Trade Stocks Using the Livermore Method

Although I am a Forex trader, I have to admit that there is probably more money to be made in trading stocks than there is in Forex, although it is just a question of degree. One of the most successful stock traders of all time that ever lived is Jesse Livermore. He explained his trading rules in two books, but as there were discrepancies between the two publications, there is a lot of confusion over exactly what his methods were. After careful study of his writings, I will outline here the broad methods that he used and which can still be used today to achieve spectacular profits.
One word of warning first: when Livermore traded stocks as a serious professional, he bought and sold the stocks themselves on a 10% margin. This is quite different to most of today’s online brokers that allow trading in individual stocks. To do this properly and without paying far too much in fees and commissions, you really need to start with a five-figure sum, and use a top-of-the-range broker.
… THERE IS PROBABLY MORE MONEY TO BE MADE IN TRADING STOCKS THAN THERE IS IN FOREX…”
Here is how Livermore did it:

Step 1 – Determine Whether the Stock Market is a Bull Market or a Bear Market

Livermore explained that he did not start to become a real professional until he learned to anticipate big market movements. One of the advantages of trading stocks is that you can use the wider economic cycles and conditions to predict whether they are more likely to broadly rise or fall.
There are several statistical definitions of what constitutes a bull market or a bear market. Traders can also look to economic fundamentals to confirm whether a bull or bear cycle exists. Perhaps the easiest method is to use some fairly simple technical analysis of the major stock index itself, with the most significant of all global stock indices being the S&P 500. Moving averages are most commonly used: for example, if the 50 day simple moving average is above its 200 day equivalent, a bull market can be called, with the converse signifying a bear market. Alternatively, you might want to look at whether two consecutive months close above or below the 12 month simple moving average to determine the same.
When you trade stocks using the Livermore method, you only go long during a bull market and short during a bear market.

Step 2 – Prepare to Open New Trades When a New Bull or Bear Market Begins

Livermore stated that a stock trader’s job was to begin buying stocks right at the start of a bull market, and hold on until the bull market was over; or to begin short selling stocks right at the start of a bear market, and hold on until the bear market was over. He also pointed out that sometimes a market is not quite bullish and not quite bearish, which would mean time to get out of existing trades but not time to open new ones in the opposite directions.

Step 3 – Sector Selection

When the trader is ready to start going long or short, they must decide which stocks to buy. Stockindices can be bought, but profits can be maximized by picking the hot stocks of the coming cycle. This is best achieved by a top-down approach that looks at sector indices which are published by several financial services companies. Of course, studying the economic situation of that sector can be helpful as well. Technically, you can look at the prices of the sector indices, and see whether they are also looking as bullish or bearish as the wider market index, which is an important confirmation that you are looking within the right sector.

Step 3 – Stock Selection

Livermore traded the two hottest stocks from each selected sector that he wanted to be in. Again, a simple technical method of seeing which stocks are making the strongest new highs or lows can be used, in addition to studying the companies’ financial data, market share, products etc. There were two major advantages of being in the two hottest stocks of a sector: firstly, a benefit of diversification, and secondly, Livermore saw that if one of the stocks started behaving significantly worse than the other stock, this was a likely indication that something was wrong with that company, and when that happened he would get out of that stock.
An important part of trading stocks using the Livermore method is focusing on key companies that are at the forefront of technological change and customer demand. Livermore focused a lot during the early part of his career on sugar, steel and railways, which were key components of the economic changes during the late 19th century. During the current bull cycle it is certain he would be buying Apple shares in the same way he bought sugar when new technology was being developed to make sugar affordable to the masses.

Step 4 – Making the Trade

Livermore liked to buy breakouts and sell breakdowns. He also always scaled into his new trades, and not in equal position sizes either. I can illustrate this with an example.
Suppose you have identified the start of a bull market. You are interested in stocks A and B within sector C. Stock A makes a new high price, higher than it has been for several weeks or months. Livermore would buy stock A immediately, but with only one quarter of the total amount of shares in that stock that he might eventually buy. He would then wait to see how it acted. If it continued to rise strongly and make new highs, he would buy again: half of the remaining three quarters, and then wait some more time. If the pattern repeated itself, he would then buy the remainder of the shares that he wanted. He did say that you could use a 1% rise in price as a signal to add to the trade, but he probably used his own judgement more than he used any set percentage.
If at any time the move up seemed to fail, Livermore would get out. By scaling into the trade, he protected himself from more severe losses when he was “wrong” about the momentum of the move. When he was wrong, he would patiently wait until everything looked right again, and try the trade again.
Livermore did not use hard stop loss orders. He just got out when he judged himself to have been wrong.

