This book on Jesse Livermore is written by Richard Smitten, who apparently developed a software based on Livermore’s trading technique and IPO-ed a company based on that IP.
Much of the content is drawn from Jesse Livermore’s own book How to Trade in Stocks, and Edwin Lefèvre’s Reminiscences of a Stock Operator. As I had read the previous two books, much of the content in this book is familiar to me. Nonetheless, this book helped me in 2 ways: (i) a good reminder of the key tenets of trading, and (ii) it made me discover two things that I did not notice before.
The first is that Livermore would enter into a position based on a bounce at the bottom of a Darvas box (read the first set of italics text below). The second is that in Livermore’s Market Key, he used a fixed plus/minus 3 points from a Pivotal Point to determine whether or not that support/resistance level was broken. Most people nowadays simply take a Close above a resistance level or below a support level to mean that the level has been broken. IBD uses a fixed $0.10 from a support/resistance level to set a buy point. In Livermore’s case, 3 points in a $30 stock would mean 10%, and 5% for a $60 stock. This meant that a stock had to move 5% to 10% beyond a level to confirm a break of the level. This might seem quite excessive, but Livermore had purposely set out his rules to filter off minor fluctuations, and these days with stocks like MLNX and NSM going up and down ~5% a day, a 10% buffer for confirmation may not seem that unreasonable.
The second point above also made me take a [very quick] re-look at the Market Key, and I realised that Livermore used a threshold of 6 points for trend reversal, and 3 points for trend continuation, i.e. a higher bar was set if you want to reverse a current trend. This makes sense, and is pretty interesting. I have not currently incorporated such a thing into my current system, and this would be something interesting to think about.
Enough of my rambling, some of the key points are captured below. I would recommend reading my book reviews on the other 2 books first before reading this one, because key points captured in the previous 2 book reviews may not be captured here.
Watching the Market
- To invest or speculate successfully, one must form an opinion as to what the next move of importance will be in a given stock[my note: up or down]. In order to anticipate correctly, one must have a definite basis for that anticipation.
- Familiarize yourself with a stock, or different groups of stocks, and if you figure the timing element correctly (i.e. the pivotal points) in conjunction with your records, sooner or later you will be able to determine when a major move is due.
- The market leaders in a strong bull market are the first to go up and the first to roll over and go down.
- It is significant that a large part of a market movement occurs in the last forty-eight hours of a play, and that is the most important time to be in it.
- For example: Take a stock that has been in a Downward Trend for quite some time and reaches a low point of 40. Then it has a quick rally in a few days to 45, then it backs and fills for a week in a range of a few points, and then it starts to extend its rally until it reaches 49. The market becomes dull and inactive for a few days. Then one day it becomes active gain and goes down 3 or 4 points, and keeps on going down until it reaches a price near its Pivotal Point of 40. Right here is the time the market should be watch carefully, because if the stock is really going to resume its Downward Trend in earnest, it should sell below its Pivotal Point of 40 by 3 points or more before it has another rally of importance. If it fails to pierce 40 it is indication to buy as soon as it rallies 3 points from the low price made on that reaction. If the 40 points has been pierced but not by the proper extent of 3 points, then it should be bought as soon as it advances to 43.
- If either one of these two things happen, you will find, in the majority of cases, that it is the beginning of a new trend, and if the trend is going to be confirmed in a positive manner, it will continue to advance and reach a price over the Pivotal Point of 49 by 3 points or more.
- Stocks are never distributed on the way up, they were distributed on the way down. This is because on the way down, the public will hold on to their stock hoping it to rally and sell at break-even.
On Industry Groups
- Be careful on turning completely bearish or bullish on the whole market. In 1929, Livermore saw copper (major commodity used to predict the market in 1920s) and the motor group roll over, and he arrived at the faulty conclusion that he could safely sell everything and jump on the short side. He was wrong. The rest of the market kept moving in its upward spiral and Livermore lost his shirt on those trades.
- When you clearly see a move coming in a particular industry group, act upon it. But do not let yourself automatically act in the same way in another industry group until you plainly see signs that the second group is in a position to follow the trend of the first group you are trading.
- Make a deep and thorough study of industry groups (not the larger industry sectors) in order to differentiate the good groups from the bad. Buy groups in a promising position and short industry groups that are not.
- I would explain that I do not take the action of a single stock as an indication that the trend has been positively changed for that group.
When to Play
- Before pulling the trigger on a trade, place as many factors in your favor as possible.
- No trader can or should play the market all the time. There will be many times when you should be out of the market, sitting in cash waiting patiently for the perfect trade.
- Wait until all the factors are in your favor before making a trade — follow the Top Down Trading rules.
- Livermore believed that if he was right in his timing and pulled the trading trigger at the appropriate moment, then the momentum would be like a tidal wave right behind the trade, and it had to go up. Therefore, if the stock did not go up right away, he would have to assume his judgement was wrong.
- I become a buyer as soon as a stock makes a new high on its movement, after having had a Normal Reaction (i.e. a reaction where the sales volume will be much less than on previous days of its advance).
- When your chosen stock reaches the point you had previously decided it should reach if the move is going to start in earnest, that is the time to make your first commitment.
- You will notice I always tried to make my first trade at the psychological time, that is, at a time where the force of the movement was so strong that it simply had to carry through (my note: my guess is he refers to break-outs to new high, or break-outs of pivotal points).
- If you have timed the movement correctly, your first commitment will show you a profit at the start. From then on, all that is required of you is to be alert, watching for the appearance of the danger signal to tell you to step aside and convert paper profits into real money.
- Whenever I have had the patience to wait for the market to arrive at what I call a “Pivotal Point” before I started to trade; I have always made money in my operations.
- When a speculator can determine the Pivotal Point of a stock and interpret the action at that point, he may make a commitment with the positive assurance of being right from the start.
- Pivotal Points are an essential timing device, a trigger that reveals when to enter, and when to exit the market.
- New highs are very important for timing.
- When the tape doesn’t agree with your decision to buy or sell, wait until it does [my note: then try again when it does].
What to Play
- Trade only the leaders in any particular industry group. New leaders emerge with each new market.
How to Play
- Top Down Trading
- Market trend
- Industry group
- Sister stock
- Individual stock
A Clear Plan is Essential
- The successful speculator must formulate his plan in advance of a stock’s movement.
- Before buying a stock, establish a profit target and risk/reward ratio.
- To play the market properly requires silence, and seclusion to examine the situation, and to appraise, and deliberate on new information that comes to hand during the trading day. One must always have a clear strategy to play the market and clear rules to follow.
- Always establish a stop before making a trade.
- Reversal Pivotal Point
- A change in the basic market direction — the perfect psychological time at the beginning of a new move, representing a major change in the basic trend.
- Almost always accompanied by heavy increase in volume. These confirming volume often end the day with volume that is 50% to 500% above the average daily volume.
- Start buying with a small position. If it works, enter more.
- Buying more than 5% to 10% above the initial Reversal Pivotal Point may be too late, the trading edge may have been lost.
- Continuation Pivotal Point
- A consolidation, often allowing a stock’s ratio of earnings and sales to catch up to its current price. It is usually a natural reaction in the stock’s progress.
- A pattern forms that demonstrates support or resistance lines.
- Stock should emerge from headed in the same direction it was in before the correction.
- One-Day Reversal
- The stock tries to continue to go higher, but did not manage to close higher, with greater volume showing greater effort but worse result.
- High is higher than the High the previous day.
- Close is below Close of the previous day
- Volume is higher than the volume of the previous day.
- Volume Spikes
- Volume spikes with at least 50% increase over the average daily volume.
- Watch what the next action will be. Spikes often reflect exhaustion of a stock’s momentum and appear at the end of a move. If prices stall, the stock may have topped out.
- Break-Out from Consolidating Base
- Essentially a break-out from a Darvas box. Saucer-shaped patterns (e.g. stock reacts down then recovers) usually form in these boxes.
- Break-Out on New High / Low
- When a stock breaks out to new ground, the old overhang has been cleared out of the way because people who were holding it at a loss would have sold it at break-even.
- When the majority of people has sold their stock, the stock is in a position to make a new run.
Why Patterns Occur
- All through time, people have basically acted the same way in the stock market as a result of greed, fear, ignorance, and hope — that is why the formations and patterns recur on a constant basis. The patterns the trader observes are simply the reflections of human emotional behavior.
- The most stocks that can be handled at any one time is 10. It is much safer and you are more in control if the number is no more than 5 stocks.
- Don’t buy your entire position all at one time
- … it should be said that too many speculators buy or sell impulsively, acquiring their full line at almost one price. That is wrong and dangerous.
- Cash is your lifeline, don’t lose your line.
- Decide the total number of shares you want to trade. Buy in at 20%-20%-20%-40%, each time averaging up.
- Never lose more than 10% of your investment
- Livermore’s Bucket Shop rule where people put in 10% of equity and margin the rest. Once the stock drops 10%, you are wiped out.
- Never meet a margin call, and never average losses.
- Always keep a cash reserve
- The successful speculator must always have cash in reserve, like a good general who keeps troops in reserve for exactly the right moment, when the odds are in his favor, and then moves with great conviction, and commits his reserve armies for the final crushing victory.
- You need a good reason to buy a stock and a good reason to sell
- Make sure everything is in your favor before making a trade: market direction, industry group, sister stock, pivotal point.
- As long as the action of the overall market and the stock does not give you cause to worry, let it ride.
- One key thing that allowed Livermore to stay with position is that he viewed profits as the house’s money that he is playing with, not his money. Hence he wasn’t afraid of losing the house’s money. It only becomes his money after he has cashed out of that position.
- Put half the profit from a windfall trade in the bank.
- Take 50% of your profits out of the stock market so you have to make a conscious effort to put it back in.
- Restrict any serious pyramiding to the beginning of the move
- It is unwise to pyramid if the stock was far from the Pivotal Point base – better to wait for the next Continuation Pivotal Point or the break-out to a new high.
- Cash out when unsure
- When Livermore deduced that a change was coming, and he wasn’t sure exactly when or how severe the change might be, he cash in all his positions and waited.
- Have a price stop and a time stop
- I always have two stops in mind when I enter a trade: I have a price stop and I have a time stop. I will not stay with any trade more than a few points if it moves against me and I will not stay with a stock position for more than a few days or perhaps up to a week, if the stock does not perform as I expect it to perform.
- Don’t get yourself into a permanent loaded-up or tied-up condition with no buying power held in reserve.
- Decide definitely the amount of money you are willing to risk should your calculations be wrong.
- Just remember, without discipline, a clear strategy, and a concise plan, the speculator will fall into all the emotional pitfalls of the market and jump from one stock to another, hold a losing position too long, cut out of a winner too soon, and for no reason other than fear of losing the profit.
- Dealing with media news
- First, try to interpret the immediate and direct influence on the opinions and actions of stock traders with regard to a particular stock.
- Second, watch the tape like a hawk to detect how the news has influenced the buying and selling of specific stocks as a whole in that market industry group.
- Beware of inside information… all inside information!
- Disregard the action of insiders, they are too close to see the weaknesses.
- Disregard any statement made by key executives.
Using the News
- People think that I am simply a speculator, a trader, who finds situations and plunges into them. Nothing could be further from the truth. I often pick up small, seemingly useless clues in the newspapers and after checking them out, investigating what is behind them, I will act upon them.
- In the solitude of the morning hours, after being rejuvenated from sleep, with nothing to distract me, I carefully read the papers. I have often used small specific news items like weather events, like droughts, insect problems, labor strikes, and assess how they would affect the corn, wheat, or cotton yields that often lead me to a possible good trade.
- I got my real news on the financial side by examining the actual prices and actions in the commodities market such as coal, copper, steel textiles, sugar, corn, wheat.
- I also look at the automobile sales, and employment figures. I got a feel from this information and often a correct judgment on general business conditions in the United States.
- I did more than just scan the headlines of the newspapers; I read the paper carefully looking for small items of news that might provide me with important clues, especially about an industry group or a specific stock that had changed from weak to strong or vice-versa.
- The headlines are for the suckers. A good speculator has to get behind the news and see what was really going on.
- Boys, it is my observation that there is no better time than the early morning to gain an enormous advantage toward being a successful stock trader. There is silence in the house, no person or thing is disturbing your concentration, and the mind is renewed after a good night’s sleep [Livermore goes to bed at ten and wake up at six].
- You will learn as you grow older that most people simply get up at a certain time in the morning, get ready, and go directly to the office. Often, these same people feel the desire to go out at night during the week to the cinema, a play, a long dinner with several drinks. In other words, they feel the need for social interaction or recreation during the weekdays. This may work well in other fields of endeavor, but it is a dangerous practice on a regular basis if a person wants to be successful in seriously trading the stock market.
- The successful trader must always be in top physical form.
Synthesize All Pieces of Information
- The careful, disciplined man must be aware of everything, ignorant of nothing. You cannot afford to be careless about anything. Sometimes overlooking a single item, big or small, can ruin everything, kill all your plans. Like a general in wartime — his men’s lives depend on his thoroughness in planning and executing that plan. In the stock market there is no room for error and carelessness.
- It was no one single fact, it was a plethora of facts that often led me finally down a narrow path to a trade.
Play for the Main Movements
- The intent is to catch the major moves, to indicate the beginning and the end of movements of importance.
- At the beginning of the move you will notice a very large volume of sales with gradually advancing prices for a few days.
- Real movements do not end the day they start. It takes time to complete the end of a genuine movement [from a trader from the mountains].
- The speculator who insists on trying to profit from daily minor movements will seldom be in a position to take advantage of the next important change marketwise when it occurs.
- I found it was an easy matter for me to turn around and get out of a position, when vitality was lacking after a stock crossed the Pivotal Point and there were many occasions when I reversed my position and went over to the short-side.
- But by being consistent and never failing to re-enter the market again whenever your Pivotal Point is reached, you cannot help but be in when the real move does occur.
Livermore Market Key
- From trial-and-error, Livermore determined that
- If there is a 6 point move in the opposite direction, that signifies a possible trend change and the recording column is moved to the opposite direction (e.g. Downward Trend to Natural Rally, or Natural Reaction to Natural Rally, or Upward Trend to Natural Reaction, or Natural Rally to Natural Reaction)
- If there is a 3 point move in the same direction as the recording column past a Pivotal Point (i.e. 3 points above a Pivotal Point in the Natural Rally column, or 3 points below a Pivotal Point in the Natural Reaction column), then the trend in the same direction is confirmed (e.g. Natural Rally to Upward Trend, or Natural Reaction to Downward Trend).