21 timebars.
This is a reversal or extension pattern, Ex-pect prices to reverse at point A.
If the dollar amount between the 1.27 priceand 1.618 price is too great, the tradershould wait for more confirmation (i.e,doji or hammer or another indicator) ofan exhaustion move.
The thrust down from 1 to A will give agood clue as to what to expect, If pricesget to the 1.27 within 5 bars or less priceswill most probably extend to the 1.618.
There should be no price swings betweenpoint 1 and point A. If there is a priceswing Pattern #6 becomes a Gartley“222" pattern
This is a very important pattem when daytrading because point X is often theopening price of the day.
 
 
7. When prices react in the direction of the
trade, the protective stop should betaised to break even.
8. Profit objective should be the total distance
between points 1 and A, 
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Pattern Eight 7. When prices react in the direction of thetrade, the protective stop should beraised to break even.
8, Profit objective should be the total distancebetween points 1 and A.
 
1
1. Time frame between X and point A will be5 and 13 time bars (i.e,, 5 mminute, 30minute, daily). On rare occasions 21 timebars.
2. This is a reversal or extension pattern.Expect prices to reverse at point A.
3. Ifthe dollar amount between the 1,27 priceand 1,618 price is too great, the tradershould wait for more confirmation(i.e., doji or hammer or another indicator)of an exhaustion move.
4. The thrust down from 1 to A will give agood clue as to what to expect. If pricesget to the 1.27 within 5 bars or less priceswill most probably extend to the 1.618.
5. There should be no price swings betweenpoint 1 and point A. If there is a priceswing Pattern #6 becomes a Gartley "222"pattern.
6. This is a very important pattern when daytrading because point X is often theopening price of the day,Larry Pesavento
 
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Stock Trading Using Pattern Recognition and Geometric Ratios62
Pattern NineThree Drives to a Top
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. The pattern should be easily identified, If
you have to force the numbers, it is prob-ably not this pattern,
Symmetry is the key to this pattern. Points2 and 3 should be 1.27 or 1.618 price ex-pansions of the A and C swings.
The time frarnes from point A to 2 and Cto 3 should be symmetrical.
. If there is a big price gap in this pattern at
any time it is a sign that the 3 drive pat-tern is wrong and the trader should waitfor further confirmation that a top is inprogress.
Price swings A and C will usually be at the-618 or .786 retracement of the previousswing. When the market is a vertical(blow off) pattern, these retracementswill only be ,382.
Three drives to a top is a rare pattern. Af-ter you start to see this patttern, it will bemuch easier to interpret. Don't search forthe pattern, it should jump out at you asyou study the chart.
Larry PesaventoStock Trading Using Pattern Recognition and Geometric Ratios
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The pattern should be easily identified. Ifyou have to force the numbers, it is prob-ably not this pattern.
Symmetry is the key to this pattern. Points2 and 3 should be 1.27 or 1.618 price ex-Pansions of the A and C swings,
The time frames from point A to 2 and Cto 3 should be symmetrical
If there is a big price gap in this pattern atany time it is a sign that the 3 drive pat-tern is wrong and the trader should waitfor further confirmation that a bottom isin progress.
Price swings A and C will usually be at the618 or .786 retracement of the previousswing. When the market is in a free fall(exhaustion), these retracements willonly be .382,
Three drives to a bottom is a rare pattern.After you start to see this patttern, it willbe much easier to interpret. Don't searchfor the pattern, it should jump out at youas you study the chart.
Larry Pesavento67
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December S&P Example of Primary Pattern Ten5 minute Three Drives to a Bottom
                 
     
    
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A word of caution: When thethree drives pattern fails, it oftenleads to a huge continuation movein the direction of the trend.
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Classical Chart Patterns UsingRatio and Proportion
ia of you who follow the standard trad-ing pattern discussed in technical analysismay find this section interesting, I have se-lected the four more common patterns tradersencounter: Head and Shouders (Bottoms andTops); Double Bottoms and Tops; SymmetricalTriangles (Broadening Tops and Bottoms); Dy-namite Triangles.
If the trader will analyze the pattern us-ing the ratios discussed in this book, it willmost probably be enlightening, besides in-creasing probabilitites of a profitable trade.
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 Stock Trading Using Pattern Recognition and Geometric Ratios
8
 
Bonus Pattern: The Butterfly
 
4.618 —
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Top
 
This pattern was discovered by BryceGilmore and myself while we were runninganalysis routines on his Wave Trader SoftwareIt is a very powerful pattern and is seen at sig-nificant tops and bottoms only, The “Butterfly’beauty lies in its symmetry. It is my secondfavorite pattern, just after the Gartley 222
When several of my close friends re-viewed this book for me, they suggested that Iomit the Butterfly pattern. I already knew myresponse to the suggestion. I firmly believethat you can give the trading public the HolyGrail and they still don't grasp the principle.The reasons for this are probably related to ageneral level of skepticism and inability to ac-tually do the work involved. This pattern is farremoved from any Holy Grail! Find a few on |your own and make your own judgement, Iknow you will find the time well spent.
Characteristics of the“Butterfly”Pattern
1. It is formed by the connecting of two tri-angles.
2. An AB = CD pattern is present in the ex-tension move.
The extension move can be either 1.27 or1.618, Any move beyond 1.618 negatesthis pattern. Should this occur, a verystrong continuation move is in progress,
It is found only at significant tops and bot-toms.
The time bar relationship usually is in ra-tio and proportion to the price bar,
It is correct over 80 percent of the time.The retracement moves inside the butter-
fly will usually contain .618 and .786moves. 
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 Stock Trading Using Pattern Recognition and Geometric Ratios
 
