November 2006
Trading Tip: Larry at the Expo
by Howard Arrington
The material for this article is from the seminar presentation by Larry
Pesavento, given Nov. 18th in Las Vegas at the Traders Expo on the methodology
he uses in his trading. I have extracted the text from a video tape
I made of his presentation. The text has been edited to summarize the
principles being taught in the seminar. I also created my own examples for
this article that mimic the charts shown in Larry's Power Point presentation.
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Bias:
Take money out of the equation and you will trade a lot better. I have
always said I would be almost infallible as a trader if you would take off the
price, the time, and the name of any chart I was looking at, so I would not know
if I was trading wheat, the Euro, the S&P, or IBM or Google.
Because then I would have no bias at all. Because I have been doing this
for 43 years, I have biases, and I have to fight those all the time.
Usually that is when I get into trouble, when I fight them, and so I do a lot of
psychological work to try to get around them.
AB=CD:
This is an uptrend. You have higher tops and higher bottoms. What
we are trying to do with a forecast tool is to find these spots (there a trend
line meets a channel line.)
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Point C might be a 61.8% retracement of the AB move, and CD
might be a 1.618 expansion of the BC move. We are trying to take these
ratios of 0.618, 0.786, 1.272 and 1.618 and find the point in time
where we are expecting a turn, match the price to it, put the trade on and see
how it works. A tool I use often is the AB = CD tool. I
am looking for the CD leg of the move to be equal to the AB leg of the
move. The BC wave will be a retracement that is around 61.8 percent
of the AB leg. Here is an example.
Neural Net Timing:
I use the Neural Net timing tool to tell me when to expect a
change in trend, as in this example at Point C. I look for a
retracement to the 61.8% price level and put on the long trade at Point C.
The Neural Net is showing a high probability that the market will continue to
rise the rest of the afternoon, which it does in this example.
Even if you did not keep this trade overnight to get to Point D,
you still had a small profit buying at Point C and then closing out near the end
of the day. We are trying to find those points where the market is getting
ready to trend and you have a nice Fibonacci number to buy off of.
It is that simple. You do not have to have any oscillators, MACDs, moving
averages, or any of those things to make it complicated. Oscillators are
lagging indicators based on things in the past. With pattern recognition,
we are talking about things that occur in the future. We are looking to
Point D for our trade. Now we are going to be wrong some of the time.
Pesavento Patterns:
(Larry then showed a chart with just a zig-zag
line). You should learn to do a chart like this. I am going to overlay the Fibonacci
numbers on the swings of the chart. I use the Pesavento Patterns tool to
label the swings, like this example.
Look for the Fibonacci numbers given earlier. You
will learn to spot the AB=CD relationships. In a downtrend, we want to
sell into rallies. In an uptrend, we want to buy on
retracements. Use the Neural Net timing tool to find places where it is
showing the time for a bottom or the time for a top, and trade at the Fibonacci
price levels.
We are trying to match the price with the time, which is an
unusual concept because most people do not have TIME in the future.
The Neural Net curve is going out one day into the future and showing with a high
probability when the market is going to turn. I wish we had a chance
to show live trading in today's seminar because you probably would not believe
it when you see it for the first time.
Do I make money every day? No, I do not make money every
day. But I make more money than I lose. I have more profitable days
than losing days. When I do lose, it is because I misinterpreted what I am
looking at, or the Neural Net is totally wrong.
When you are ready to do a chart for the next day, this is the
type of analysis that you want to do. You want to mark all the
relationships on the chart that you can see. Put on the Pesavento Patterns so you
see all of the Fibonacci percentages. You will start to see the bigger
patterns of the AB=CD. The numbers you are watching are the 0.618, 0.786,
1.272, and 1.618. Any time you are getting ready for an expansion swing
that is occurring into a forecast High, and the current contraction swing is
arriving at a 0.618 or 0.786, that is when you are looking to be a buyer.
Now I can't show you everything in just one hour. If you
have interest in these types of patterns, begin by learning to mark up a chart
with the swing
relationships like the Pesavento Patterns. That you can get right out of
my book (Fibonacci Ratios with Pattern Recognition). That is real easy to
do. But it is going to take you awhile to do it. I have spent 15
years trying to find this, because I did not know what 1.272 was until
1986 and I had already been trading for 25 years. So it was a real
revelation when I found 1.272. Then when I found 0.786 a little
later. That was when I wrote the book, and it was named 'Book of the Year' in
1997. And,
it has been pretty popular ever since.
