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Jesse Livermore's Stock Pattern Can Give Investor An Early Entry

IBD research shows that buying a stock at a new high when the market is strong is preferable to buying a stock at a new low.

However, finding a lower entry in a base isn't always a bad idea. Under the right circumstances, it can be ideal.

Jesse Livermore's shakeout plus 3 pattern can deliver big gains, and you don't have to wait until the stock makes a new high.

The pattern involves two lows, with the second low undercutting the first. The stock is bought when it rises 3 points above the first low in strong volume.

When the stock is high-priced, say 80, 100 or 200 a share, add at least 6 to 10 points to the first low. You want to see the stock make a significant move up before building a position.

The second low tells you that weak holders are being shaken out. The surge past the first low tells you funds are buying shares and resistance is minimal.

In Livermore's time (1877-1940), big-money operators sometimes started the drive to the second low with a little selling of their own. They wanted the shares of the weak holders, and driving the stock to a second low was the easiest way to grab shares at reduced prices.

After backing up the truck and reloading the bed with the cheaper shares, the big money could add to their positions without the average price getting too high.

Manipulation, though, couldn't have accounted for all or even most of a stock's story. If the stock had strong fundamentals, conviction would naturally draw more money into the stock, fueling the run-up.

Whether it's about financial pools in Livermore's era or the dark pools today, individual investors make the mistake of looking at market realities as "unfair." It's wiser to look at the market in terms of odds. They are either working for you or against you.

Baxter Travenol Laboratories (BAX), which changed its name to Baxter International in 1988, shaped a shakeout plus 3 in 1966. The first low was notched in July 1966 at 28.25 1. The second low settled at 25.50 in the week ended Oct. 14 2. The shakeout plus 3 set the buy point at 31.25. On Oct. 18, Baxter broke past the entry. Daily volume was 180% above average. The stock then retreated almost 3% below the ideal buy point before finding traction. Baxter rose 112% in six months.

Getting all of that gain would've been tough. Investors who held the stock — until it broke under its 50-day line in big volume May 31 — could've booked a 74% gain.