ASIA PACIFIC’S PREEMINENT TRADING MAGAZINE

www.traders-journal.com

SEPTEMBER 2006 / VOLUME 2 ISSUE 7

When to Stop Trading

Problem With Sell
Trading Should Be a Game
Weigh Your Options

The
Psychology
of Trading
SG$8.80 / A$13.80 / HK$68 / RM$19.80

Trading Tools:
AB=CD Pattern
Options and Mispricing
ISSN 1793-2149
Utilizing WebLogs
Moving Averages
Risk Free Options Arbitrage MICA (P) 280/05/2006
 TECHNICAL ANALYSIS

Larry Pesavento, a trading

veteran of over 40 years, and
Leslie Jouflas explain the AB=CD
LESLIE JOUFLAS LARRY PESAVENTO
pattern and how we can use it

AB=CD Pattern
– Keeping it Simple

History of the AB=CD Pattern

In 1935 a book was published for sale to investors at an incred-
ible price of $1500. That book was Profits in the Stock Mar-
ket by H.M. Gartley. On page 249 Gartley describes a chart
pattern, “Practical Use of Trend Lines”, which we now call the
AB=CD Pattern.

Gartley’s description of the AB=CD pattern illustrated how the

market would rally in an uptrend and then retrace. It would
then rally to another uptrend then make another retracement
forming an upsloping parallel channel. It was from this de-
scription that the AB=CD pattern achieved its nickname as the
“Lightning Bolt”. Figure 1

18 SEPTEMBER 2006 / VOLUME 2 ISSUE 7

Gartley spent several pages referring to these trend lines and Important Characteristics of the AB=CD
parallel lines as excellent signals when used in conjunction with
other working tools. He also applied these lines to price ratios. Pattern
He used mainly ratios of one third and half retracements. The AB=CD pattern will be perfectly symmetrical, meaning AB
equals CD about 40% of the time. The other 60% of the time
AB=CD Pattern Structure variations of the pattern will be present. What this means is that
after the AB leg is formed and the retracement leg, BC, has com-
The AB=CD pattern is found in all markets and on all time pleted, the CD leg will be entirely different than the AB leg. The
frames. The pattern is a measured move where the second leg is two legs may or may not be perfectly symmetrical.
“equal” to the first leg. It should be noted that the C-D leg can
extend and will not always be exactly “equal”. Some of the ways the CD leg can vary from the AB leg are:

• CD leg is an extension of AB of anywhere from 1.27 to 2.00

or greater.

• CD leg has a slope or angle steeper or wider than AB. (See

Figure 4)

At first glance this would make the trader think the pattern is
not tradable. The key lies in identifying the BC leg. The most
important thing is to watch the price action coming after point
Figure 2 C has formed. The C leg determines the relationship to the AB
leg.

There are three legs that form this pattern. The first leg of the
pattern is labeled A-B. After the completion of the first leg, a Variations
retracement or correction will occur that will usually find sup- These C leg phenomena can be described in 3 ways:
port or resistance at one of these Fibonacci levels; .382, .50, .618
or .786. This correction or retracement is labeled BC and is the • First; if after point C has occurred and a gap exists in the
second leg of the pattern. (Note: Strongly trending markets will direction of point D, this will usually indicate that the CD
usually see only a retracement to the .382. leg will be much greater than the AB leg. It indicates a 1.27
or 1.618 of AB).
Once price resumes in the same direction of the A-B leg
the C-D leg then begins to form. Once we identify the CD leg • Second; a wide range bar (twice normal size) at point C is
forming we can project the potential pattern completion and also another indication that the CD leg is going to be ex-
form a trading strategy. As the CD leg forms and completes we tended.
will monitor the final leg for any warning signs that would alert
us to a change in market conditions that may signal us to pos- • Third; ideally AB=CD moves are symmetrical in price and
sibly pass on the trade or wait for further confirmation before time. For example; if the AB leg is 6 bars up then the CD leg
entering the trade. Warning signs would include: will be 6 bars up. (See Figure 5)

• Wide range bars

• Gaps near completion in the CD leg
• Tail closes in opposite direction of trade

When studying this pattern it is important to

know what invalidates the pattern. Here are three
items that would invalidate the AB=CD pattern:

1. C can not exceed A. Meaning the retracement

of AB can not exceed 1.00

2. C can be a 1.00 retracement of the AB leg, this

is a rare pattern and a double top or bottom,
but it is a valid pattern.

