How to Probe for Profits
Famed Trader Jesse Livermore reduced risk and produced huge profits using this trading tactic.
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One of my key trading tactics is to buy very small initial positions in various stocks that catch my eye. They may have interesting news or a good chart setup, but I don't know much about them and want to do further research before I put more cash at risk.
If I don't find anything compelling, I'll dump the stock for a small gain or loss and move on to something else. But if there is something intriguing, I want to pursue it to a greater extent. I'll increase my position, dig a bit deeper into the fundamentals, and watch the price action more closely.
The losses incurred on these small trades, which are of no further interest, are irrelevant. I consider them just a cost of doing business. I don't mind striking out dozens of times if I can hit just one home run.
Many traders fear the idea of making a losing trade of any size. They worry too much about their batting average and think it reflects on them negatively if they have a bad trade. They want to be absolutely sure they are buying the best possible stock before they commit any money to it. They then jump in aggressively with a single purchase, cross their fingers, and hope for a quick profit.
This rigid approach to establishing a trade overlooks tactics that can reduce risk and enhance profitability. What I am doing with my small initial buys is probing for the right combination of fundamentals and technicals. The probing strategy isn't complicated. It is nothing more than making small, calculated buys to test the water. This allows traders to build confidence, manage risk, and capitalize on evolving market conditions. The goal is to approach trades as a dynamic process rather than one-off transactions.
The Power of Probing Buys
Probing involves initiating a trade with a small position to gauge price action and market dynamics. If the stock performs favorably, you increase your position incrementally and hopefully align with the building momentum. If the trade underperforms, the limited exposure minimizes losses, allowing you to exit without significant damage.
Legendary trader Jesse Livermore is considered by many to be one of the greatest traders of all time. He was known as the "Boy Plunger" for his big, bold bets, and once was one of the richest people in the world.
Livermore had huge wins and huge losses. What was particularly frustrating for him was that many of his major losing trades would have eventually worked extremely well if his timing had been just a little different. He built his position too big and too fast, and couldn't stay with them when they didn't immediately work.
Eventually, Livermore dealt with this problem of timing by developing a method he called "probing." Rather than jump right in immediately, he would probe the market by making small buys that would help him gain a sense of the price action. If he liked what he saw, he would add to the position and start to pyramid it as it moved in his favor.
He compared this approach to a military officer sending out a reconnaissance patrol to spy on the enemy and gather intelligence. The knowledge gained by this probing would allow him to attack aggressively at the right time.
The probing method has several benefits. First, it helps to keep emotions under control when you start small and keep the risk limited. You will find that your view of a stock will often change very fast once you actually own some. I often find that I will avoid a chart that at first glance seems too technically extended, but after I make a small initial buy and then watch the action, my attitude about it will shift as I follow the price action more closely and gain a sense of the stock's personality. Rather than just dismiss it as a missed trade, I am now focused on looking for an opportunity to press as the chart develops.
A second benefit of the probing approach is that it allows for a much higher level of aggressiveness when you trade incrementally. Since you can manage risk more closely, it is possible to take bigger positions as you monitor the situation.
Livermore had two key conditions to his probing buys. First, he made sure to determine the exact size that he ultimately intended to hold if the stock developed properly. He had a plan in advance and didn't just add shares randomly. His initial probing buy would generally be about 20% of the total. The goal is to have a plan and not be tempted to modify it as your emotions kick in as the price action develops.
This first rule goes hand-in-hand with a second, which is that you only add to the trade if it is acting in a positive manner. You don't try to lower your basis because you hope that the market will eventually appreciate the positive fundamentals of this stock. What you do is add to your position as the price action proves that the market is discovering the merits of the situation. That is what helps you improve your timing. You aren't trying to guess when a stock will move. You are embracing it as it moves and does what it is supposed to do.
Much of the movement of any stock is random and doesn't have much meaning. Good traders can take advantage of that as they watch the situation and consider it in context with overall market conditions.
One variation that I add to the probing approach is trading part of the position with shorter timeframes. Rather than treat it as one big trade that is established incrementally, I will think of it as several trades with different time frames. This has many of the same benefits as the probing approach, but helps to mitigate risk when there are some quick flips and reduces risk as you build a position.
Waiting for the "perfect" trade leads to a tremendous amount of missed opportunities. Probing forces action by committing a small stake, which sharpens your focus and deepens your understanding of the stock's behavior. Even a modest buy transforms theoretical analysis into practical insight, positioning you to seize opportunities as they unfold.
Probing buys offer a disciplined, adaptive approach to trade and invest by balancing risk and reward in a more effective manner. By starting small, observing price action, and scaling strategically, traders can improve timing, manage emotions, and maximize profits. In a market full of uncertainties, probing turns cautious steps into confident strides, unlocking the potential for consistent success.
At the time of publication, DePorre had no position in any security mentioned.