Step 5 – Sitting Tight

One of Livermore’s most famous quotes is “I made more money by sitting tight than I ever did by being right.” What he meant by this was that nobody could foresee every market swing, so get in at the beginning and don’t get out until the whole market has played out. In this way, you might buy a stock for $10 and sell it two years later at the end of a bull market for $210, and make huge profits. He warned specifically about selling on pull backs out of fear the market was turning, and then trying to buy the shares back later. Livermore suffered from this in his early years of stock trading.

Conclusion

There you have an outline of the stock trading method of a man who was probably the greatest stock trader of all time. One final word of warning: Livermore went bankrupt several times, and this was due mainly to his poor money management skills. He simply risked too much of his capital on his trades. Be careful that in this area, you do not follow his example.
Trading Stocks
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Should I Trade Exotic Currencies?

This question is particularly important for anyone who insists on trading anything but the major currency pairs. First of all, and perhaps most importantly, did you know that Vietnam’s currency is called the Dong? That is too good to be true. For simplicity’s sake and in case you do not yet trust me here’s a chart of the Dong:
Dong

What are Exotic Currencies?

That being said, for those of you who are unsure exactly what constitutes exotic currencies, they are often the ones you never hear about. No one talks about them because they tend to move a lot more, can be more susceptible to change and most likely scares many traders. However I have a secret for you…exotic currencies shouldn’t scare you. On the contrary, exotic currencies, or exotics tend offer some of the best opportunities in foreign exchange (FX).
Don’t believe me? Well here are three reasons you should consider adding an exotic currency pair to your watchlist:
1) They are “technically obedient”. What does this mean? This means that if there is a breakout from support or resistance, it’s for real, and you can use the next level of support or resistance for a very high probability target. This regularly is not the case with the majors, which are held hostage by a number of other market forces.
2) They MOVE. As I alluded to above, exotic currencies trend to move a lot, which scare people. However, nobody ever made profits with a stagnated currency pair. For example, if the Turkish Lira gives you a trade, it’s going to get down and boogey. It’s not going to move 10 pips and then stop and reverse.
One important note to make, an exotic currency pair could move 2,000 pips and then stop, stone cold. Why? Because only a small number of banks trade these exotics, so once a move starts, it continues and rumbles along, and once it’s over, there isn’t any other trader out there to reverse it. Coming back to our example of the Vietnamese dong, this is why you get savage trends like those seen in the chart above.
EXOTIC CURRENCIES SHOULDN’T SCARE YOU… EXOTICS TEND OFFER SOME OF THE BEST OPPORTUNITIES IN FOREIGN EXCHANGE…
3) Finally, trading exotics is FUN. Apart from the word exotic, which is sure to elicit some vision of a beach in Thailand or palm trees in some picturesque cove, exotic currencies help cut through the monotony of an otherwise moribund trade. As a corollary, trading should not be about excitement, however why not enjoy what you are doing, especially if this is your job, career, or in some cases life? Truthfully, it is much more fun to tell the cashier at the grocery store that you “trade the dong” than it is to say, “I trade forex.”
Another question entirely, and perhaps best fit for a future topic of discussion, is what kinds of strategies work for exotic pairs? Presently, I’ve got one that I use utilize a few times a week. I’ll share it with you right now, as long as you promise to stay in touch (see the end of this article), and because you caught me in a jubilant mood.

