8/7/2019 Trading FX Like Jesse Livermore Traded Stocks

1/5

The Ofcial Advocate or Personal Investing

Originally published March 2009. SFO magazine.

1 SFOmag.com

Jesse Livermore is widely considered to beone of the greatest stock traders of all time.On more than a few occasions, he traded ashoestring into at least a $1 million fortune. Itis said that the 1929 stock market crash wasthe pinnacle of his career, when he shortedstocks and made more than $100 million.Somehow though, he ended up broke andcommitting suicide in 1940.

His demise is most likely because he didnot follow his own trading rules. Still, when

Livermore followed those rules, his tradingsuccess was unparalleled.

The keys to his trading are not limited tothe stock market. Foreign exchange traderscan apply Livermores techniques to gain anedge in their trading as well.

SomE BACkGRoUND

In modern trading jargon, Livermore would beclassified as a swing or position trader. In Edwin

Lefevres 1923 classic trading book Reminis-cences of a Stock Operator, Livermore explainsthat the common thought of the day is younever grow poor taking profits. No, you dont.But neither do you grow rich taking a four-pointprofit in a bull market. He would build his posi-tion gradually, putting himself in place to catchthe meat of the trend.

Livermore was a speculator who would pickhis battles more than a trader jumping in andout of the market everyday. He thought that

trying to pick tops and bottoms was for fools,but he often found himself buying close tobottoms and selling close to tops as a result ofhis trading strategy.

In Jesse Livermore: Worlds Greatest StockTrader, author Richard Smitten writes in theguise of Livermore that I always wanted totrade along the line of least resistance, so I wasgenerally moving along with the crowd, theherd, most of the time I was always hunting

T r a d i n g F X L i k e

T r a d e d S t o c k s

Jesse Livermore

B y J a m i e S a e t t e l e

8/7/2019 Trading FX Like Jesse Livermore Traded Stocks

2/5

2 SFOmag.com

Figure 1:Daily DJIA Chart

for the clues to the change. So I was alwaysready to separate myself from the popularthinking, the group thinking, and go the oppo-

site way. These major changes in trends werehard to catch, but I did not want to ride thesled downhill with the crowd, unless I had soldstocks short.

PIvoTAL PoINTS

Livermores strategy was based on what hetermed pivotal points. Most traders todayare aware of pivot points, and many tradersuse some form of pivot points (of which thereare too many to count) in order to identify

support and resistance, which aids in enter-ing and exiting trades. To my knowledge,Livermore was the first trader to refer to apivot concept. If he was not the first, then hecertainly was one of the first.

Livermore defined pivotal points as daysthat contained heavy volume. After a pro-longed move, significantly increased volumewas a key signal to him that the market wasat the end of its major move. Rather than exit

his position instantly, he would wait for themarket to roll over and confirm that what hesaw was what he referred to as a reversal

pivotal point. At the end of a trend, a reversalpivotal point may be referred to today as ablow-off top or a panic bottom.

However, not all pivotal points lead toreversals. Heavy volume is often presentnot just at the end of a major move but alsotoward the middle of a trend. Take a look at astock chart to see for yourself. If, for example,heavy volume occurs and the market in ques-tion does not roll over right away (or bounceright away), then a continuation pivot point

may have occurred. When a continuationpivot point occurred, Livermore added to oreven initiated his position.

ADAPTING To THE FX mARkET

You are probably wondering how it is possibleto apply Livermores trading tactics, pivotalpoints, to the FX market. Volume is requiredin order to identify pivotal points in the waythat Livermore did. Because the FX market

350300250

200

150

100

50

16,00014,00012,00010,0008,0006,0004,0002,000

45

35

25

155

Jan 29 Apr Jul Oct Jan 30 Apr Jul Oct Jan 31 Apr Jul Oct Jan 32 Apr Jul Oct Jan 33

Volume

Average True Range

Source: TradeStation

A strong relationship exists between volume (red) and a one-day average true range (lower black).

8/7/2019 Trading FX Like Jesse Livermore Traded Stocks

3/5

3 SFOmag.com

does not trade through a centralized ex-change, no indication of volume is available.It is, therefore, impossible to trade FX in theway that Livermore traded stocks, right?

