Watch out, bears! The bulls are ready to roll up their sleeves. That was the message in Thursday's big push higher last week.

Ever since the market bounced back from GE's nasty earnings miss, there's been a sense that the buyers have more mojo than the sellers. That bullish mojo seemed to dry up Wednesday, suggesting angst over the Fed's next move. But then came Thursday, and the bulls went all out. Friday was so-so, but the optimism endures.

Trades that have been working for a long time -- energy, metals and so on -- have temporarily reversed. Stuff that was beaten down -- tech, financials, home builders and so on -- have caught a strong bid.

So does that mean it's time to reverse last week's call for more pain in the financials? Is it time to embrace new upside there and change the game plan around?

Nope. Not unless the key facts have changed. The bottom line is, there's a new hope jag in town... but the question is how long it will stick around.

Of course, you can make some good coin being long selective names. My friend Cash's Blackstone pick, for example, is up about 20% from his recommended entry point as of this writing. (See previous Taipan Daily episode, "Cash Makes a Controversial Call.") But on the whole, I'd still rather be on the sidelines in financials (waiting for a reversal) than long them.

It's also interesting to note that financial stocks, in rally mode, are approaching their 50-week moving average from below. Meanwhile gold and silver, in correction mode, are approaching their 50-week MA from above.

The 50-week MA could act like a ceiling in regard to the financials. For gold and silver, it could act like a floor. I suspect that, at some point soon, these markets will trade places and revert back to longer-term trend.

Why? Because underlying conditions haven't changed all that much… and as Jesse Livermore once noted, the speculator's greatest and truest allies are underlying conditions. Inflation is still a growing (and global) threat. Western banks are still coughing up hairballs. Consumer pain is still an early stage problem, in both the U.S. and Europe; the printing press still looms. Evidence on the ground hasn't truly improved. The only thing that has, really, is Wall Street's mood.

The Best Trading Book Ever Written

Speaking of Jesse Livermore there. Hopefully you've heard of him.

Livermore was a great trader in the early years of the 20th century. The book that tells his story, Reminiscences of a Stock Operator, is widely agreed to be the best trading book of all time. There are gems of insight on nearly every page. And though Reminiscences was first published in 1923, its wisdom applies today more than ever. (Technology has advanced since then, but human nature not a whit.)

If you haven't read Reminiscences and have no interest in trading, then that's fine. If you do have an interest in trading, however -- or even just the least bit of curiosity -- then by all means run, do not walk, to get your hands on a copy of this book.

The author of the book is a man named Edwin Lefevre. (Livermore told his story to Lefevre, a professional writer, who then turned it into a first-person narrative. The narrator in the book gives his name as "Larry Livingston.") You can find a copy in your local bookstore, or on Amazon.com... or even free on the Internet. (The font isn't all that appealing, but the book is available in PDF form here: http://www.scribd.com/doc/7923/Reminiscences-of-a-Stock-Operator)

For those not inclined to read the whole thing, I have a list of the top trading quotes and stories from the book. (I've read it multiple times, and compiled the list years ago.) It's a pretty long list, but not as long as the 250 or so pages.

Since the text has passed into public domain, I imagine it would be okay to post that list on the Taipan Web site -- but only if enough folks are interested. (If that sounds good to you, send an e-mail to (taipan@taipanpublishinggroup.com) with something like "Livermore quotes" in the subject line.)

This is the quote that came to mind most recently:

[The successful trader] must not only observe accurately but remember at all times what he has observed. He cannot bet on the unreasonable or the unexpected, however strong his personal convictions may be about man's unreasonableness or however certain he may feel that the unexpected happens very frequently. He must bet always on probabilities -- that is, try to anticipate them.

I call this "playing the odds game." It means being aware of reward to risk, being aware of the chances (or "odds") of an event happening, and combining those two things in an effort to make good trading decisions.