Exotic Currency Trading Strategy

Thus, here’s a simple system for trading an exotic currency pair - in this case, the American dollar vs. the Mexican Peso (USD/MXN). As a side note, do you know why I adore this currency pair (I call it the Taco, by the way)? Because if there is a short-term breakout on the pair, it’s usually good for a nice little run. Again, think MOVES. Here’s an example:
Mexican Peso
In the morning, around 8:00 Eastern US Time, I draw trend lines on the chart. I also draw basic horizontal support and resistance. For this, I use the 15-minute chart.
Then I wait for a breakout. If it breaks out above resistance or below support, I take a trade in the direction of the breakout. When should you stop, or a better question is when should you stop? Quite simply, I then hold the trade until it reaches the next level of support or resistance.
If the trajectory of the currency pair reverses (which is uncommon), I don’t hold the losing trade. Instead, I exit with a loss if it closes back inside the broken support or resistance. Simple. Easy. Bada-boom, bada-bing. Don’t try and be a hero.
If you’re not familiar with supports or resistances, just go to YouTube. There are twelve bajillion free videos about it or some word that the English language has not even caught up with that denotes an extremely large number.
Ipso facto, that’s it - that’s the entire system.
I’d love to hear from you if you read the article and you’re going to give exotics a try. You can text me anytime to 304-281-8332, and you can use WhatsApp if you live outside the United States.
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Role Play, baby.

Chart 1
Click to Enlarge
You may have seen the above scenario play out on your charts: you spot a Support and the Support gets broken; the market rises back up and bounces against that previous Support level. In other words, Support has become Resistance. They’ve reversed roles.
Now, that’s straight forward in principle but what’s the psychology behind the market and how do we trade this information? Let’s look at a real-life trading scenario in this AUD/USD daily chart.
[Click to enlarge]
Chart 2
And now let’s walk through a trade by reading the chart from left to right.
Phase 1. Selling pressure creates a downtrend.
Phase 2. Increased buying pressure steps in to pause the downtrend and create a Support. The buying pressure could be from traders covering their short positions or because new buyers believe the market has gone down far enough.
Phase 3. After the market rises briefly, the dominant trend established in Phase 1 continues pushing the market back down.
Phase 4. The market breaks the previous Support. Keep in mind that the buyers that bought when the Support was created (Phase 2) now have their trades sitting at a loss. These traders would want to get out at breakeven if given the opportunity.
Phase 5. After the broken Support area, there’s a pullback as further buying steps in. This is typical of how a market moves: in waves of buying and selling.
Phase 6. Here we can confirm if the downtrend will continue after the Support was broken (i.e. the break was not a false breakout). And next, we find a point to enter our trade. Without a point of entry for our trade, none of this matters! As the market moves up and reaches the broken Support, we should expect the previous buyers to get out at breakeven. This will create a new wave of selling and that’s why Support turns into Resistance.

However, this is not a guaranteed outcome. Of course, the market could just continue rising past the broken support and start a new uptrend. Therefore, we have to see a clear rejection of this price level to show that the downtrend is still in play.
In this chart, that is exactly what happens: a bearish Pin Bar is produced within a few pips of the previous Support. A Pin Bar at this price level means there is confluence to give a strong entry signal.
Entering the trade: You can enter at the open of the next bar after the Pin Bar. Your Stop-Loss should be a few pips above the high of the Pin Bar. Your Profit Target could be a simple 1:1 risk/reward or you could trail your Stop-Loss for a larger target. The 1:1 Profit Target is hit immediately at the next candle.
A better entry method would be to go down to a lower timeframe, such as the hourly, and see if a Resistance is produced at the previous Support level on that lower timeframe. This would provide you a superior risk/reward for your trade. I took this trade on the daily Pin Bar with a 1:1 reward so I’m not going to pretend to have done better than that!
Sometimes a Support or Resistance will break and the market will just continue without pulling back much. In those cases I miss the trade even though I’m correct on the direction. That’s okay – you can’t catch every single move all of the time. You have to decide your criteria for each trade to make sure the probabilities are in your favour. And you must enter only when all those criteria have been met. Trading requires patience above all else.
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Are There any Good Forex Trends Left?

One of the easiest and most reliable ways to make money trading Forex is to follow trends and let winning trades run for as long as they will run. When you trade like this, most of your trades are small losing trades, but sooner or later they are more than paid for by a few huge winners. It takes some discipline to trade like this, but it is pretty easy. You don’t need to be a genius or even very experienced or knowledgeable to trade profitably in this style.
What you do need, of course, is at least one trend to exploit. When the Forex market is very flat and trends are completely absent, trend traders cannot avoid losing money if they want to participate, so identifying trends becomes really vital.
ONE OF THE EASIEST AND MOST RELIABLE WAYS TO MAKE MONEY TRADING FOREX IS TO FOLLOW TRENDS AND LET WINNING TRADES RUN FOR AS LONG AS THEY WILL RUN.
So, what are the best ways to define a trend that you want to trade?

