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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