New Patterns for Harmonic Traders

[RichardCox 10]

New Patterns for Harmonic Traders

 

Harmonic trading is not exactly a new approach to technical analysis. Its foundations stretch back nearly 80 years, when H.M. Gartley devised the trading structure (now known as the Gartley pattern) that would ultimately form the basis of the harmonic strategies undertaken by modern practitioners like Scott Carney. So, while Gartley’s original structure did not implement the Fibonacci price leg ratios that characterize the harmonic patterns used today, it is clear that harmonic trading is not a new phenomenon. If fact, patterns like the Crab, Butterfly and Bat have been tested extensively and have been shown to forecast future price activity with truly incredible probability levels.

 

But what should be remembered here is that harmonic trading is a constantly evolving discipline. This should be evident in the fact that many innovative traders have developed the ideas originally presented by early pioneers like Gartley, and discovered many new patterns in the process. Here, we will look at some of the latest discoveries which might not be as well known as some of the structures listed above. But the Shark, Cypher, and Nen Star should also be considered as viable additions to any harmonic trading arsenal. Next, we will outline the structural parameters that define these newer patterns.

 

Trading Harmonic Patterns

 

First, it should be understood that there are important similarities when trading all harmonic structures. The commonly understood structure unfolds in four price legs, resembling an “M” shape for bullish patterns and a “W” shape for bearish patterns. These structures are marked by five price points: The X point marks the beginning of the structure, and this is followed by an impulse move to point A, a corrective move to point B, a trend-based move to point C, and then an extended correction to point D. Each of these moves will fall in line with a specific Fibonacci retracement. Different retracement levels will define different harmonic patterns.

 

This D point is the structure’s critical area, as this is where the pattern has reached completion and is sending the signal to buy or sell the asset. This area is referred to as the Potential Reversal Zone (PRZ), where prices are expected to start moving in the opposite direction. The fact that these patterns culminate in the “Reversal Zone” should be a key indicator that these patterns are used to establish contrarian positions. Stop losses for these trades can be placed just above or below the PRZ, as one of the key advantages of the harmonic pattern is that it defines a price reversal with a high level of accuracy. This enables traders to keep stop losses relatively tight, as any violation of the PRZ suggests that the harmonic pattern is invalid and should not be used as the basis for a position. Since the Gartley is the foundational example of the harmonic structure, it is pictured in the first charted example (in both bullish and bearish reforms). Note the price points, Fibonacci ratios, corrective and impulse moves, and the expected reversal direction. The second charted example shows a bearish Gartley (W shape). The box above the D point is the PRZ, which is where a short position would have been triggered.

 

The Shark Pattern

 

Now that we understand how the patterns are traded, we will look at some of the most recently discovered variations on these patterns. First is the Shark pattern, which is a variation on the traditional M and W shaped patterns but follows the same general idea in producing trading signals. The Shark pattern is composed of two separate price segments: A Harmonic impulse wave that fails, and another Harmonic impulse wave that hits extreme levels. Shark patterns must be actively managed and possess pre-defined profit targets once positions are established. Support and resistance levels are defined by precise price ratios.

 

The ideal Shark structure requires price moves that obey the 88.6% retracement parameters and the 113% reciprocal ratio. The pattern looks to capitalize on the excessive nature of the extreme harmonic impulse wave (relative to recent averages). In order for the pattern to remain valid, prices must immediately reverse at the completion point (point C), initiating the new trend. The diagrams for the Shark pattern will look different than most of the traditional harmonic patterns, because it is an emerging 5-0 pattern that is traded after point C. The pattern’s D point is actually the profit target, and is found at the confluence of AB=CD and the 50% Fib retracement of BC. Since the pattern is traded off of the C point, traders will need to actively manage these positions: The Shark pattern is not a “set it and forget it” type of structure. The next graphic examples show the needed price levels, first as a blank graph and then in real-time charts (first bullish, then bearish). Below you can find the pattern parameters that define the overall structure:

 

● Drawn from the initial 0 point, price travels to point X in its first impulse move (this move defines the needed price retracements that follow).

● Prices then retrace in a corrective fashion back to point A.

● Prices then extend further in the original impulse direction, to point B. This move will equal 113% to 161.8% of the initial impulse move.

● Volatility then picks up drastically, as prices reverse to point C. This move will be equal to 88.6% to 113% of the initial impulse move. This move will also mark 161.8% to 224% of move XA.

● Profit targets are defined by the move AB, which can also be found using the 50% Fib retracement of the move BC.

 

The Cypher Pattern

 

Next, we look at the Cypher pattern, which more closely resembles the traditional “M” and “W” patterns that have risen to prominence. The Cypher pattern unfolds in five points (X-A-B-C-D), with the buy and sell zone marked by the D point. Profit targets are then defined by the retracements that follow, and are based on the corrective move CD. As we can see in the next charted examples, profit targets can be dual in nature, with traders closing part of the position as prices hit the 38.2% Fib retracement of the move CD. Stop losses should then be moved to break even and the remainder of the position can be closed for a gain once prices hit the 61.8% Fib retracement of the same move (CD). A real-time example of a bearish Cypher pattern is shown next, and the pattern parameters are found below:

 

● Drawn from the initial X point, price travels to point A in its first impulse move (this move defines the needed price retracements that follow).

● Prices then retrace in a corrective fashion back to point B.

● Prices then extend further in the original impulse direction, to point B. This move will equal 113% to 141.4% of the initial impulse move.

● Volatility then increases, as prices reverse correctively to point D. This move will be roughly equal to 78.6% of the initial impulse move (XA). This move will also mark 127.2% to 200% of move AB.

● Profit targets are defined by the move CD. Profits should be taken as prices approach the 38.2% and 61.8% retracement of move CD.

 

The Nen Star Pattern

 

The Nen Star Pattern is sometimes confused with the traditional Bat pattern, but there are some important differences in their respective retracement structures. The next charted example illustrates the bearish Nen Star pattern. Below are the parameters that define the structure:

 

● Drawn from the initial X point, price travels to point A in its first impulse move (this move defines the needed price retracements that follow).

● Prices then retrace in a corrective fashion back to point B.

● Prices then extend further in the original impulse direction, to point B. This move will equal 113% to 141.4% of the initial impulse move.

● Volatility then increases, as prices reverse correctively to point D. This move will be roughly equal to 127.2% of the initial impulse move (XA). This retracement also separates the pattern from the Cypher structure. The final move will also mark 127.2% to 200% of move AB.