Lesson #3 Jesse Livermore's Trading System- Top Down Trading

Wait until the Preponderance of Evidence is in your Favor. Use Top Down Trading. Be Patient!

Jesse Livermore

“Top Down Trading” (TDT) was Jesse Livermore’s unique trading system which outlines how one of the world’s most famous speculators read the tape.  Livermore emphasized the importance of keeping things simple by remaining as objective and unbiased as possible.  Here is the official checklist Livermore used every time he bought or sold anything:
The Market (TM): Livermore emphasized the importance of always knowing what type of market you are in before making a single commitment, on either the long or short side. He did this by checking the line of least resistance for the major averages and never used the terms bull or bear. Instead, he used: uptrend, downtrend or sideways. Once defined, he would only go long in a uptrend, short in a downtrend and stay on the sidelines when the market was trendless and moved sideways.
The Industry Group (TIG): Livermore always checked the underlying health of a specific industry group before he bought or sold a single share of any security. He always wanted to confirm that the industry group was moving in the same path of least resistance as the underlying stock in question. This step helped him reinforce his ideas.
Tandem Trading (TT): After confirming the entire industry group was moving in the same path of least resistance (up, down or sideways) as the underlying stock in question and the overall market, he would then look for another leading stock in the group and compare them (to make sure he was participating in the strongest 0r weakest name).
A.) The stock in question: Livermore only focused on leading stocks of the day. He notes that each market cycle produces a new batch of leading stocks and leading industry groups. Furthermore, rarely did prior leaders re-emerge during future cycles. Once he narrowed the universe of stocks down to a manageable list of leaders he would then study their historical prices and identify “pivotal points” (a.k.a ideal times to buy/sell the stock). He would only act if/when all the criteria were aligned and when the stock passed its “pivotal point,” and would immediately unload his position if the stock did not act the way it was supposed to act after passing that level (i.e. failed breakout).
B.) A sister/cousin stock in the group: Livermore was also very interested in how other stocks in the group acted before he committed his capital. He wanted to make sure other stocks in the group were acting well and moved in tandem with his theory (up, down or sideways) on the group. Again, everything else being equal he would participate in the strongest or weakest stock in the group.
Final Step in Top Down Trading: “Due Diligence” – Review all four criteria again: After he completed his process he would review all four criteria again to make sure he didn’t overlook anything and that he was indeed following his rules. Once everything was “inline” he would pull the trigger and had a very low tolerance for losing positions. Livermore never averaged down (which occurs when someone buys more shares as the stock drops to lower their average price) and always averaged up ( bought more as a stock advanced because the market is telling you are “right”).
A. The Market
B. The Industry Group
C. The stock in question
D. The tandem stock
*Source: How To Trade in Stocks: The Classic Formula For Understanding Timing, Money Management and Emotional Control by Jesse Livermore with updates and commentary by Richard Smitten
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Lesson 1: Don't Be A Wall Street Fool


Reminiscences of a Stock Operator by Edwin Lefèvre and Roger Lowenstein is one of the most powerful investment books every written. Many people believe the book outlines the story of Jesse Livermore, one of the most famous stock market operators in history. The book contains a wealth of wisdom and prescient information that has stood the test of time. Many of the concepts are applicable today! Over the next few weeks, I will break down much of that “market wisdom” into a series of easy to digest blog posts.

Lesson 1: Don’t Be A Wall Street Fool

There are a million ways to make money in the market. Some are successful and some are not. Any succssful market operator can tell you that regardless of your trading strategy the one universal thruth to be a successful in the market is to develop and employ a sound market based trading plan. Otherwise, you will be at the mercy of your emotions which will lead to sub par results.
(For the purpose of these posts, I will atttribute any quotes to Livermore.)
Livermore said,

“My plan of trading was sound enough and won oftener than it lost.  If I had stuck to it I’d have been right perhaps as often as seven out of ten times.  In fact, I always made money when I was sure I was right before I began.  What beat me was not having brains enough to stick to my own game–that is, to play the market only when I was satisfied that precedents favored my play.  There is a time for all things, but I didn’t know it.  And that is precisely what beats so many men in Wall Street who are very far from being in the sucker class.  There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.  No man can always have adequate reasons for buying or selling stocks daily–or sufficient knowledge to make his play an intelligent play.
I proved it.  Whenever I read the tape by the light of experience I made money, but when I made plain fool play I had to lose.  I was no exception, was I?  There was the huge quotation board staring me in the face, and the ticker going on and people trading and watching their tickets turn into cash or into waste paper.  Of course I let the craving for excitement get the better of my judgment.  In a bucket shop where your margin is a shoestring you don’t play for long pulls.  You are wiped out too easily and quickly.  The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages….A stock operator has to fight a lot of expensive enemies within himself.”

Lesson 1: Don’ be a Wall Street Fool!

Develop a sound market tested trading plan, then trade your plan. Always remember there are times to be long; times to short and times to be flat. Write it down, it is VERY TRUE!!!