Try using Grayscale and using more than two colors. Also use ignore white which is an option in Live Trace Options.
You might have to make adjustments in the Live Trace Options until you understand how to make it work for your needs.
It takes a littlke experimenting to learn how to use the options. But experimentation is a user requirement of this feature.
Honest, you can get what you want but it requires work.
Wade. Thank you for responding. I've attatched a short clip below showing my process and the results. As you can see, even at 15 or 30 colors, I'm still left with the problem of my transparency converting to white. As i mentioned before, the Ignore White checkbox gets me no further because my white hilights go transparent as well. I need my hilights to go to white, and my transparency to go transparent. It would seem like such a simple request.
Ok I understand. What to do is to turn it into a live paint group and manually restore the white that urns transparent with the live paint bucket set to white.
since it is a transparent background if I have this correct place it as a psd and I choose to view as a transparent image you will see that at the bottom of the Live Trace Option, not really certain that is even necessary as it an image place as a psd file on a transparent background.
You can add a blur to smooth the edges.
Or you can, if this is a transparent image in photoshop, select it turn the selection into a path and save that as a clipping path to use in AI after yu used the Live Trace.
Of course there is the manual method of using the pen tool.