The Wisdom of Jesse Livermore


From How to Trade In Stocks – By Jesse Livermore:

Spikes and One-day Reversals:

Livermore was very wary of any aberration in the price or volume of a stock that he was tracking. Sometimes, the price would spike, accompanied by abnormally heavy volume of at least a 50 percent increase over the average daily volume. This often led to what he named One-Day Reversals or trading climaxes. They often were like a red flag warning of a change of trend.

An aberration to him was any strong deviation from what was normal for the stock. He considered a spike in the stock price, high volume, as well as low volume, all aberrations, deviations from the norm. To him, these were possible danger signals, and often signals to exit a trade.

The spiking pattern is often a result of pent-up energy in the stock, as in a pressure cooker. It is the follow-through action of the stock that then becomes important to observe as to what the next action will be. These
spikes are often a reflection of exhaustion in the stock’s momentum, and they often appear at the end of a move, like a last gasp. They can provide a terrific signal for the observant, savvy trader.

The One-Day Reversal was a strong signal for Livermore, a signal that made him sit up and take notice. A One-Day Reversal occurs when the high of the day is higher than the high of the previous day, but the close of the day is below the close of the previous day, and the volume of the current day is higher than the volume of the previous day.

This scenario was a potential screaming danger signal to Livermore. Why? Because all during the stock’s rise, it followed the trend, the line ofleast resistance, it had only normal reactions. Then, all of a sudden, it had an abnormal, sudden aberrant reaction. It moved 15 points in only 3 days on heavy volume—it has broken its pattern! Even though the stock may have risen in price, this is not a positive sign, but rather a danger signal that must be heeded! It was Livermore’s belief that if you had the patience to sit with the stock all during its rise, now after the one-day reversal pattern appears you must have the courage to do the right thing and acknowledge this danger signal. You must now consider selling the stock, because you have received a valid warning signal.

Importance of Volume:

From the beginning of his trading career, Livermore was keenly aware of the importance of volume. Volume is a key factor in recognizing true Pivotal Points and other recurring patterns. It was obvious to Livermore that as the volume drastically changed in a stock, it was a clear aberration or deviation from the normal behavior of the stock. But was the volume accumulation or was it distribution? Livermore was an expert at detecting distribution. He had formed a strong opinion on that subject, because he knew how stocks were distributed by the pool runners of his day. The pool runners, experts like Livermore, were often charged with distributing the stock of the insiders who had formed a pool with their own stock for
the purpose of controled distribution.

How did the pool runners do it? The same way as they do it today. Stocks were never distributed on the way up, they were distributed on the way down. The reasoning was simple—people will not take their losses when they should. The public will hold on to their stock as it drops and wait until it rallies back to the price where they bought it, so they can sell it. This is why so many stocks falter as they rally back to the old high. The people who bought at the high are now selling to get their money back—because they got a serious fright—and are now happy to recoup their losses.

To the astute trader, a change in volume is an alert signal. It almost always means that there is something afoot, a change, a difference, a possible aberration. A serious change in volume always caught Livermore’s attention. He would ask himself—was it the volume leading to the blow off, setting the stage for a decline, or was it a real interest in the stock, was it being accumulated getting ready to be driven higher?

Livermore never spent any time looking for the reason why the stock was attracting a lot of volume. He simply took it as an axiom that volume was an alert signal. It was happening, that why was enough for him. He knew that the actual reasons why would be revealed later when the chance to make money was gone.

Conversely, if there is heavy volume, but the prices stall and do not go up and make new highs, and there is no strong continuation of the current move, beware. This is often a strong clue, a warning, that the stock may have topped out and the accumulation is over and the stock is now going through a distribution phase.

Note: The end of a market move is usually pure distribution, as stocks go from strong hands into weak hands, from the professionals to the public, from accumulation to distribution. It is often a market move by the promoters of the stock, a deception, to trick the public, who view this heavy volume as the mark of a vibrant, healthy market going through a normal correction, not a top or a bottom. This last gasp of heavy volume also provides a great opportunity to sell out any illiquid or large holdings. Livermore knew it was foolish to ever try to catch the tops or the bottoms of the moves. It is always better to sell large holdings into an advancing strong market when there is plenty of volume. The same is true on the short side, you are best to cover the short position after a steep fast decline.

Livermore was always on the alert for volume indications as key signals at the end of a major move, either in the entire market itself or in an individual stock. Also, he observed that at the end of a long move, it was not uncommon for stocks to suddenly spike up in a straight shot with heavy volume and then stop and roll at the top, exhausted. Then they would retreat, downward—never to make a new high before the onslaught of a major correction.

This is not the same book as I read but it contains the sections that I was looking for: richard_smitten-trade_like_jesse_livermore-en.pdf


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