U.S. Markets close in 2 hrs 57 mins

Livermore's 'Shakeout +3' Pattern Marks Early Entry

Famed trader Jesse Livermore is worth reading about. His story features smart moves and dramatic highs and lows.

It's much more than what can fit in a short newspaper column. But one aspect of Livermore's legacy that can be reviewed quickly is a stock chart pattern called the " + 3.

This rare pattern consists of two sharp sell-offs, with the second slump undercutting the first sell-off's low. It's a bit like a double-bottom structure, but it generally unfolds more quickly — within a few weeks vs. the 's seven weeks or more.

So where does the "+3" come in? That refers to when you see the stock turn itself around after its two big sell-offs. You'll see it bounce back and soon jump to new high ground.

You want to see the stock rise at least three points above the first sell-off low in heavy , triggering an early entry. That's where you get the "+3." So if a stock has a first sell-off low of 30, a three-point gain past that price represents a 10% rally — signaling real demand.

For a higher-priced stock, you could look for a bigger gain. If it trades, say, around 50 or 60 a share, you might want to see a five- or six-point gain and think of that pattern as a "shakeout +6" if you want. The point: It must be an unusually strong move higher.

Lululemon Athletica (LULU) provided a good example of a shakeout + 3 with its action in late 2011 through early 2012.

The athletic clothing retailer made its first low at 42.18 on Oct. 4, 2011. 1 It dropped to its second low at 41.70 on Dec. 1. 2 Then came the market's follow-through on Dec. 20, confirming a new uptrend. That put IBD-style investors on the lookout for good stocks staging breakouts.

Given that Lululemon was trading around 40, you would watch for the stock to rise past 42.18 by at least 3 points or more. The stock delivered on Jan. 4 with a nearly 9% gain in big volume to 51.15, 3 more than 8 points higher than the 42.18 low.

As with any , you want to see big daily volume, meaning 40% above average or more. Lululemon's turnover surged 104% above average that day.

After shaping and then clearing a pattern first defined by the legendary Livermore, Lululemon ended up climbing as high as 81.09 in early May, a 79.5% gain.