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Jesse Livermore

Terminology

Bond

A bond is a contract between a corporation (or government agency) and an investor where the investor loans the corporation (or government agency) a certain amount of money for which the investor receives an agreed upon interest payment.

Money Management

Money Management is a risk management approach that uses a rules based method to limit the risks on each individual trade which includes adjusting the number shares traded. Thus as the risk level increases, the number of shares traded decreases.

Position Trader

Position Trading is a stock trading strategy that uses technical analysis to determine when and where to enter and exit the trade.

Stop Loss

When a stocks price drops below a predefined price level, the stock is sold. This is a money management strategy to limit capital losses.

The Investing Style of Jesse Livermore

" There is only one side of the market and it is not the bull side or the bear side, but the right side."  Quote by Jesse Livermore

The Investing Style of Jesse Livermore; Picture of an older day financial newspaper with yellow coloring showing a stock chart and data for investors to select and build their portfolio.

The Early Days

During the early 1900s, in the days of Jesse Livermore, investing was a term used to describe an income producing asset and thus corporate bonds were considered an investment.

Stocks, with the exception of some large blue-chip corporations and utility companies, mostly did not pay dividends and as such buying stocks was considered speculation rather than investing.

Jesse Livermore's investing style is best summed up as speculative trading. Jesse based his trading decisions largely on the price action of the stock or commodity he was trading and utilized strict money management rules.

This approach was radical in his days as most stock purchases were based on nothing more than tips and rumors and fundamental analysis for the most part did not exist.

Studying the price action was a difficult task without computer technology and very few bothered with it.

A notable exception was Charles Dow and his successor Peter Hamilton who published numerous articles dealing with the price movement of the Dow Averages.

Jesse Livermore is more widely known for trading stocks but he was also an active commodities trader.

While Jesse Livermore never used price charts (as they needed to be plotted by hand in Jesse's days) his trading techniques bear a remarkably strong resemblance to modern day technical trading techniques such as position trading.

Unlike modern day technical traders who focus exclusively on the information contained on a stock chart, Jesse Livermore traded more like a modern day speculator by incorporating market conditions, industry conditions and stock leadership into his trading strategy.

He was also fully aware of the current economic conditions and had a sound understanding of economics.

He also had a through understanding of industries and the leading companies in their industry.

Top Down Trading

Rather than simply finding a stock to trade, Jesse Livermore first determined the market conditions, then the industry conditions and finally the stock leadership and would also locate a sister stock.

Top Down Trading:

  • The Market: Jesse Livermore would first determine the current market direction which he called the "Line of Least Resistance". Jesse never used the terms Bull or Bear, but basically if the line of least resistance is upwards, Jesse would look for long sided trades and if the line of least resistance was down then Jesse would look for short sales. Nowadays it's referred to as trading with the market. Jesse traded NYSE listed stocks.
  • The Industry Group: Jesse Livermore would then check the industry groups. If the market was trading upwards, Jesse would look for a strong industry group which was also moving upwards and look for the strongest stock in that industry group. Jesse was also a notorious short seller and would look for weak industries for the weakest stock when the line of least resistance for the market was down.
  • The Sister Stock: Jesse Livermore always looked for a sister stock for comparison with the stock he was trading. This in essence is similar to Dow Theory which uses two different Averages for conformation. The sister stock is a direct competitor and Jesse reasoned that if the sister stock was showing signs of reversing then the stock he was trading might follow even if it was not currently showing any signs. Jesse Livermore watched the price action of both the stock he was trading and the sister stock very carefully.
The Investing Style of Jesse Livermore; Picture of an industry sign with animated three dimensional letters depicting the American global stock investing on a concrete background.

Jesse Livermore's view was that understanding industry group action was essential to successful trading. Jesse never rushed or forced an entry.

A quote from Jesse Livermore reads "Wait until the Preponderance of Evidence is in your Favor, Use Top Down Trading and be patient".

The group movement premise was quite simple to Jesse Livermore. If the basic reasons are sound for a particular stock in an industry to come into favor, the rest of the stocks in that industry should follow for the same basic reasons.

For Jesse this also worked on the short side. When an industry goes out of favor then all stocks in that group go out of favor.

