Jesse Livermore: Lessons From A Legendary Trader

By Cory Mitchell AAA

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.

The enormity of his success becomes even more staggering when considering that he traded on his own, using his own funds, his own system, and not trading anyone else's capital in conjunction. There is no question that times have changed since Mr. Livermore traded stocks and commodities. Markets were thinly traded, compared to today, and the moves volatile. Jesse speaks of sliding major stocks multiple points with the purchase or sale of 1,000 shares. And yet, despite the difference in the markets, such automation increased liquidity, technology, regulation and a host of other factors that still drive the markets today.

The Test of Time
Given that this trader's rules still apply, and the price patterns he looked for are still very relevant today, we will look at a summary of the patterns Jesse traded, as well his timing indicators and trading rules. (For more classic and lesser-known investing titles to add to your collection, check out Investing Books It Pays To Read.)

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. (Find more profitable entry and exit locations with this standard indicator; read Measure Volatility With Average True Range.)

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. (For more read our Greatest Investors Tutorial.)

Timing the Market
Any trader knows that being right a little too early or a little too late can be as detrimental as simply being wrong. Timing is crucial in the financial markets, and nothing provides better timing than price itself. The pivotal points mentioned above occur in individual stocks and market indexes, as well. Let price confirm the trade before entering large positions.

Jesse Livermore believed no matter how much we "feel" that we know what is happening, we need to wait for the market to confirm our thesis. And only when it does do we make our trades - and we must do so promptly. (From picking the right type of stock to setting stop-losses, learn how to trade wisely in Day Trading Strategies For Beginners.)

Trading Rules
The trading rules that follow are simple, and have been included in many trading plans by many traders since they were created nearly a century ago. They are still valid today, and were created under Jesse's truism: "There is nothing new in Wall Street. There can't be, because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again."

  • Trade with the trend. Buy in a bull market, short in a bear market.
  • Don't trade when there aren't clear opportunities.
  • Trade using the pivotal points. (Learn how to spot the pivot point from which a new movement will emerge; read Find A Trend With The Partial Retrace.)
  • Wait for the market to confirm opinion before entering. Patience leads to "the big money."
  • Let profits run. Close trades that show a loss (good trades generally show profit right away).
  • Trade with a stop, and know it before you enter.
  • Exit trades where the prospect of further profits is remote (trend is over or waning).
  • Trade the leading stocks in each sector; trade the strongest stocks in a bull market, or the weakest stocks in a bear market.
  • Don't average down a losing position.
  • Don't meet a margin call; close the position instead.
  • Don't follow too many stocks.

Summing Up Jesse Livermore's Strategy
Jesse was highly successful, but also lost his fortune several times. He was always the first to admit when he made a mistake, and when he lost money it came down to two potential culprits:

  1. The rules for trading were not fully formulated (not the case for most of his losses).
  2. The rules were not followed.

For today's trader, these are still likely the culprits that keep profits at bay. To be profitable, we must actually create a profitable trading system, and then we must adhere to it in actual trading.
Jesse outlined a simple trading system for us: wait for pivotal points before entering a trade. When the points come into play, trade them using a buffer, trading in the direction of the overall market. Let the price dictate our actions and stay with profitable trades, until there is good reason to exit the trade. Losses should be small and trading should be avoided when there are no clear opportunities. When there are trading opportunities, trade stocks that are most likely to move the most. (For more books, check out Ten Books Every Investor Should Read.)

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