How to Define a Good Forex Trend

Think of individual currencies, and how that currency is performing against other currencies. A good trend in one currency pair should also be visible in other pairs involving that currency. For example, if you see what you think is a good upwards trend in the EUR/USD currency pair, you should also see a similar trend with the Euro being strong against some other currencies and the U.S. dollar being weak against some other currencies.
The best trending currencies over the last 15 years have been the U.S. dollar, followed by the Euro. The smaller currencies tend to trend in a less stable way. A trend should show steady, stable directional movement over a period of time, not wild gyrations up and down.
A good starting point is to look at the USD against the other 7 major currencies. Look at a weekly chart of each of those 7 pairs. Put a few indicators on the chart: the 10 period RSI (Relative Strength Index), the 3 period EMA (Exponential Moving Average), and the 10 period SMA (Simple Moving Average). All of these indicators should be set to closing prices.
Now look at each chart and ask the following questions:
  1. What is the value of the RSI? Which of the 7 currency pairs have the highest/lowest values?
  2. Is the price higher or lower than it was 3 months ago?
  3. Has the pair very recently made new high or low prices for the last 3 months?
  4. Are the two moving averages both angled smoothly and steadily up or down, or are they twisted together?
Let’s apply these tests to each of the aforementioned currency pairs and see if we have any good Forex trends.

EUR/USD

EURUSD
The price is about the same as it was 3 months ago. The RSI is very close to its median 50 level. The moving averages are now pointing upwards but have been choppy over the past several weeks. There is no good trend here, in fact this is an excellent example of a ranging currency pair.

GBP/USD

GBPUSD
This looks like a pair that might just be beginning a downwards trend. The price is below where it was 3 months ago, and the last week has bent the moving averages into a downwards trend shape. Most importantly, the price has just been making – and is very close to – new 3 month lows. The RSI is 44. Here we see a stronger USD and a weaker GBP and a possible pair to trade short.

USD/CHF

This is the same situation as the EUR/USD pair, with no good trend in place, just ranging action now.
USDCHF

USD/JPY

This is a strange chart, but still it looks like a downwards trend might have begun. However the excessively large and bullish pin bar that was made last week does look like a cause for concern, indicating possible instability: not an orderly descent. Nevertheless, the RSI is quite negative at 37.29, and the price made strong 3-month lows just last week. This suggests a strong JPY and weakening USD.
USDJPY

USD/CAD

Finally, we see a clear upwards trend that meets all of our criteria.
USDCAD
The price has been rising for several weeks, and made a new 3 month high price just last week. The moving averages are quite smoothly extended upwards in good order. The RSI is very high and bullish at 73.86. The trend might be mature but you should never see an established trend and assume it will end just because it has been going on for a long time.

AUD/USD

This is a nice, clear and stable downwards trend that has been going for 16 weeks. As I write, the pair just made a new 3 month low, in fact it also made new 3 month lows last week. The moving averages are smoothly moving down and the RSI is at a very low 23.67. This is an excellent trend.
AUDUSD

NZD/USD

A very similar picture to AUD/USD. This is a nice, clear and stable downwards trend that has also been going for 16 weeks. The pair made a new 3 month low last week. The moving averages are smoothly moving down and the RSI is at a very low 24.83. This is an excellent trend.
NZDUSD

Conclusion

These charts have shown that although the USD seems strong overall, it has shown weakness and a possible downwards trend against the JPY. This is a little worrying, as the best trends occur when the USD is showing either strength or weakness against all the other major currencies.
There is no doubt that the weakest currencies and healthiest trends lie in shorting the AUD, and to a slightly lesser extent the NZD. There is also the trend of a weak Canadian Dollar.
A logical approach might be to trade with half of total risk divided equally short AUD/USD and NZD/USD, with the remaining half going to long USD/CAD.
These trends look fairly healthy but they will be much healthier still if and when the USD gets a more confirmed bullishness, including against the JPY.
There are still some good trends left: short AUD/USD and NZD/USD, long USD/CAD.
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Turning $10,000 into $1Million in Forex - Part 3

A few weeks ago we published parts one and two of a series of articles explaining how to give yourself a realistic chance of turning $10,000 into $1 million by trading Forex. Here I covered the topics of how long it might take, money management, trading strategies, back testing, forward testing, and identifying low risk entries. In this, the final part of the series, I am going to explain how to determine which currency pairs to trade, how to control overall risk, and outline some more advanced strategies for exiting trades. Careful study of all of the three parts of this series should give you the opportunity to build your own complete trading strategy that will give you a realistic change of turning $10,000.


