Price Forecasting with Harmonic Patterns Pt. 2

[RichardCox 10]

In the next part of this article, we will look at ways to fine-tune these harmonic trades and discuss a newly discovered harmonic pattern many traders might not have seen previously.

 

Creating Tight Trading Parameters

 

One of the main benefits of the harmonic trading patterns is that the create incredibly tight trading zones that pinpoint reversals down to a very small number of pips. This allows traders to set stop losses and trade entries that are extremely fine-tuned with the PRZ. This area is referred to as a “zone,” and not a level, however, because the reversal point is actually not an exact price. This is because there are two relevant measurements that produce slightly different results. First, we have the retracement (or extension) of move XA which gives us one number at the D point. Second, we have the extension of price move BC which gives us a slightly different D point.

 

The space between these two D points forms the Potential Reversal Zone, and this area is used as the basis for both trade entries and stop losses. It should also be noted that price move BC can have varying lengths of extension, and this can produce different results for the PRZ. Because of this, it is important to be aware of the fact that price move BC, so traders should watch the length of price move BC to get a better sense of what is actually going to happen in the PRZ.

 

Watching Price Move BC

 

When all the projected price moves meet the criteria for harmonic patterns, positions can be established anywhere within the PRZ. In some cases, the PRZ will be larger (for example when using longer term time frames), and when this happens, traders should watch the price action to see if price move BC shows a longer extension, as this can change the overall structure and create different entry points.

 

When placing a stop loss, the order can be set outside of the widest possible extension of the price move BC. For example, if we are watching a developing crab pattern, this would should be seen at the 3.618 measurement. If prices reverse within this measurement, stop losses can be placed above/below this Fibonacci level, as you would need to see an additional extension later in order to invalidate the pattern. If the pattern does become invalid, the position should be closed but the total risk will be relatively minimal when compared to other types of trading patterns.

 

Profit Targets and Stop Losses

 

Another strategy method to consider is to wait for prices to hit the extreme calculation levels in the PRZ and then to show signs of retreat from that area (helping to validate the price point). Once this activity is seen, there is a greater likelihood that the stop loss (placed outside the PRZ) will not be hit and so this helps to increase the probability for a successful trade. Harmonic patterns often develop during times of high market volatility, so you do not want to set yourself up in a position where prices are showing an extreme move and run right through the PRZ.

 

When looking at profit targets, traders can use support and resistance levels that can be found inside the pattern. Many traders look at the B point when looking for an initial profit target, as a majority of the market is influenced to change positions after the original pattern unfolds. Finding profit targets with harmonic patterns is a much more proactive process than what is seen when trading other types of patterns. It is important to watch how prices react when coming back to the price points within the pattern. Another strategy is to watch for shorter term patterns that might conflict with your original position.

 

For example, if you are in a long position based on a bullish Bat pattern on a daily chart, there might be an instance where you see a bearish Crab unfold on the hourly charts. This is essentially an indication that now might be a good time to close the position, as prices have likely traveled as far as they will go with respect to your original trade. It is very common to see multiple patterns inhabit the same space on a chart, so it is important that these occurrences not be ignored, as this can be a very good indication that there is indecision in the market.

 

The Shark Pattern

 

Next, we will look at one of the newest harmonic patterns - the Shark pattern, which was discovered by Scott Carney in 2011. Visually, the pattern structure can be seen in the first attachment.

 

Those with some experience with harmonic relationships might notice that the Shark pattern is a building 5-0 structure which is traded from the C point, with a target at the D point. The D point price target is not shown in these graphics but this level can be calculated using the confluence in price moves AB=CD and the 50% Fib level from the BC price move.

 

In addition to these trading signals in the Shark, subsequent trading signals can be found as well, and these will allow traders to build further on the position strategy. These signals come from the 3 subsequent patterns that can emerge after the Shark formation is initiated. The first can be seen as the Shark leads to the 5-0 structure. The next attachment shows this structure’s visual elements. With the pattern, it is easy to see how the Shark can ultimately unfold, becoming the 5-0 pattern but at the same time it should be remembered that not all 5-0 patterns start with a Shark pattern.

 

From the graphic, we can also see how the initial profit target in the Shark comes at the D point in the 5-0 structure. As the 5-0 develops, traders can enter into positions at the D point (in the opposite direction of the trade taken with the initial Shark signal). Another element to watch is the fact that price move BCD in the 5-0 structure will, in many cases, become the price move XAB in a later Crab or Bat pattern. Key measurements here can be seen with the B point showing at the 50% Fib of price move XA, as these are components of both the Crab and Bat patterns.

 

Given this information, traders should look for developing Crab or Bat patterns, and once the C point can be identified, traders can position themselves with a trade based on a Bat Action Magnet Move (BAMM), which is based on the Bat harmonic structure. These trades allow for positions to be established at the price level from the B point, targeting the D point of the next developing pattern. Generally, BAMM trades are taken only when the signal is inline with the dominant trend (BAMM trades are not contrarian). But even in cases where the BAMM trade is not taken, the final position can be taken if a Crab or Bat pattern later forms. So, as you can see, the Shark pattern can be highly useful for initiating a series of four possible trades, as long as the Fibonacci calculations meet the measurement requirements.

 

Conclusion: Using Harmonic Patterns to Trade Extreme Market Moves

 

Harmonic trading offers a great deal of precision for traders looking for reversal points in extreme market moves. Perhaps the primary benefits of these reversal points is that they are confined within a very tight area (the PRZ), and this allows traders to set small stop losses and limit risk. Harmonic trading is more mathematical and less subjective than most other approaches in technical analysis but it can take time to see stable patterns emerge. Here, we looked at the traditional harmonic patterns, and a new entry into the harmonic world with the Shark pattern. Many of these patterns have similarities and can change from one structure to another, so traders should closely watch their charts when dealing with these patterns - especially on the smaller time frames.