Jesse Livermore also stated that the only exception to this group behavior was when a single stock was significantly large that it created its own industry movement.

The Current Leaders

Jesse Livermore predominantly traded the industry leaders rather than the small-cap stocks. This had a lot to do with the times as there was no computerized screening available.

Any proposed stocks had to be manually tracked and Jesse felt more comfortable tracking the leaders rather than the minor issues.

Jesse Livermore predominantly traded the industry

leaders rather than the small-cap stocks

Jesse never used high stock prices as a signal to sell a stock as his reasoning was that a leader can go on to much higher prices. He was one for buying new highs and short selling new lows which was a contrarian point of view in his day.

His line of reasoning was that if the minor issues were still following the leader then the leader still had further to rally for a long sided trade or conversely had further to sell for a short sided trade.

Jesse Livermore also noted that the leader in an industry group is not necessarily the largest company.

The leader he defined as a significant company which was the first to make its move. He reasoned that the first to make its move would be the stock to continue to make its move.

He also noted that the leader changed with each subsequent bull market.

He also called the tops of markets by noting that the as strongest industry groups began collapsing it was a signal that the market overall may be heading for a correction.

Reversal Pivotal Points

Reversal pivotal points as Jesse Livermore called them are the tops and bottoms of major moves. These pivotal points are usually referred to as Relative highs and lows nowadays.

Jesse used these reversal pivotal points to note the market direction and the direction of the industries he was tracking. Jesse also used these to determine when an individual stock was ready to make its move.

Jesse Livermore was an extremely patient stock trader and had stated that it was his sitting and waiting that made him his money.

For Jesse to take a trade he would wait for the reversal pivotal point to confirm a stock's new uptrend direction and he would buy a small test parcel of shares which he called a probe.

As the stock continued higher he would progressively buy more parcels of shares. That is, Jesse pyramided into his position at successively higher prices and this was one of his money management rules.

Jesse Livermore rigorously used stop-loss exits if the stock price moved contrary to his expectation. He was adamant that markets are never wrong but opinions often are.

Jesse noted that if he was wrong then he had only a small position to dispose off, but if he was right then his small position did not trigger an exit and a new uptrend had begun from which he would pyramid into.

Compared to modern day technical traders with trades only lasting for days or weeks, Jesse Livermore was a long-term stock speculative trader with trades lasting up to several years.

Jesse was after the big moves and did not care about the short-term noise.

The Investing Style of Jesse Livermore; Picture of a stock investor using his hand to draw a graph using a thick blue pencil to symbolize stock price increasing for investors and traders.

Continual Pivotal Points

A continual pivotal point for Jesse Livermore is basically a pullback in an up-trending stock or a rally in a downtrend.

He used these continual pivotal points as confirmation that the uptrend was progressing and would buy more shares each time the stock price traded above the Relative High of the pullback.

Jesse Livermore only ever added to his positions at new Relative Highs. He also applied the same principle to short selling and would only short sell when the stock price dropped below the Relative Low of a minor rally.

As a general rule Jesse was cautious about how high above the pivotal point the confirmation was. He preferred 5% to 10% from the continual pivotal point low to the relative high.

Spikes

Jesse Livermore carefully studied the price and volume nature. Jesse was wary of price spikes which he classified as an abnormal price increase over several days accompanied by abnormally high volume of a least fifty-percent increase over the normal volume.

Jesse called this an aberration which to him was any price and/or volume action that deviates from the norm. He considered aberrations a danger signal and would often exit the trade.

Downward Spikes for short side trades were also considered aberrations for Jesse and he would often use this as a signal to exit his short positions.

Breakout to a New High

New highs formed the basis for Jesse Livermore to add to his position. To Jesse, breakouts from consolidation were positive events as this indicated the stock had further to climb.

Jesse Livermore did not anticipate the breakout but rather waited for the price to actually make its new high.

He never tried to figure out why the stock would breakout, but simply followed the price and volume action.

Jesse was wary of breakouts on heavy volume that did not lead to a strong continuation. He considered this a warning that the stock may have topped out.

He used the same breakout principle for the short side with the stock breaking down out of consolidation. He expected the stock to make a strong move downwards.

Jesse liked to exit a portion of his position on strong moves and would often exit his entire position on moves which were significantly stronger than the norm.

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