Introducing the Livermore Index
“do not have an interest in too many stocks at one time. It is much easier to watch a few than many.” Jesse Livermore
“confine your studies of movements to the prominent stocks of the day. If you cannot make money out of the leading active issues, you are not going to make money out of the stock market as a whole.” Jesse Livermore in How to Trade in Stocks
Like many other traders, I fell in love with Reminiscences of a Stock Operator” which was a book based upon the famous speculator Jesse Livermore. The trading concepts introduced in the book both from a pure technical as well as psychological standpoint are timeless. The most interesting part of this book was the concept of trading the “active stocks” and following the “leaders.” This concept was brought up in Jesse Livermore’s own books on the market, where he emphasizes trading stocks that are highly liquid and active, and are leading the market. He also discusses finding stocks that have a predictable “personality” and tend to suit his style very well. Livermore’s writings and concepts were reborn in modern days through legendary trader Nicholas Darvas (How I Made $2,000,000 in the stock market) and William O’Neil of Investors Business Daily (How to Make Money in Stocks). These three books (including Reminiscences of a Stock Operator) are my three favorite investment books of all time. All of them emphasize using a trend-following/breakout method trading the “active” stocks and “market leaders” as the path to investment success. Some of the more modern success stories such as the world-record holder for highest annual return Dan Zanger (who is definitely no flash in the pan), also uses a similar approach. Dan Zanger also discusses having a proprietary list of his own “pet” stocks that fit his criteria. Purportedly they are “volatile” and tend to give fewer false signals.
From my experience and observation, I have noticed that the most successful investors/traders use this type of method to achieve phenomenal wealth whether they are trading stocks or futures. In contrast very few have done the same with short-term approach. It also seems that all of these investors/traders apply some sort of filter to identify the best stocks to trade. The IBD 100 is currently the only formal index that best represents this approach. It is in fact a very respectable index, and a good resource for active traders. However it suffers from several drawbacks: 1) the approach is not universal: it is specific to stocks only and cannot be applied to other asset classes 2) it makes too many assumptions about how the market should work versus the way it actually works: I actually tested numerous statements/assumptions made by O’Neil and found that many do not have statistical validity 3) it contains too many illiquid and speculative stocks that Livermore would never consider trading (or even O’Neil himself).
So, to address these issues I created “The Livermore Index” which is a universal method that can be applied to any asset class and its components. The Livermore Index is ideal for short-term or long-term trend trading or momentum-based approaches as we shall soon see. The method used to create the index is proprietary, but it uses only a few different measures. The Livermore Strength Rating or “LSR” is used to rank each stock by its favorability. The highest LSR stocks are the ones you want to trade, as they are the “easiest” and most likely to make you a sizable profit using any type of trend strategy–including standard breakouts which have in the last 10 years been very difficult to trade. Needless to say, the results of using this method were quite shocking, and completely break the paradigm of how to identify the “active” or “market-leading” stocks. More on this to come……….
to be continued