How to Decide Which Currency Pairs to Trade

There are basically two approaches that can be taken in deciding which currency pairs to trade at any given time.
One approach is to build a diversified universe of currency pairs, and trade them all according to the entry and exit rules of your trading strategy. For example, you might take the seven major global currencies and put all of the possible 28 pairings as instruments in your universe. The major advantage of this is that you will be exposed to every good move in the market and well diversified. However, the major disadvantage is that you might be wasting your time trading currency pairs that are not really going anywhere. If you do take this approach, it could be wise to use stricter rules for trade entries, for example only trading in the direction of the trend. It is also a good idea to take measures that ensure you do not have too many trades open in highly correlated currency pairs at any given time. I address this issue below in How to Control Risk. Below is a sample equity curve achieved over the past 6 years by this type of strategy:
Currencies
An alternative approach is to take the same diversified universe of currency pairs, but only trade the ones that have the strongest momentum. This is known as “best of” momentum. For example, assuming you take the universe of 28 currency pairs I mentioned above, you could check each weekend to see which 6 pairs have moved the most over the past 3 months, and only trade those pairs, and only in the direction of the trend. The major advantage of this is that you limit risk and most of the time end up trading only what is hot in the market. The major disadvantage is that you can end up for quite long periods entering too late in the moves to make any profit, while missing out on the starts of any new, sudden directional moves. Below is a sample equity curve achieved over the past 6 years by this type of strategy:
Chart 2- Currencies
It is clear that in recent years, a “best of” strategy produced better risk-adjusted returns.
Something else that can be tried with “best of” momentum is being prepared to trade currency pairs just before and after any major news announcements are scheduled. For example, it might be that the Australian dollar is doing very little, but that tomorrow the Reserve Bank of Australia will be making its major monthly policy announcement. In this case, you could try to trade the AUD against the weakest and strongest currencies during a short time window around the announcement.


How to Control Risk

It is important not to have too many trades open at any one time, especially in currency pairs that are highly positively correlated, and especially if you are trading a universe of currency pairs without any kind of “best of” filtering. You should have maximum limits for: total number of trades open at any time, total number of long/short trades open in any particular currency, total number of long/short trades open in highly positively correlated currencies. For example, you might say no more than 12 trades open at any time, no more than 8 trades open in highly positively correlated currencies (e.g. NZD and AUD, or EUR and GBP), no more than 6 trades open in the same direction for any single currency. It might seem that these rules are restrictive, especially when there is a strong move, but these restrictions are beneficial to profits in the long-term. It is usually the case that the first entry signal you get turns out to be the best trade in any case. Do not forget that you can always close some of an existing trade that is in profit and open a trade in one of the later signals if you really want to. The important thing is to keep a limit on your risk.
There is an additional element to risk: the risk of a sudden huge movement in a currency, such as happened with the Swiss Franc in January 2015. Such events are rare, but in these events stop losses can be completely useless. As an additional precaution to control your overall risk, you should avoid trading any currencies that are subject to a peg against another currency imposed by their central bank.


Advanced Exit Strategies

Exits are very difficult to get right. In a sense there is no “right” exit as no matter how skilled a trader you are, you will usually not be able to exit a trade at exactly the right time.
One of the most robust exit strategies you can use is a combination of deciding a minimum profit target, and then watching the price action once the target is hit. After the target is hit, watch for a failure to make a new high (in a long trade) or low (in a short trade).
An example is shown in the chart below. Say a long trade is made where the up arrow is placed towards the left. A major high is made where “1st High” is marked. There is then a deep pull back, and then at around the area where “Failure” is marked, it is starting to look like the attempt to make another high has failed, so an exit could be considered here. It takes some practice to identify major highs and lows, so I recommend practicing this technique with historical unseen price charts.
EURUSD
Before I wish good luck to anyone who will be trying to turn $10,000 into $1 million, I will just remind you that your choice of broker is very important. You will need a well-regulated Forex broker that provides good execution, and competitive fees. Usually, a deposit of $10,000 should give you a wide range of choice and VIP service.
Good luck and happy trading!
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