JESSE LIVERMORE’S TRADING STRATEGIES

Jesse Livermore has been known for creating sensations in the financial market: catching the crash of 1907 on the short side and also catching the crash of 1929 when he made over $100 million. It is best to remember that Livermore; also known famously by the name ‘boy plunger’, created his first sensation – when at 15 year old, he dumped into her mother’s lap a thousand dollars in five dollar bill: his first gleaning from the stock market.  As they say ‘it was only a trailer the full film was to play out in the future.’  

Early years

The quiet and secretive man Jesse Livermore; who in future was going to rule the stock market for four decades, was born to a New England farming couple. As a youth Livermore mostly remained sick, which resulted him gravitating towards reading. The aptitude for reading made him quick minded, improved his imagination and built in him an affinity for numbers. Early on he realized that life in the New England countryside was not for him, he spent, most of his time dreaming about the adventures he would undertake in the future. The transition came when, at the age of 14, he was pulled from the school by his father to work in the fields – the change in situation made him certain that his success would come by using brain and not just the strength of the body. Thereon, he confided with his mother, who supplied him with $5 and formulated an escape plan. And just like that, one day Livermore slipped out of the farmhouse to the main road to Boston, hailed a wagon, and rode into the city. And as luck would have it the wagon stopped in front of a Paine Webber brokerage office. Livermore simply walked inside, asked for a job, luckily Paine Webber needed a chalkboard boy to post the stock prices for the customers, and Livermore took the opportunity. Paine Webber was a learning ground for Livermore – he kept a notebook on which he would copy down the numbers from the chalkboard to see if he would recognize the patterns. Along with the flow of numbers Livermore also observed the sensitivity of the crowds: excitement rose as the prices climbed and excitement died down as the prices fell.     

Pivotal point

Livermore used to say ‘whenever I have had the patience to wait for the market to arrive at what I called a pivotal point before I started to trade, I have always made money in my operation.’ The reason for his success with the pivotal point according to him was ‘I commenced my play at the psychological time at the beginning of a move and never had a loss of worry about for the simple reason that I acted promptly and started to accumulate my line at the time my guide told me to so. Thereafter, all I had to do was juts to sit tight and let the market run its course, knowing if I did so, the action of the market itself would give me in due time the signal to take my profits.’ In short, it can be said that for him pivotal point were timing devices that he used to get in and out of the market with great success. Livermore used the pivotal points in two ways: reversal pivotal point and continuation pivotal point. For Livermore reversal pivotal point was a change in basic market direction – the perfect psychological time in basic market direction – the perfect psychological time at the beginning of a new move, representing a major change in the basic trend. And the continuation pivotal point confirmed to Livermore that the move was proceeding in the proper direction. For him the continuation pivotal point was a potential additional entry point in an ongoing move – it provided a signal, to increase position, only if the stock emerged from the continuation pivotal point, and headed in the same direction it was in before the correction, and if not, then it was a clear sigh to close the position. In addition to these Livermore also used the pivotal point to find successful short selling opportunities, he looked for stocks that traded down to a new low for at least last year or so and if they formed a false pivotal point, i.e. if they rallied from the new low and then dropped down through and formed another low, they were most likely to continue down from there and establish new lows for the move. For this reason it did not matter to Livermore, if a stock was at the bottom or to the top of a long term trending move, because he would buy or sell any stock, going long or short at any time. Livermore firmly believed that often the largest part of a stock movement occurred in the last two weeks or so of a trade; he called it the final make up phase, which was the reason why for him patience played such an important role in trading. For Livermore volume was a key factor in recognizing true pivotal point because as the volume drastically changed in a stock, it was clear aberration or deviation from the normal behavior of the stock. But what was it accumulation or deviation? Livermore knew stocks were never distributed on the way up they were distributed on the way down. The reason - people will not take their losses when they should, they wait until stock rallies back to the price where they bought it so they can sell it. That is why so many stocks flattens as they rally back to the old high, i.e. people who bought at the high are now selling to get their money back. For Livermore change in volume is a signal that there is something afoot, a change, a difference, a possible aberration, and he would ask himself – is the volume leading to the blow off; setting the stage for a decline or is it a real interest in the stock; it is being accumulated and getting ready to be driven higher. Livermore knew his pivotal point was not full proof that is why he advised - bear in mind when using pivotal point to anticipate movements, that if the stock doesn’t perform as it should after crossing the pivotal point, this is a danger signal that must be heeded immediately, because every time he lost patience and failed to await the pivotal point, he lost money. 

Livermore’s Market Key

When Livermore understood that day trading was a loser’s game for the individual trader he transformed and ironed out his trading technique, he said ‘I continued keeping my records confident that they had a genuine value which only awaited my discovery. At length the secret unfolded, the records told me plainly that they would do nothing for me in the way of intermediate movements. But, if I would but use eyes, I would see the formation of patterns that would foretell major movements. And by study of records I had kept the realization stuck me that the time element was vital in forming a correct opinion as to the approach of the really important movements.’  All was not revealed to Livermore in one go he explained ‘I wanted to find out what constituted the beginning of a Natural Reaction or a Natural Rally. So I began checking the distance of price movements. First I based my calculation on one point, that was no good, then two points, and so on, until I finally arrived at a point that represented what I thought should constitute the beginning of a Natural Reaction or Natural Rally.’ So once the whole map was clear in his head he settled for map; map for anticipating future movements.  Livermore explained further ‘for each stock I use column, each column has its heading: First Column – Secondary Rally, Second Column –Natural Rally, Third Column – Upward Trend, Fourth Column – Downward Trend, Fifth Column –Natural Reaction, and Sixth Column – Secondary Reaction.’ Livermore also had a specific colour to enter the figure in each column, he recorded the figure in Upward Trend and Downward Trend in black ink and red ink respectively, while the rest of the four columns – Secondary Rally, Natural Rally, Secondary Reaction and Natural Reaction in pencil, because use of pencil made him realize that these are simply natural oscillation. To explain how Livermore entered these figures in the six column, he explained it with an example ‘I decided a stock selling around $30.00 or higher would have to rally from an extreme point to the extent of approximate six points before I could recognize that a Natural Rally or Natural Reaction was in the making. This simply means that the market is experiencing a natural movement.  I would not take the action of a single stock - as an indication that the trend have been positively charged for the group. Instead I take the combined action of two stocks before I recognize the trend has definitely changed, hence the key price. I find that an individual stock sometimes has movements big enough to put it in my Upward Trend columns or my Downward Trend column. But there is danger of being caught in a false movement by depending upon only one stock – the movement of two stocks combined given reasonable assurance.’ Livermore further explained ‘when a recording point has been reached that is, a move of six points average by each of the two stocks I continue to set down in that same column the extreme price made any day, whenever it is higher than the last price recorded in the Upward Trend column or is lower than the last price recorded in the Downward Trend column. This goes on until a reverse movement starts, the later movement on the other direction will of course, be based on the same point average for the key price. And, I never deviate from these points – remember, these prices I set forth in my records are not my price. Theses points have been determined by actual price registered in the day’s trading.’ Livermore stressed that the Market Key formula does not provide points whereby one can make additional trade with assurance, on intermediate fluctuations which occurs during a major move. But, added that the intent of the formula is to catch the major moves, to indicate the beginning and the end of movements of importance.     

Livermore’s guide to keep emotions in check

Livermore learned very early in his trading career that trading was not ‘simply buy the stock at $10 and sell it later for more than $10: meaning the more you trade, the more you made.’ Trading to Livermore meant ‘a stock trader must constantly deal with emotions when things go bad, there is often fear to deal with. Reasonable people act unreasonably when they are afraid. The unsuccessful trader is friend with hope. People wanted to be led, to be instructed, to be told what to do; i.e. they would always move as a mob, a group, a herd – the reason being, it takes grit to stand alone. For keeping human emotions under check Livermore developed two rules: do not be invested in the market all the time, and it is the change in the major trend that hurts most speculators. The most important point to which Livermore adhered - Livermore had no feeling for a stock, and believed that, there are no good, nor are there any bad stocks, there are only stocks that make money or lose money for the speculators. That s why, if he was exiting a long position, because he believed the stock has topped out, it was easy for him to consider getting on the short side of the same stock.

Words of wisdom

Livermore believed whenever the market does not act right or in the way it should – that is reason enough for you to change your opinion and change it immediately. Remember: there is always a reason for a stock acting the way it does. But also remember: the chances are that you will not become acquainted with that reason until sometime in the future, when it is too late to act on it profitability.

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