The Line of Least Resistance

16 Oct 2016

 

In Reminiscences of a Stock Operator —  Jesse Livermore placed deep emphasis on two things:

1 - The study of general conditions and

2- The line of least resistance.

 

 

General conditions refers to the big picture, i.e. the macro backdrop. It centers around questions like:

• Is liquidity (credit) plentiful, or is it scarce?

• Are equities generally overvalued or undervalued?

• Where are we in the business cycle?

• How much debt and leverage has accumulated?

• Euphoria, apathy, optimism, panic… which fits?

• Is risk appetite waxing or waning?

 

"But I can tell you after the market began to go my way I felt for the first time in my life that I had allies — the strongest and truest in the world: underlying conditions. They were helping me with all their might. Perhaps they were a trifle slow at times in bringing up the reserves, but they were dependable, provided I did not get too impatient". - Reminiscences of a Stock Operator

 

 

The path of least resistance  

 

Jesse Livermore described the pivot point as the LINE OF LEAST RESISTANCE. A stock can move very fast once it crosses this threshold. When a stock breaks through the line of least resistance, the chances are the greatest that it will move higher in a short period of time. This is the case because this point represents an area where supply is low; therefore, even a small amount of demand can move the stock higher.

 

The path of least resistance is a fact of nature. Rivers always flow around a mountain rather than through it. Electricity always moves through a circuit’s “easiest” route. The path of least resistance means taking the easiest route. Naturally choosing the easiest option. As humans, this trait is inherent as it is in nature.

 

“I have often said that to buy on a rising market is the most comfortable way of buying stocks. Now, the point is not so much to buy as cheap as possible or go short at top prices, but to buy or sell at the right time...Prices, as we know, will either move up or down according to the resistance they encounter. For purposes of easy explanation we will say that prices, like everything else, move along the line of least resistance.” - Reminiscences of a Stock Operator

 

All financial markets move in two distinct trends: Up or Down. When markets are not in a trend, they are then moving sideways, where there is an ongoing battle between sellers and buyers.  

 

"Law 1:  An object at rest remains at rest unless acted on by an unbalanced force. An object in motion continues in motion with the same speed and in the same direction unless acted upon by an unbalanced force". - Sir Isaac Newton

 

Price fluctuations are governed by Supply and Demand in Buying and Selling activity by other humans, which means they move in predicable patterns. Like water and electricity, the market will flow through it’s path of least resistance.

 

Price movement works the same way as that river:

…price movement is like water

...…and support and resistance levels are like large rocks.

 

Wherever the resistance is at the stock is what often determines it. If the resistance is pushing from the ground up - it pushes the stock up. Whereas, if the resistance is at top, it will push the stock down.

 

 

Trading support and resistance levels to find the path of least resistance is a key skill for a trader. When entering into a trade, a trader must ensure that there are NO key support and resistance levels between their entry and target. 

 

Trading by one simple rule: trading the path of least resistance by always trading in the direction of the prevailing trend. 

 

Look for as much resistance as possible to place between our entry and stop loss… and then set entry orders in areas where there is very little (or no) resistance between entry and profit target.

 

Combining patterns, support & resistance and comparing it with trend, range and momentum to establish the most likely path of least resistance.

 

 

 

 

 

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© 2016 by aTrader