I don’t write too often about recent market action. Jesse Livermore liked to say that speculation was as old as the hills and I’ve tried to make most of my writing here “timeless” rather than “market commentary”.

I thought though, given the scale of the sub-prime problems, I would look at two of the best known stocks that have suffered in the crisis and how Jesse Livermore’s trading rules would have kept anyone who uses them out of trouble.

I’ll mention in passing that a senior contact I have at a well-known investment bank has tipped me that his own company has suffered enormous losses in debt instruments this year.

Like all the tips I get, I’ll not make much use of it – other than to pass it on here. After being stung once too often, Jesse Livermore learned not to act on inside tips – he found that acting on price and volume data was more profitable than acting on tips. Furthermore, although my contact’s bank hasn’t yet announced its losses, several others – such as UBS and Citigroup have.

So how would Jesse Livermore’s rules have kept us out of trouble?

Livermore’s number one trading rule was:

Buy rising stocks and sell falling stocks.

So let’s have a look at two of the highest profile stocks to have suffered in the US and UK stock markets recently.

Firstly, there’s the Northern Rock Bank in the UK – the only UK bank in living memory to have suffered a run, as customers queued for hours to get their money back. Here’s Northern Rock’s price chart from Yahoo Finance. There has been a clear downward trend for a considerable time and so – according to Livermore - the stock has been a clear SELL for some time. Selling sooner rather than later would have protected investors from the recent price collapse.

Northern Rock Chart 2007

Secondly there’s Countrywide Financial Corporation in the US. Again there has been a clear downward trend for a considerable time and so the stock has been a clear SELL for some time.

Countrywide Chart 2007

What’s interesting is that credit ratings agencies continued to give healthy credit ratings to companies which have run up against severe liquidity problems. The agencies’ analytical skills were unequal to the task of measuring the risks in the sector. In other words, while fundamental analysis continued to point to the financial health of many finance companies, the market itself was taking a less rosy view and stock prices had been trending downwards.

Jesse Livermore’s trading rule is as valid today as it was one hundred years ago:

Buy rising stocks and sell falling stocks.