Oftentimes, playing the odds game means passing up a trading opportunity -- even if it looks tempting in the short term. A healthy respect for probability means thinking about risk as much as reward; that in turn means thinking how a trade might play out if it were reenacted not just once or twice, but a hundred or even a thousand times.

A Poker Room Example

In poker, knowledge of the odds game (or lack thereof) can lead to very different outcomes.

When the amateur Texas Hold 'Em player folds a lousy hand, and then sees it would have turned into a monster hand on the flop, the immediate feeling is a wave of strong regret. Oh man, I could have made a ton of money with that hand! Why was I so dumb to fold? This feeling of regret becomes a spur to play weak hands more often... which only leads to trouble.

When the pro faces that same situation, the internal reaction is very different. Thanks to a working knowledge of odds, the pro feels little or no regret at missing that beautiful flop. He (or she) knows that the profits from a bad play are a siren song and a call to destruction, because the key factor is long-run probability. The pro recalls that even if a lousy play is profitable in one memorable instance, seven times out of eight it will probably cost money... and those losses over time will more than wipe out the gains.

It's hard to think like this, and not at all intuitive. Thinking in terms of long-run odds -- weighing probabilities as a matter of course -- goes against the grain of our internal wiring. Our nervous systems are designed to weigh the here-and-now evidence sitting right in front of our noses, not to concoct abstract probability chains that stretch off into the distance.

That's bad news and good news at the same time. The bad news is that learning to play the odds game is tough, and that in turn makes trading a tough discipline. But the good news is, this same reality is what makes trading lucrative. (If it were easy to master, there'd simply be no money in it.)

A Timely Investing Example

Knowing how to play the odds game is important for investors, too. Here's a timely example.

The big news over the weekend was the bust-up of the Microsoft-Yahoo deal. Microsoft refused to pay up for Yahoo's demands of more cash per share, and Yahoo refused to budge. So Steve Ballmer, Microsoft's hard-charging CEO, surprised Wall Street by declaring his intent to walk away.

I'm finishing this up shortly before the opening bell, so I don't know how much Yahoo's stock will drop. But the general thought is that YHOO is going to fall -- and fall hard. Some think the stock could be cut in half, or worse, as a result of the deal's collapse. (We'll see... by the time you read this, YHOO will be trading.)

One of the largest holders of YHOO is Bill Miller, the famed Legg Mason mutual fund manager who beat the S&P for some impressive number of years in a row. Miller's fund owns a huge slug of Yahoo stock -- a couple billion dollars' worth at last count. (According to recent reports, Miller’s fund was the second-largest Yahoo shareholder, with a 6-7% stake.)

Here's where the odds example comes in. As I told a friend Sunday night, Miller should have dumped at least half of his multibillion-dollar YHOO position, if not all of it, over the past two months or so. Why? Because once the Microsoft deal premium got priced in to the stock, holding YHOO shares was almost all risk and no reward.

Just consider the following: On news of the Microsoft offer, YHOO jumped 52% or so, to the recent range of $27-$30 per share, where it hovered for weeks. After that big jump, two future scenarios arose:

• Microsoft gives in to Yahoo's demands for another few bucks per share; YHOO rises another 5-10% to reflect the slightly higher deal price. YHOO shareholders get bought out at a slight premium.

• The deal unexpectedly collapses; Yahoo's shares collapse along with it, leaving a potential 30-50% loss (or worse) as disgusted investors bail. YHOO shareholders get killed.

The odds here are figured in reward-to-risk terms. Miller's potential reward, another few bucks per share, was tiny in comparison to his risk -- the possibility that the deal might collapse (as it actually did). Given a path divergence this stark, Miller should have cashed in most of, if not all of, his YHOO chips. (Did he though? I have no idea.)

Basic concepts like odds, probability and reward vs. risk seem elementary when you think about them. And yet, it's amazing how many investors and traders don't think about these things. In the real world, factors like sloppy analysis, emotional decision making, and even goofy institutional rules often stand in the way of common sense.

That creates opportunity for those of us willing to embrace the odds game.