STRATEGY IN ACTIoNFigure 1 reveals the Dow Jones IndustrialAverage (DJIA) from 1929 to 1933. The topindicator (red) is volume, and the bottomindicator (black) is the one-day range (this issimply a one-day average true range, or ATR).To the naked eye, a strong relationship existsbetween the two indicators.

Of course, the naked eye can be deceiv-ing. As humans, we often see what we wantto see. Statistics are required to back up our

assumption. If you export the DJIA price andvolume data into Microsoft Excel and performa correlation (correl) test with daily volumeand one-day ATR as the two arrays, you willfind that the correlation coefficient is 79percenta high correlation. I ran this test withdaily data from 1920 until November 2008.

Intuitively, it makes sense that the daysvolume and range would exhibit a strongrelationship. If more prices are being hit,

then more orders should be executed. Astrong enough relationship exists in orderfor FX traders to use one-day ATR in order toapproximate the appearance of a volume in-dicator. Simply plot a one-period ATR on your

chart and identify the spikes in it. These areessentially equivalent to volume spikes (seesidebar online with this article).

In Figure 2, I have plotted the sterling/dol-lar (GBP/USD) daily chart and one-day ATR.I have also plotted the function that paintsthe bar red when one-day ATR reaches a200-day high. (The input can be changed, ofcourse. A smaller number will produce morepivotal points.) A pivotal point (200-day high)was made Aug. 17, 2007. If price would have

dropped below that days low, then that daywould have been defined as a bearish pivotalpoint. However, the days low was neverbreached and the Aug. 17 high was broken afew days later, confirming the bullish trend.

Another pivotal point occurs Sept. 28, andthe GBP/USD shoots higher after breakingthat days high a few weeks later.

A pivotal point is made Nov. 12, but pricebreaks to the downside this time, confirming

Figure 2:Daily Sterling/U.S. Dollar Daily Chart with Pivotal Points

Pivotal points

Continuation pivotal point

2.10

2.05

2.00

1.95

1.90

1.85

1.80

0.03

0.02

0.01

Jul 07 Oct 07 Jan 08 Apr 08 Jul 08

Average True Range

Source: TradeStation

8/7/2019 Trading FX Like Jesse Livermore Traded Stocks

4/5

4 SFOmag.com

that it is time to trade from the downsidegoing forward. As long as price is below thehigh of that pivotal point, the trend is consid-ered down. The high of that pivotal pointwas never breached.

A continuation pivotal point is made Aug.13, 2008, at about the halfway point of the2.0156 to 1.7442 decline (not shown is thereversal pivotal point that occurred in Sep-tember and led to a more than 1,000-pip rallyin less than a month).

Figure 3 shows the U.S. dollar/Canadiandollar (USD/CAD) daily chart with pivotalpoints. The rules are applied just as they werewith the GBP/USD. The largest one-day ATRduring the past 200 days is identified. Which-

ever way price breaks confirms the pivotalpoint as either bullish or bearish (and some-times specifically reversal or continuation).

A false pivotal point shows up, however.On June 29, 2007, the USD/CAD appearedto have made a continuation pivotal point(bearish in this case). After falling below thelow a week later, price continues to fall butreverses July 25. The high of the July 29 piv-otal point is exceeded, rendering that point

useless. The next opportunity presents itselfless than a month later, though.

PIvoTAL PoINT REvIEW

1. Identify the largest one-period ATR over X

number of periods2. If price exceeds the high of the pivotal

point, then trade long. If price exceeds thelow of the pivotal point, then trade short.

3. If both the high and low of the pivotalpoint are broken, then the point in ques-tion is no longer a pivotal point.Experiment with different timeframes and

look-back periods. Ideas include a 52-periodlook back on a weekly chart, and a 24-pe-riod look back on an hourly chart.

