Livermore's Trading Rules
1. Trend Trading: Dancing with the Market
Trend Judgment Methods
Livermore confirmed trend direction by observing price movements and trading volumes. For example, if the price continuously reaches new highs with small pullbacks, accompanied by increased volume, it is considered an upward trend. He often used 'test positions' to validate trends: entering with a small position first, and if profitable, confirming the trend's validity.
Case Reference
In the 1907 short-selling case in the U.S. stock market, he observed that the market was unable to rebound under negative news and decisively increased short positions, ultimately achieving great success. This sensitivity to changes in trend strength was key to his success.
2. Key Point Trading: Precisely Capturing Breakouts
Key Point Identification
Livermore's key points often appear when prices break through significant resistance/support levels, such as historical highs, the end of consolidation ranges, or price gaps after major events. He emphasizes the 'time factor', meaning the breakout must be accompanied by a surge in volume and rapid movement away from the key area.
Dynamic Adjustment
If the price quickly retracts below the key point after a breakout, he would immediately stop-loss, considering it a 'false breakout'; conversely, if the price pulls back on reduced volume without breaking the key point, it is seen as a signal to add positions.
3. Pyramid Position Increase: Amplifying Profits with Controlled Risks
Position Increase Logic
The initial position should account for 10%-20% of total funds, with subsequent increases decreasing in proportion (e.g., 5%, 3%). For example, if 100 shares are bought initially, then 50 shares on the second purchase, and 30 shares on the third. This decreasing structure ensures the average cost is close to the market price, avoiding the risk of excessive chasing.
Classic Cases
In the short-selling trades before the Great Depression in 1929, he gradually increased his position using the pyramid strategy during the Dow Jones crash, ultimately profiting over $100 million (equivalent to today's tens of billions).
4. Stop-Loss Strategy: The First Rule of Survival
Stop-Loss Setting
Livermore's stop-loss is not a fixed point but dynamically adjusted. For example, in an upward trend, if the price falls below the most recent low (which breaks the trend structure), it triggers a stop-loss. He also considers market volatility, such as being forced to exit when daily volatility exceeds 5%.
Psychological Construction
He emphasized in his autobiography: "Losses are the cost of trading, just as paying rent is necessary for running a store." Accepting small losses is to avoid making large mistakes due to emotional interference.
5. Capital Management: The Cornerstone of a Perpetual Game
Position Allocation
Single trade risk should not exceed 2% of capital (modern risk management concept), but during Livermore's era, he allowed single positions to reach 10%, with total positions not exceeding 50%. In extreme markets (like 1929), he would concentrate positions into 3-4 high-certainty opportunities.
Capital Reset
After each profit, withdraw part of the profits to ensure that the account size matches current market liquidity. For example, during the peak phase of a bull market, actively reduce position size to prevent liquidity depletion risks.
6. Emotional Control: Overcoming Human Weaknesses
Discipline Tools
Livermore insisted on keeping a trading journal, recording the reasons for each trade, market environment, and emotional state. He required himself to reread the trading plan before the market opens each day to avoid making impulsive decisions during the trading session.
Stress Testing
He advised investors to simulate extreme loss scenarios (such as a 30% account shrinkage) to pre-set response plans, thereby reducing irrational behavior during panic.
7. Patience Waiting: A Must for Hunters
Opportunity Screening
Livermore only traded 4-5 times a year, spending most of his time observing. He often used the 'line of least resistance' theory: when prices fluctuate within a narrow range, he does not predict direction until a significant breakout is confirmed.
Avoiding Noise
He avoided excessive market commentary, believing that 'the more opinions there are, the more blurred the judgment becomes', focusing instead on the information conveyed by the price itself.
Supplement: Livermore's Trading Philosophy
The market is like a battlefield
He believed that price fluctuations are the result of a tug-of-war between forces and need to be perceived through 'trial and error' to gauge market sentiment. For example, when breaking through a key point, if there is insufficient following momentum, even a perfect formation may fail.
Liquidity is King
Only trade high liquidity instruments to ensure the ability to exit at any point in time. He once suffered losses because he held small-cap stocks and could not exit in time; thereafter, he strictly filtered his targets.
Contrarian Thinking
"Be fearful when others are greedy" is his creed. In 1929, he noticed even shoeshine boys were recommending stocks, which became an important signal for his short selling.
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