Jesse Livermore's Forbidden Strategy Buy High, Sell Higher

Summary

In this video, the trading philosophy of legendary speculator Jesse Livermore is deconstructed. Livermore’s approach focused on identifying major market trends, buying on strength after a pullback, and managing risk with strict stop-losses. Key strategies include buying high and selling higher, avoiding averaging down, and always trading in harmony with the dominant trend. This method remains as relevant today as it was a century ago, offering timeless insights into momentum psychology and risk management that can be applied to modern trading.

Takeaways

• 😀 Livermore's strategy was to buy high and sell higher, which goes against the common advice of 'buy low, sell high.'
• 😀 His core strategy focused on identifying the major market trend and trading in harmony with it.
• 😀 The first step in Livermore's method is to confirm that both the stock and the overall market are in a clear uptrend.
• 😀 A healthy uptrend is characterized by higher highs and higher lows on the charts. Fighting against this trend is a recipe for disaster.
• 😀 Pullbacks (or normal reactions) in the stock's price are a sign of health, not weakness, especially when accompanied by low volume.
• 😀 Livermore bought stocks after they broke out to new highs, signaling strength and confirming the end of the pullback.
• 😀 New highs act as a confirmation of strength, forcing shorts to cover and bringing in momentum traders.
• 😀 Risk management was critical in Livermore's method, especially through the use of a protective stop-loss to limit potential losses.
• 😀 The stop-loss was placed right below the low of the pullback, defining the risk and serving as an invalidation point.
• 😀 Livermore considered averaging down a major mistake. He believed in accepting small losses to preserve capital for future opportunities.
• 😀 The key principles of Livermore's strategy—buying strength, managing risk, and following the path of least resistance—are timeless and still applicable today.

Q & A

What is the core strategy of Jesse Livermore in trading?

Jesse Livermore’s core strategy was to buy high and sell even higher, which is the opposite of the common advice to buy low and sell high. His strategy focused on buying stocks in strong uptrends after a pullback and waiting for a breakout to new highs.

What is the importance of identifying the main market trend according to Livermore?

Identifying the main market trend is essential because, according to Livermore, the big money is made in the major moves, not in small fluctuations. He emphasized trading in harmony with the market's overall trend, whether it is an uptrend or downtrend.

What is Livermore's approach to handling pullbacks in a stock's price?

Livermore viewed pullbacks as a normal reaction in a healthy uptrend, not a sign of weakness. He considered them as opportunities for entry when a stock consolidates on low volume, signaling that big institutions are holding their positions.

Why does Livermore advocate buying after a breakout to a new high?

Livermore recommended buying after a breakout to a new high because it signals that the pullback is over, and the buyers are back in control. This confirms the strength of the uptrend and indicates that the stock is likely to continue rising.

What role does risk management play in Livermore's strategy?

Risk management was non-negotiable for Livermore. He used protective stop-loss orders to limit his losses, defining his risk precisely and ensuring that he would exit a trade immediately if it moved against him. This helped him maintain discipline and minimize large losses.

What is Livermore’s stance on averaging down in losing positions?

Livermore considered averaging down as a cardinal sin. He believed that it was a foolhardy act driven by hope and emotion, and it violated his trading rules. Instead of averaging down, Livermore advocated accepting small losses and cutting them quickly when the trade setup was invalidated.

How does Livermore define the concept of a 'normal reaction' in a stock's price movement?

A 'normal reaction' is a pullback in a stock’s price that occurs during an uptrend. It typically involves a decline on low volume, indicating that the larger institutional players are still holding their positions. This consolidation phase is a sign of a healthy market, not a cause for concern.

What is the significance of a stop-loss in Livermore’s trading methodology?

The stop-loss is critical in Livermore’s methodology as it defines his risk on each trade. By placing the stop-loss right below the pullback low, he ensured that if the trade was wrong, he could exit without significant losses. It served both as a risk management tool and an invalidation point for the trade.

Why is it important to wait for a new high before entering a trade after a pullback?

Waiting for a new high confirms that the pullback is over and that the uptrend is resuming. This signals that the buyers are back in control and that the stock has cleared a major hurdle, making it a stronger and more reliable entry point.

What is the key takeaway from Livermore’s trading strategy for modern traders?

The key takeaway is that Livermore’s strategy emphasizes the importance of identifying strong trends, buying with momentum, managing risk effectively with stop-losses, and never averaging down in losing positions. This timeless approach to trading can be adapted to modern markets to achieve consistent success.