TImING AND moNEY mANAGEmENT

One of the more famous quotes from Remi-niscences of a Stock Operator: It never wasmy thinking that made the big money forme. It always was my sitting. Many read thisquote and assume that Livermore meant thathe lets the position ride in order to catch thebig move. This is true, but there is a moreimportant interpretation from the same book:

Figure 3:U.S Dollar/Canadian Dollar Daily Chart with Pivital Points

Continuation pivotal point

Apr 07 Jul 07 Oct 07 Jan 08

Reversal pivotal point

False pivotal point

Pivotal point

Pivotal point kicks off downtrend 1.20

1.15

1.10

1.05

1.00

0.95

0.90

0.026

0.022

0.018

0.014

0.010

0.006

Average True Range

Source: TradeStation

8/7/2019 Trading FX Like Jesse Livermore Traded Stocks

5/5

5 SFOmag.com

Copyright 2011 by Wasendorf & Associates Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form by anymeans, electronic or mechanical including posting to another website, photocopying, recording or by any informative storage and retrieval systemwithout the written permission of Wasendorf & Associates Inc.s President.

This article is strictly the opinion and conjecture of its writers and is intended solely for informative and educational purposes and is not to beconstrued, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securitiesherein named. This article is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach.Information is obtained from sources believed to be reliable, but is in no way guaranteed. Further, there is no guarantee of any kind that is implied orpossible where projections of future conditions are attempted. The publisher is not liable for typographical errors.

Commodity futures, securities, options and forex trading involve risk and are not suitable investments for everyone. Any investment should becarefully considered in light of an investors personal financial objectives and risk tolerance.

The article contained herein may provide hypothetical or simulated performance results. Hypothetical or simulated performance results havecertain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have notactually been executed, the results may have over- or undercompensated for the impact, if any, of certain market factors such as the lack of liquidity.Simulated trading programs are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made thatany account will or is likely to achieve profits or losses similar to those shown. Further, past performance does not guarantee future results.

No man can always have adequate reasonsfor buying and selling. In other words, thereare times when the correct trade is no trade.

Nothing is wrong with sitting in cash. Manyotherwise profitable traders fail due to over-trading. In this sense, the pivotal point is notjust a timing technique. Waiting for a pivotalpoint to form also serves as a money manage-ment device by discouraging overtrading.

During Livermores success as a specula-tor, margins for stocks were no more than 10percent. In other words, a trader need only putup one-tenth of the value of the investment(10-to-1 leverage). The low margin requirementwas probably one of the reasons that Livermorefocused so much on timing. In this respect, thestock market that Livermore traded in the early20th century is similar to the FX market today(where margins are significantly lower thaneven 10 percent).

Smitten wrote in his book from the perspec-tive of Livermore that timing was everything toa speculator. It was never if a stock was goingto move; it was when a stock was going tomove up or down. This seems quite obvious,but many traders I see pay little attention towhen the market might move. It seems to becommon practice to enter, long or short, andwait for the move to play out. The market maymove sideways for some time before movingin the expected direction. By the time the breakoccurs, conditions may have changed and thebreak may be in the opposite direction.

Besides, it is not sensible always to be ex-posed to market risk. Rather, wait for a pivotalpoint to form before risking capital.

USING THESE TooLS

A quote from Lefevres book wraps it up:But in actual practice a man has to guardagainst many things, and most of all againsthimselfthat is, against human nature.

Trading in the way that Jesse Livermore didoffers many benefits. Among the most impor-tant is the way in which pivotal points discour-age overtrading. Overtrading is a detrimentoften overlooked by traders wondering wherethey went wrong.

Another benefit of trading with pivotal pointsas Ive described here is that you always knowwhere you are wrong. A stop is always placed onthe other side of the pivotal point. Not overtrad-ing and always knowing where the stop shouldbe placed help immensely in controlling thehuman impulses that so often result in mistakes.

Not controlling his human impulses is whatultimately did in Livermore. When he wasable to follow his rules and stay objectiveabout the market, he was one of the great-est stock (and commodity) speculators ofall time. I hope that this look into his tradingtactics help you improve your FX trading.

Jamie Saettele is senior currency strategist atForex Capital Markets LLC in New York and au-thor of Sentiment in the Forex Market. His tech-nical strategy is published daily at DailyFX.com.Saettele is an active currency trader employinga discretionary approach to the FX market.Sureenough, the former support level turned intonew resistance, and the EUR/USD moved down-ward and resumed its new downtrend.