The Opening Price
 
I first met John Hill of the Commodity Re-search Institute in Hendersonville, NorthCarolina in late 1974 or early 1975. At thattime, I was recovering from a tremendous lossin cattle, soybean oil and soybean meal. | waslong many contracts during the 1974 Octoberbreak. 1 started with nothing, but ran it up toagreat deal of money. I then realized that I hadthe ability to make that kind of money. How-ever, I neglected to realize that I confused suc-cess with a bull market and | was unpreparedwhen the bear market finally came,
During these last 23 years, John and Ihave remained good friends and have sharednumerous good trading ideas, In 1982 I wentto John's ranch in Hendersonville and spenttwo weeks with him looking at various ways oftrading the markets. One of the best discover-ies we made was a computer study which re-vealed to us the principle called Trading in theDirection of the Opening Price. We worked fortwo solid weeks in several different markets,relating the opening price to the price actionof that day. It is probably one of the mostamazing statistics that 1 have ever seen as atechnical indicator in trading commodities.
Several years later, Earl Haddady of theHaddady-Sibbett Corporation published thesame statistics in a book called The Importanceof the Opening Price. We heartily recommendthis book to anyone interested in trading com-modities and especially to those involved inday trading. It puts a tremendous advantageon your side when you’re trading in the direc-tion of the opening price
The principle behind the importance ofthe opening price probably stems from the factthat the markets are open only six hours aday. That leaves 18 hours for decision making
to occur. When you consider the fact that theforeign markets are open in Hong Kong, To-kyo, Singapore, Sidney, London and Amster-dam, you get an even greater flavor of whatoccurs during the 18 hours when our marketsare closed, It is my opinion that decisions aremade during the 18 hours that are effected onthe opening of our market, I realize that mostof the volume is not done on the opening— itis done during the complete day. However, toexplain how the opening price is so signifi-cant, one must remember that these peoplehave been making thought decisions and ana-lytical decisions during the past 18 hours in or-der to come up with strategies for the follow-ing days.
The Opening Price Principle is this: theopening price will be the high or low of thatday 85-90 percent of the time, In other words,the price at the opening will be either within10 percent of the high or the low of the day onthat particular day. There are two ways thatyou can prove this principle to yourself. First,take a commodity chart like Commodity Per-spective or Futures Charts, something thatshows the opening price which would be thesmall left-hand bar on the daily bar chart—notthe closing price, but the left-hand side whichis the opening price. Take a red pencil anddraw a little circle around the opening price.Continue that through the life of the contract.Set the chart down and you'll see that the highor the low of the day was the opening priceapproximately eight or nine times out of 10.The second way to test the importance of theopening price is to use the day trading charts—that is Intraday charts—if you have access tothem. Using an intraday chart, mark the open-ing price and draw a line across the time zoneLarry Pesavento
a
for the rest of the day—a horizontal line wherethe opening price is indicated. You'll be sur-prised how often prices meander around thatopening price whether it is the high or the lowof the day. Even when it’s not the high or thelow of the day, the opening price seems to besome kind of harmonic or equilibrium pricethat the market bounces against several timesduring the day.
Armed with this information, a daytrader and, actually, a position trader can en-ter the market to his advantage with probabili-ties on his side. The charts on the followingpages show examples of how to use the open-ing price advantage as part of your armamen-tarium for strategy in entering a market for aposition trade and also for profiting on a daytrading basis. Keep in mind that this techniquedoes not work all of the time, but that it doesput probability in your favor a great deal of thetime,
There is an important concept here toremember: forget about the closing price ofyesterday. It means absolutely nothing whenyou're dealing with the opening price con-cept. Whether the price gaps up or the pricegaps down is of no consequence to you whenyou are using the opening price to enter amarket. You must forget the closing price ofthe previous day; the opening price is your fo-cus, especially when day trading. Whenever Itaught this principle, students always seem towant to hang onto the closing price of yester-day. You must remember not to useyesterday's closing price when using theopening price principle.
You will see that this technique does geteasier with practice as you become more ac-customed to its use, The charts on the nextseveral pages present examples of how to usethe opening price in conjunction with patternsand pattern recognition formations in order to
set up day trading probabilities. You may wantto use the “Key of the Day” (Opening + High+ Low divided by 3) with this technique. Ifprices are above Key of Day, only go long. Ifbelow Key of Day, only go short.
Keep in mind that in day trading—andalso position trading—you must be concernedwith both the Price and the Time Axis. Somepeople who day trade will inadvertently losemoney because they forget about the TimeAxis. They think they are trading just for sev-etal days when, in fact, they put a trade on fora day trade and it turns into a position tradewhich gaps the opposite of what position theyare holding, resulting in a loss. When you areday trading, you should be out on the close. Ifyou are position trading, you should positionyourself for a longer term move somewhere inthe neighborhood of three days to threemonths, depending on your style of trading.
One of our favorite day trading tech-niques is to buy that (.618) retracement fromthe opening price with a stop at the (.85)retracement. In other words, if the marketdropped more than 25 percent below the (.618)you would be able to say that you were wrong;your stop limitation is very small and youwould be able to profit as the market movedhigher. The Microsoft chart on page 92 illus-trates this point perfectly. The market did, infact, move higher and you turned a profit atthe end of the day,
‘Two important things to remember whenday trading: 1) Get a very fair commissiontate. A $25 - $30 range is completely accept-able. 2) Good volatility is essential. Trade themarkets that are quite volatile and highly ac-tive with a great deal of volume.
Examine the following intraday charts(Yahoo, Intel, Pfizer and September S&P 500)and you will see how the opening price fitsnicely with intraday Fibonacci retracements.Stock Trading Using Pattern Recognition and Geometric Ratios a4
Remember: