Wednesday, September 30, 2009

Jesse Livermore: Lessons From A Legendary Trader

Sorry about the disappearing act, reality, in the form of a 30 minute 1% drop in the markets, intruded.
I told my favorite Livermore story last year during the hubbub of September '08: "Making Money the Jesse Livermore Way"
No, not short selling, that's socially unacceptable at present.
Today, the Jesse Livermore way is: GET LUCKY!...
It went on to relate the story of Jesse shorting Union Pacific during the spring of 1906 and having the stock move against him.

Today's piece is from Investopedia via Yahoo Finance:
Born in 1877, Jesse Livermore is one of the greatest traders that few people know about. While a book on his life written by Edwin Lefèvre, "Reminiscences of a Stock Operator" (1923), is highly regarded as a must-read for all traders, it deserves more than a passing recommendation. Livermore, who is the author of "How to Trade in Stocks"(1940), was one of the greatest traders of all time. At his peak in 1929, Jesse Livermore was worth $100 million, which in today's dollars roughly equates to $1.5-13 billion, depending on the index used....

...Price Patterns
Jesse did not have the convenience of modern-day charts to graph his price patterns. Instead, the patterns were simply prices that he kept track of in a ledger. He only liked trading in stocks that were moving in a trend, and avoided ranging markets. When prices approached a pivotal point, he waited to see how they reacted.

For instance, if a stock made a $50 low, bounced up to $60 and was now heading back down to $50, Jesse's rules stipulated waiting until the pivotal point was in play in order to trade. If that same stock moved to $48, he would enter a trade on the short side. If it bounced up off the $50 level, he would enter long at $52, closely watching the $60 level, which is also a "pivotal point." A rise above $60 would trigger an addition to the position (pyramiding) at $63, for example. Failure to penetrate or hold above $60 would result in a liquidation of the long positions. The $2 buffer on the breakout in this example is not exact; the buffer will differ based on stock price and volatility. We want a buffer between actual breakout and entry that allows us to get into the move early, but will result in fewer false breakouts.

While Jesse did not trade ranges, he did trade breakouts from ranging markets. He used a similar strategy as above, entering on a new high or low but using a buffer to reduce the likelihood of false breakouts.

Price patterns, combined with volume analysis, were also used to determine if the trade would be kept open. Some of the criteria Jesse used to determine if he was in the right position were:

  • Increased volume on breakout.
  • The first few days after the break prices should move in the breakout direction
  • A normal reaction occurs where prices retrace somewhat against the trend, but volume is lower on retracements than it was in the trending direction.
  • As the normal reaction ends, volume increases once again in the direction of the trend.
Deviations from these patterns were warning signals and, if confirmed by price movements back through pivotal points, indicated that exited or unrealized profits should be taken....MORE
Here's an online version of Reminiscences of a Stock Operator.
And how did Jesse's short of UNP work out?

...Then, at 5:12 AM - April 18, 1906- this happened:

San Francisco City Hall after the 1906 Earthquake.
San Francisco City Hall after the 1906 Earthquake.