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Thoughts for a trading mentor

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Thoughts for a trading mentor

Fri, Sep 8 2006, 10:49 GMT
by Larry Pesavento

The Trading Tutor

Harmonic Numbers - II

Harmonic numbers are price swings that repeat with such consistency that they can be used to predict how far a price swing may go and where to place a stop when the trade is wrong. Harmonic numbers are best used for short term swing trading – from intraday to three or five day swings.

In order to find harmonic numbers you should examine 30-minute charts of the stock you are following. Find the one price swing that appears most often. This will be the harmonic number for that stock. However, don't stop there! Multiply that price swing by 1.27 and 1.618 and you will find the larger swings as well. It is necessary to gather a sample size of at least 100 to make it statistically accurate.

Completing the search for harmonic numbers will accomplish one very important principle of understanding why markets work the way they do. All price swings are related to each other by the four primary ratios: .618 - .786 – 1.27 – 1.618. Each swing will be harmonically related to each other by these ratios.

Knowing these numbers will alert you to impending dramatic price swings and volatility because once harmonic numbers begin to expand you will be prepared to see where the next expansive swing occurs.

Personally, the best use I’ve found for harmonic numbers is there use in stop – loss placement. For example, if the harmonic numbers in Intel were 3.5 points, then this would represent the absolute maximum you could allow. If the risk is too much then use .618 of 3.5 (2.1 points).

Take some time and prove this market principle to yourself. It will pay handsome dividends. However, you must do it yourself. Remember the immortal words of Jim Twentyman, “defy human nature – do the work yourself.”

Cycles

Cycles are present everywhere in nature from the cosmos, the seasons and the plant and animal kingdom. This is also true of all actively traded stocks and commodities. Each has its own internal clock or vibration.

Edwin Dewey was the first to do definitive studies on cycles through his prestigious organization known as the ‘Foundation for the Study of Cycles’. Paul Tudor Jones would eventually support and takeover the research project.

The first big money maker in the commodities market was based on cycle theory. I had read James Hurst’s book, ‘The Profit Magic of Stock Transaction Timing’, (1972). This book became a classic in cycle theory, ironically, another cycle book came out at he same time by William Garret. Hurst’s book was $10.00 the Garrett book was $30.00! Hurst’s book became the best seller. However, the material in the Garrett book was priceless for WD Gann Aficionados because it illustrated the geometric characteristics of a price chart. It also described how to square a circle through the progression of the Fibonacci Summation series and the use of the ellipses. The Garrett book was in my library for over five years before the crafty Bryce Gilmore explained its significance.

Cycles repeat but usually for two or three repetitions before expanding or contracting in dramatic fashion.

Those of you that want to study cycles should study the works of these two masters.

At War with the Odds

No one can argue against the successful investing strategies of Peter Lynch of Fidelity Funds. His compounded rate of return is one of the best Wall Street has seen and it extended over a decade. In Peter Lynch’s book on his investment strategy, he emphasizes that traders should learn the elements of the game of Poker to increase their understanding of investing. Since tournament poker is one of my hobbies, I thought we might check out what Peter Lynch was saying about this popular game of skill.

Poker, unlike nearly all casino games, requires skill to consistently win. The casino does not take a percentage in tournament poker, each player is trying to beat the other players in the hand and win the pot. Poker, like trading, is based on probability. Participants in the event must always be cognizant of the risk versus reward of each trade or hand. There is an old saying in Poker that goes something like this, “If you sit down at a poker table and don’t recognize who the sucker is, then you are the sucker.” The same is true of all neophyte traders who want to beat the Wall Street boys but have no knowledge or experience as they enter the world’s toughest business.

Published on  Fri, Sep 8 2006, 10:49 GMT