What you are trying to do is find the particular times for the
turns, and the prices for those turns will be at a Fibonacci relationship.
Every day when I walk in, I have a place where I want to be a buyer and a place
where I want to be a seller in the 10 major things I want to trade. I wait
for the Neural Net tool to tell me when the time is right. Then I look to
see if the price is right where I want to buy it. Of those 10
market, I will probably have 4 or 5 orders to execute, and I might only get
filled on 3. I might miss the other 2 orders by just a little bit.
Human Nature:
(Audience question: What is the time frame of the
charts? Are these daily charts?) This particular chart happens
to be a 5-minute chart. The principles work on basically any chart.
If you took off the time scale and the price scale, no one could tell which
chart it was. The charts basically look all alike. They have to
because we are all human beings, right? Do you know why you lose
trading? Because you are a human being and you want to avoid
pain. So when you are watching the monitor, you are focusing on the up
ticks when you are long and the down ticks when you are short. If you
would stop looking at the monitor and just follow your trading plan you would be
better off. If you put a limit order in and put an alert on so it will
either stop you out or alert you at your first price objective, then go back and
look at it. I look at the markets early in the morning for about a half
hour just to see how close I am to what I expected. Then I don't watch
it. I do other things. If it gets to my price it will beep, and then
I will look at it. Isn't that an easier way to trade than to sit there all
day long and agonize over everything that you are doing? Agonizing is not
trading.
When you see these young kids in a trading room, with 400 to 500
in the room, go back 6 months later and there will be a whole new group of young
traders. Because very few people get this right when they do it. The
statistics of people making money in this business, 90% of first time traders
are going to lose. Why? They don't know what they are doing.
Now the person that stays with it over 3 or 4 years, is going to learn the rules
and develop a trading methodology. You are looking at someone who is very
biased about what I do because I have been doing this pattern recognition stuff
for a very long time. I have not found anything that works any
better. I have a pretty good idea there will be a top right
there. (Larry points to a point in the future on the chart which
completes an AB=CD pattern at a 1.272 ratio at a Neural Net timing
point.) I am not waiting for an oscillator or anything to go.
Now I have a Neural Net tool that gives me the timing of when to enter the
market.
Complexity:
(Audience question: How you keep yourself from adding more
to your methodology? Are you continually learning and trying new
things?) I learn something all the time. All I have to do to learn
anything is just call Howard. He will teach me something because he knows
a lot more about this stuff than I do. My stuff that I do is really
simple. And I don't understand computers very well. I am totally
computer paranoid. I literally panic, so I keep it really simple.
I haven't done anything different than what I have been doing for so many
years. I have looked at other things, but I just don't do anything
different. I see these same retracement patterns every day, and then I use
the Neural Net tool to try to give me my timing. I try to be right 3 days
a week, break even 1 day a week, and I'll lose 1 day a week.
My biggest problem that I have is because I am a strategist for
a hedge fund, and I have to give predictions of where I think things are going
to go in seven or eight weeks, like when crude oil was topping out. I got
that one right. And I have to make an opinion, and I have to realize that
my opinions are wrong a lot. So I have to protect myself against
myself. Usually if you are in something 3 or 4 periods (bars) and it is
not working out you will be wrong. Usually this stuff works out right
away, I mean almost instantaneously, within 20 to 30 minutes. If you are
not profitable after 20 or 30 minutes then there is probably something wrong,
and you should get out of it and look at something else.
Christmas Present:
I'll give you a Christmas present. If you are really
interested in trading, buy Mark Douglas's book 'Trading in the
Zone'. Its a $25 book. If you will read that book and then
reread 3 pages a day for the rest of your trading life, you will do great.
What the book will do is teach you that you know nothing about the markets and
that it is not necessary to know everything about the markets. You will
learn that it is about probabilities. Even though this is a trade, it is
just 1 trade out of a hundred trades. As soon as you lose you have to go
right into your next trade and follow your trading plan. The only thing
that prevents me from making money would be if I were sick or they close the
markets. That's the only way I am not going to make money. I will
sit there all day long and trade live in front of audiences. That's the
fun part when you are at a show and can show people in real-time what this is
doing.
The Ensign Windows program has a playback system where you can
actually go back in time and pull up some charts and update them as if they were
live, and that's fun to do too. But in one hour today I can't do
this. What I am trying to do in this hour is show you what the AB=CD
formation is, hopefully you will look at the four Fibonacci levels we talked
about, and maybe even take a look at the Neural Net timing tool. If you
are trading currencies and take a look at this, you will not trade without
it. It will get you hooked because it is a real edge in the markets that
you have never seen before. But it is not infallible. It is only a
probability and it is only a tool. There is nothing incredibly mysterious
about it. It is just mathematics and looking at patterns. These
numbers are in the market everyday and that is why they repeat so much and gives
you an edge. But most people do not do this type of work.
Repetition:
I walked through the Expo hall yesterday watching all the
exhibitors showing their charts with oscillators. There was nobody
doing this kind of thing. They use some Support and Resistance, but no one
was looking at all the patterns and how they relate. Once you see how this
swing repeats again here, here and here, you see this basic vibration in the
market repeats over and over again. That is all the markets are ever
doing, repeating over and over again. It only goes up, down or
sideways. It is not the hardest thing in the world.
My little daughter when she was about six, we would get
Commodity Perspective every Saturday morning by special delivery because we did
not have computers back then. I would get my charts on Saturday morning
and she would help me draw the lines. I would let her mark up charts like
cocoa and coffee which I did not trade. I would ask her which direction
the market was going. She would look at the chart and say, this one is
going up, or this one is going down. If the market was going sideways she
would put her thumb in her mouth and shake her head. That is what
most of us do anyway when we don't know what the market is doing.
(Audience question: What is your daughter doing
now?) She is a doctor in Denver, Colorado.
(Larry then showed several examples of the Neural Net curve for
the next day, and then added the bars to the chart so the Neural Net curve and
the bars could be compared. Correlation was high, but not
perfect. Some examples were shown where the Neural Net curve had a better
fit when plotted inverted on the chart. Please read my 2002 Trading Tips
article about Neural Networks.)
Always Use Stops:
The Neural Nets do not work this well all the time. That
is why you have to use stops. Let me tell you about my personal
trading. Whenever I put a trade on, 2 things happen. I don't use
electronic trading and I know you are not going to believe it, but I still pick
up the phone and call an order desk. I tried a couple of electronic trades
and I screwed them both up. So I am still picking up the phone can calling
my broker. I am probably one of twelve people who still do that. My
broker will not take the order if I do not give the corresponding stop loss
order. The two reasons why you lose in this business is that you put your
stop too close because you don't know what is going on, and the second thing is
you don't put a stop in immediately. If you don't put a stop in when you
place the trade or shortly thereafter, just send the check directly to me.
Then you won't have to worry about commissions you pay to your broker. You
have no chance if you don't protect yourself. You don't know what is going
to happen next. Even with the Neural Nets you do not know what is going to
happen next with 100% certainty. No one knows that.
(Larry then showed a Swiss currency chart where the Neural Net
correlation was high for the first few hours of the day, and then the currency broke down
when the Neural Net curve was turning higher. This was a good example
where having a stop was necessary. The Neural Net curve ascended the
balance of the day and the actual market went sideways.)
Face Value:
Currencies are the best thing to trade because you are trading
the most pure thing in the world. There is no supply and demand to worry
about. It is just people moving money. That is all it is. You
do have to worry about when people talk about the money, though. People
like George Saros use the markets to manipulate their position. You might find that
hard to believe, but it is true.
Do you folks know what my educational background is? I
have a Masters degree from Harvard, a Doctors of Jurisprudence from Yale, and I
worked for Chief Justice Burger for 2 years before I became a Navy Seal, and I
won the Congressional Medal of Honor twice. (Audience chuckles) Now
what I just did to you is what CNBC does to you each day. They sit there
and lie to you. (Audience laughs) Well, they do. No, its
true. They are passing on to you all this information they are getting
from these self-serving sources. After a while you would think they would
get the picture they are feeding them this stuff.
When I worked at Drexel, which is no longer in existence because
of Mike Milken, they used to have stock broker meetings on Monday mornings and
they would have portfolios of stocks that Rothschild who owned Drexel was trying
to get rid of, and the joke was put lipstick on this thing and get rid of
it. And that is what the brokers tried to do. That was back in the
70s. Now you buy something and it goes up forever. Back in those
days it was difficult to be a stock broker. You have to be real careful
when anybody tries to tell you something.
Exceptional Timing Tool:
(Larry then went through several additional chart examples that
illustrated the Neural Net timing. Most of his examples were using
2-minute bars. The Neural Net curves are available Monday through Friday
for the hours of 8:30 a.m. to 3:00 p.m. Eastern time. Creation of a
Neural Net curve for a 24-hour day is a project that
has not yet been accomplished, but might come to pass.)
In my Friday seminar, the Neural Net curves were so exceptional,
I had to separate the bars from the curve so you see what the market was
actually doing. One lady said I know you are pulling my leg so she got up
and left. The Euro on Friday actually was so perfect that it tracked
all of this. There were little swings and the correlation was nearly
perfect. When you get days like that you walk out wishing it could be like
that every day. But, unfortunately, it is not.
(Audience question: In nearly every chart you have shown,
why does the correlation at the beginning of the day look better than the last
couple hours of the day?) Yes, the last hour of the day you will
have less correlation. The reason why is because you have gone through
several hundred 2-minute bars towards the end of the day, and so the correlation
is less. But we have tested it early in the day, tested in the
middle and tested it towards the end of the day. It doesn't make any
difference. Once the probability curve is made for the whole day it is not
going to change very much.
(Audience question: What do you base the day upon for a
currency pair?) We use the opening time for the Chicago Merc opening time
because that is how my research got it started. Back in 1990, there wasn't
any Forex currencies to trade. Initial tests were done on the Merc
products for the pit traded currencies. Beginning of the day refers to
8:30 a.m. Eastern zone time for all currency pairs for the Neural Net
curves. The curves go through 3:00 p.m. Eastern time.
(Audience question: Does the Neural Net work better with
one currency than another?) No, any 2-minute chart you want to look at,
whether it Gold, S&P, soybeans, or Google, doesn't make any difference.
It is a probability based thing. It is going to work some of the time and
lose some of the time. It gives you a probability of being right more than
it is wrong. In my personal trading, I am close to being right 70% of the
time. I want to be in markets where they are playing big with
lots of volume and volatility. It is not going to work on thinly traded
stocks, IPOs, or stuff like that. You want volatility. You want
liquidity. And that is what Forex offers you.
You have really great risk control. You can view things
overnight. When you wake up you can put a trade on and be out of it by the
end of the day. That is an ideal situation without risking very
much. My problems as a trader when I have to make an investment decision
for the hedge fund, when crude oil was making highs up there during the fighting
between Israel and Lebanon, all the things I was looking at, how was I saying
oil is not going to make $80? $78 was it. I agonized for
months. Every day they would call me and say why is it not breaking?
I said, 'When it gets above $80, call me. I don't know when it is
going to break.' Now it is $56 and they want to know where it is going
next. I don't know. All I can tell you is that was the top.
$55 may be the bottom but I am not sure.
Trade of the Year:
I do a trade of the year every year. I have been doing it
for many years and some of my trades in the past have been buying crude oil at
$11, buying gold at $2.50, selling Treasury bonds when they were selling at
$127, buying the Nikkei Dow when it was at 7000. Out of the last nine
years I have had 7 winners and 2 break evens. And this year, I hate to say
this, I have a very, very strong negative bias towards the stock market.
If I could stand up on a chair, I would yell and scream at you, but it
probably would not make any difference. But I see very bearish connotations.
If the INDU goes below 11,500, which is about 700 points from
where it is right now, you have a chance to lose a lot of money if you are in
the stock market. The reason behind this would take me 2 hours to go
through. The patterns are there just like we were in the year 1999 and
2000. Very, very negative. Whether it works or not, I don't
know. Believe me, I know nothing about fundamentals. I never read a
newspaper. I don't listen to television. This is all about what is
on that bar chart. That is all I know.
(Audience question: How strong was your opinion back in
2000?) If you want to know, it was in this meeting in San Francisco, March
24th a Saturday, and I had 400 people in the room and the markets had been going
straight up. People were walking into the room with their equity runs of
how much every one was making. I was standing on a small podium, and I was
showing them all these patterns, the Butterflys and Gartleys. Everything
was so bearish, much like it is now. But it seems worse now because we
have divergences. The NASDAQ is not even 38% retracement from the high in
2000, and most of the stocks that were popular then like JNPR and CMGI, these
stocks used to be $200 and $300 stocks and now they are nothing.
And I got up on my small podium, and I yelled and screamed at
them. I had 400 people in the room and I said if the NASDAQ goes below the
low of last week, get out of all your stocks. All you are risking is if it
goes back above the high you can buy them back. At least protect
yourself. That week, Business Week, U.S. News and World Report and TIME
magazine had the same cover of a bull, one with NASDAQ 5000, Dow Jones
15000, and the other with something about the NASDAQ going to the
moon.
On November 6th, 2006, on Barron's front page was the DOW
13000. The Dow has a very poor track record. You don't ever want to
get your picture on the front of TIME magazine. That is not good.
That is usually when it is over. It is really not a very good
thing. One person out of 400 people called me to thank me for
getting him out of the market. And as you know, the NASDAQ has dropped
85%.
(Audience question: Do you feel that same way now?)
I feel more so now because we have so much divergence. The Transports, and
the NASDAQ have divergence. We do not have the euphoria like back then,
but we have euphoria in other markets like the bonds and in real-estate
market. People do not realize how badly they can get hurt in
real-estate. But they will learn.
If you bought a house in Beverly Hills in 1929, you had to hold
that house 36 years before it got back to even. I am not saying
things will be as bad as 1929. When you see a piece of real-estate in New
York that is 1200 square feet going for 2.3 million dollars, you know something
is not right here.
(Audience question: What is your prediction for the
Dollar?) I do not like to make predictions like that. I give a
'Trade of the Year' based on patterns. If the Dollar goes below 83, and it
is at 85 now, there is a chance the Dollar could melt down. That won't be
good for anything. It hasn't rallied very much, and if it breaks really
hard, and the Euro gets above 130, the Euro could go to 150., the Pound could go
to 2.50. Remember, the Pound used to be $7, so a lot of these things could
still move.
(Audience question: If the markets break down, will Gold
go to $1000?) They are totally different markets. I know you believe
that the man who makes the rules, rules the Gold. Each market is
different. I do not look at inter-market relationships. I do watch
for relationships among the currencies. But gold investors are different
than stock investors. A gold investor is always a gloom and doomer.
He is always looking for the end of the world, and always has a little bit of
paranoia. But remember a paranoid person only has to be right once.
(Audience laughs)
Bar Chart Tells It All
All I do is just look at the patterns. I don't do anything
else, don't look at fundamentals, or watch the Federal Reserve. None of
that stuff. My Masters degree is in Business and my BS degree is in
Pharmacy. I don't know anything other than what is on those bar
charts. I believe the sum total of all buyers and sellers is in the bar
chart. They can lie to you, right?, like Enron. They can cheat
you like K-Mart, Wal-Mart and some of the others, but they can't hide from
you. If prices are going up there are more buyers, and if prices are
coming down there are more sellers. That's all you really have to
know. Sometime between when Enron went from $95 to zero, it had to cross
the 200 day moving average, didn't it? And if anyone ever talks to you
about trading a 200 day moving average, don't walk away from them, run away from
them. That thing doesn't work. That is the biggest crock of
baloney. They have been using that for 60 years, and it still doesn't
work. That's just my opinion, however wrong it may be.
(Audience question: How do you decide what price to trade
at?) When I look at a particular time, I want to also look at the previous
day and know support and resistance points. If the market is moving down,
I might wait for a rally to then sell short. If it is not making a
point I want to hit, I might pass on the trade, or wait for a retracement move
to get in. More often then not, because it is based on patterns, you are
going to get a lot of places where the highs and lows are going to come in at
your numbers. It repeats over and over. Just go back and look at old
charts. Patterns repeat over and over. Do you know what it is like
to wake up in the morning knowing you can beat the markets? It is a great
feeling.
(Expo staff opens the door and announces 5 minutes
remaining.) Oh, thought that was a margin call. (Audience laughs
loudly)
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