Jesse Livermore’s trading success was founded on the skills he acquired as a 14 year old office boy, taking prices from the NYSE ticker tape and writing them on the quote board.
The work, which less inquiring minds might have found tedious, enabled the young Livermore to begin to discern trading signals in the stream of numbers he processed each day.
Livermore later commented:
“To invest or speculate successfully, one must form an opinion as to what the next move of importance will be in a given stock. Speculation is nothing more than anticipating coming movements. In order to anticipate correctly, one must have a definite basis for that anticipation… “
So, how did Livermore identify trading signals?
To begin with, he wrote prices in a book. As each number arrived on the ticker tape, it would be entered in the book, building up a series of numbers. Modern traders – and many traders in Livermore’s time – plotted price and volume data on a chart.
Livermore, however, did not use charts. From his office-boy days he was accustomed to looking at raw numbers and he never deviated from this approach.
In order to see the trading signals Livermore saw, it’s helpful for most people to see a chart rather than a list of numbers. So, here is a chart showing what Livermore would have regarded as a clear trading signal – the pivotal point.
Clear Trading Signal
“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.”
In this chart, the price has trended downwards, and then risen from a low of 40c. The rally reaches 49c and then peters out, with the price retracing to its low point. This point is a pivotal point.
Livermore would look to trade any significant move upwards or downwards from the pivotal point.
• If the price fell below, say, 37c, Livermore would sell short.
• If the price rose above, say, 43c, Livermore would buy.
• He would observe the price action carefully after the buy because 49c – the high of the earlier rally – is another pivotal point. If the price failed to rally above 49c – again by 3c, say – Livermore would exit from the trade.
“I never benefited much from a move if I did not get in at somewhere near the beginning of the move. And the reason is that I missed the backlog of profit which is very necessary to provide the courage and patience to sit through a move until the end comes – and to stay through any minor reactions or rallies which were bound to occur from time to time before the movement had completed its course.”
Once a stock had broken out of a trading range – such as in the chart above, which has broken downwards – Livermore would begin trading. In this case the breakout is downwards and so Livermore would sell the stock short.
He would look for signals that the new trend was behaving normally and that it would be safe to stick with the trade:
- At the beginning of the move there should be an unusually large volume of shares traded.
- Prices should move generally in one direction (upwards or downwards) for a few days.
- A normal reaction should be observed – volume will decrease compared with the volumes observed during the initial trend, and the price may move against the trend somewhat.
- Within a day or two of the normal reaction, volume should increase again and the price trend should be resumed.
Provided this pattern is repeated, it is safe to stick with a trade.
If there should be a deviation from the pattern, it is a warning sign. If the pattern fails and the price moves against the trend by more than a little, this is your exit trading signal.
Other key buying signals are defined by what we would nowadays describe as broken resistance or broken support:
“I become a buyer as soon as a stock makes a new high on its movement, after having had a normal reaction.”
The chart below shows a buying signal on the major trend when, after a normal reaction, the stock reaches a new high. There are also many shorter-term buying signals. Each time the stock falls back a little and then goes on to a new, higher price is a short-term buying signal.
Broken Support: “The same applies whenever I take a short side. Why? Because I am following the trend at the time. My records signal me to go ahead.”
In General – Trade With the Market Direction
Livermore advocated trading in the same direction as the overall market – catching the major trend.
- In a bull market, look for stocks to buy.
- In a bear market, look for stocks to short.
- In a flat market, be cautious about entering trades. You might end up losing money that would have performed better in strongly trending market.