3. D must exceed B in order for the pattern to

complete at D and be a valid AB=CD.

Figure 3

SEPTEMBER 2006 / VOLUME 2 ISSUE 7 19

 TECHNICAL ANALYSIS
If figuring the 1.27 or other extension numbers
simply use that number in place of the 1.618).

Time Bars in the AB=CD pattern will usually be

a range from 5 to 8 bars. When the CD leg is
extending beyond 8 bars in an up or down move
the probability is for a price extension where CD
will be 1.27 or 1.618 of the AB swing. (See Fig-
ure 5)

The reader should keep in mind that these pat-

terns are only probabilities, they are not certain-
ties and trying to use these patterns without a
solid understanding of them, and a sound money
management strategy is equivalent to trading sui-
cide.

Figure 4 Larry Pesavento is a veteran of over 40 years in trading.

He is a former member of the Chicago Mercantile
Exchange where he traded S&P futures and Foreign
This next sentence is very important, if the CD leg is made in Currency. He also traded at the prestigious Commodity Corporation
just a few bars that will strongly indicate that the CD leg is going of Princeton New Jersey. He also managed Drexil Burham Lambert
to be an expansion of the AB leg. You can imagine as an example Commodity Department in Beverly Hills, California. Larry’s library of books
of this thrust principle – if you had 2 Ferrari automobiles on the and trading systems has been accumulated over the past 5 decades. Larry
racetrack, one with diesel fuel the other with high tech gasoline, has written 9 books on trading ranging in subjects from Astro Harmonic
it would be easy to understand the high tech gasoline powered phenomena, Pattern Recognition swing trading and Artificial Intelligence.
Ferrari getting to the finish line first. Watch the C leg, because if He currently trades for a Hedge Fund and mentors private students on a
it starts fast, that is the faster Ferrari going further, faster. one on one basis only. Larry can be reached at [email protected] or
via his website www.tradingtutor.com
Slope and Time Frames Leslie Jouflas has been a full time trader since 2000 and has begun trading
The slope or time frame of the BC move can also be helpful in private managed money. She also enjoys teaching and encouraging new
determining the pattern. BC legs usually will correct to one of students to the field of trading. Leslie met Larry several years ago while he
the ratios; .382, .50, .618 or .786. The slope of this BC leg is was teaching a 5 day workshop. Leslie can be contacted at frredrica@msn.
usually a good indication of what the next CD leg will be. For com
example; assume that the AB leg was 15 trading bars to point
B and now the BC leg has taken 8 bars and has only retraced Larry Pesavento is the author of several books on trading and has co-
.382% of the AB leg. This is a sign of the market absorbing a authored a recent book with Leslie Jouflas titled, Essentials of Trading: It’s
lot of selling at a high price, it is a shallow retracement and was Not WHAT You Think – It’s HOW You Think
not able to retrace to .50, .618 or .786%. (See
Figure 4) We would assume that prices would go
much higher and possibly quite rapidly once the
selling slows. However, if the market retraces to
a .618 or .786 retracement, the CD will most
probably be a normal move equaling AB=CD.
(See Figure 3)

To figure the extension of the CD leg use the dif-

ference of the AB leg and multiply by 1.27 or
1.618 then add that figure to the high of low of
C. The example in Figure 4 would be figured like
this:

(A = 1256 - B = 1274 = 18 points)

18 x 1.618 in this chart example = 22.86
add this to C: 1266.25 + 22.86 = 1285.37
which is the projection price at D for the 1.618
extension.
Figure 5

20 SEPTEMBER 2006 / VOLUME 2 ISSUE 7