify these key market moments. A speculator has to be patient, Livermore remarked that he always made money when he waited and traded on the confirmation of these pivotal points.
  2. When entering a new trade rooted in a pivotal point thesis, Livermore let the market tell him what to do. He got his clues and cues from what the market told him. He did not anticipate: "To anticipate the market is to gamble; to be patient and react only when the market gives the signal is to speculate." One must be right on the moves but also right on the timing. Therefore, Livermore pioneered the probing strategy similar to a commanding officer sending out a reconnaissance platoon to probe the enemy lines and gather intelligence before unleashing the troops. Averaging into an allocation enables you to avoid pitfalls. If your initial allocation loses 10% it's time to cut losses, admit your mistake, and exit the trade. Averaging in is a sure way to confirm judgement.
  3. If the line of least resistance cannot be identified, it is best to be in cash. The trend is your friend. No trend means get out. Investors should learn to be comfortable in cash.

With these three rules providing a conversational foundation, let's discuss the market outlook.

On Friday we were faced with a potential double whammy of negativity because of Federal Reserve bond purchase tapering on Wednesday and a Larry Summers nomination to Fed chairman by President Obama. Summers was a disaster waiting to happen because of his anti-stimulus bias. The decision to pull his name from consideration provides the stock market with a significant long-term boost.

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