Jesse Livermore: the rules of the most famous speculator

The short version

Jesse Livermore was the most famous speculator of the early 20th century. His rules come down to a few ideas that nearly every trend trader still uses: trade in the direction of the market, buy strength at key price levels, add only to winners, cut losers fast, and be patient with the positions that are working.

Who he was

Livermore (1877 to 1940) started as a teenager chalking up prices at a brokerage office in Boston and learned to trade in the bucket shops of the day, betting on price moves. He went on to trade enormous positions in stocks and commodities. He made fortunes going short in the 1907 panic and again in the 1929 crash, and he went broke more than once in between, which is part of why his rules carry weight: he learned most of them by losing money.

His life is the basis of Reminiscences of a Stock Operator (1923), written by the journalist Edwin Lefèvre as the story of a trader called Larry Livingston. In 1940 Livermore published his own book, How to Trade in Stocks.

He was known as the Boy Plunger for his early bets and later as the Great Bear of Wall Street for his short selling.

His rules

• Trade with the market. Most stocks move with the general market, so first decide which way it is going. He made his biggest money when the whole market was moving his way.
• Buy the leaders. Concentrate on the leading stocks in the leading industries. When the leaders falter, the market is usually turning.
• Pivotal points. He waited for a stock to break through a key price level, often an old high or a round number, before buying. A move through such a point on heavy activity told him the trend was confirmed.
• Add only to winners. Start with part of a position and add more only if the first part shows a profit. Never average down on a loser.
• Cut losses short. Decide in advance where you are wrong and get out there.
• Sit tight. His most quoted line is that the big money is made by sitting through the trend, not by trading in and out of it.

The line of least resistance

Livermore didn't trade on what a stock ought to do. He watched what it was doing. Prices, he said, move along the line of least resistance: when buyers keep absorbing every offer, the path is up; when sellers keep overwhelming every bid, it is down; and when a stock just churns, neither side is in charge, and he stayed out. His job was to recognise which way the path had opened and go with it, not to argue with it.

Probing: building a position in parts

He rarely bought a full position at once. He started with a small first lot as a test. If the stock moved his way, the test had passed and he bought more, then more again, each time only after the earlier buying showed a profit. If the first lot went against him, he took the small loss and waited.

The method makes the market confirm a trade before most of the money is in it. The largest positions end up in the stocks that are working, and the losers stay small because they never grew past the first lot.

The Livermore Market Key

In How to Trade in Stocks he set out the record-keeping that disciplined his trading. He followed two leading stocks in the same industry and wrote their prices, and their combined price, into columns: upward trend, natural rally, natural reaction and downward trend. Prices moved between the columns only on moves of a set size, which filtered out the day-to-day noise. When both stocks, and their sum, confirmed a change, he took it seriously; when only one did, he waited.

The details are dated, but the two ideas still hold: judge a stock alongside its industry, and wait for confirmation before acting on a change in trend.

What his losses teach

Livermore went broke more than once, and by his own account the cause was nearly always breaking his own rules: acting on tips, trading too large, holding a position after the market had turned against it, or trading when there was no clear trend to follow. That is why traders still read him. His losses show what happens when rules are dropped, and his gains show what happens when they are kept.

Why it still matters

Livermore wrote before charts were drawn by computers, before relative strength ratings and before most of the methods on this site had names. Yet Stan Weinstein's stages, William O'Neil's leaders and Mark Minervini's pivots all trace back to the same lessons: follow the trend, buy strength, let the market prove you right before you add, and never let a loss grow.

Books by and about him

• Reminiscences of a Stock Operator (1923), by Edwin Lefèvre: his life as a story, and the more widely read of the two.
• How to Trade in Stocks (1940), by Livermore himself: his rules, pivotal points and the Market Key, in his own words.

Using his ideas here

• New 52-week highs: every US stock that closed at a one-year high tonight, the modern version of a pivotal point.
• Breakouts today: stocks clearing their 20-day high on heavy volume.
• Sector rotation: the leading industries, where he looked for the leading stocks.
• Market timing: which way the whole market is going, his first question.