What is Harmonic Trading?
Harmonic trading is a methodology that utilizes the recognition of specific price patterns and Fibonacci numbers to determine highly probable reversal points in stocks. This methodology assumes that trading patterns or cycles, like many patterns and cycles in life, repeat themselves. The key is to identify these patterns, and to enter or to exit a position based upon a high degree of probability that the same historic price action will occur. Although these patterns are not 100% accurate, these situations have been historically proven. If these set-ups are identified correctly, you can discover significant opportunities with a very limited risk.
Official Website: HarmonicTrader.com
The Harmonic Patterns are defined by specific price structures that are quantified by Fibonacci calculations. Essentially, these patterns are price structures that contain combinations of distinct and consecutive Fibonacci retracements and projections. By calculating the various Fibonacci aspects of a specific price structure, Harmonic Patterns can indicate a specific area to examine for potential turning points in price action.
The Bat Pattern
Bullish
Bearish
The Bat pattern is a precise harmonic pattern discovered by Scott Carney in 2001. The pattern incorporates the 0.886XA retracement, as the defining element in the Potential Reversal Zone (PRZ). The B point retracement must be less than a 0.618, preferably a 0.50 or 0.382 of the XA leg. The Bat utilizes a minimum 1.618BC projection. In addition, the Amibroker=CD pattern within the Bat is extended and usually requires a 1.27AB=CD calculation. It is an incredibly accurate pattern and requires a smaller stop loss than most patterns.
One of the most comprehensive references to Harmonic Trading was outlined by J.M. Hurst in his cycles course from the early 1970s. His Principle of Harmonicity states: “The periods of neighboring waves in price action tend to be related by a small whole number.” (Hurst, J.M., J.M. Hurst Cycles Course, Greenville, S.C.: Traders Press, 1973.) The important concept to grasp is that price waves or distinct price moves are related to each other. Futhermore, Fibonacci numbers and price patterns manifest these relationships, and provide a means to determine where the turning points will occur.
When these turning points are identified correctly, trades are executed at a price level where the cycle is changing. Essentially, this type of trading is respecting the natural ebb and flow of buying and selling. In doing so, these trades are executed “in harmony” with the market. For example, when a stock is bought at this turning point, the majority of the selling that has driven the price down is very close to ending. Quite often, the harmonic techniques identify trades at or very close to the exact reversal point.
The Ideal Butterfly Pattern
Bullish
Bearish
The structure of the Butterfly pattern was discovered by Bryce Gilmore. In my experience, I believe an Ideal Butterfly Pattern, which requires specific Fibonacci in the structure - including a mandatory 0.786 retracement of the XA leg as the B point - offers more precise Potential Reversal Zones (PRZ). Also, the Butterfly pattern must include an Amibroker=CD pattern to be a valid signal. Frequently, the AB=CD pattern will possess an extended CD leg that is 1.27 or 1.618 of the AB leg. Although this is an important requirement for a valid trade signal, the most critical number in the pattern is the 1.27 XA leg. The XA calculation is usually complemented by an extreme (2.00, 2.24, 2.618) BC projection. These numbers create a specific Potential Reversal Zone (PRZ) that can yield powerful reversals, especially when the pattern is in all-time (new highs/new lows) price levels.
It is important to note that Harmonic Trading works on any time frame - intra-day, daily, weekly or monthly stock charts. I believe the clearest trade opportunities, or "set-ups," appear on daily charts for position or swing trades. However, hourly charts provide excellent set-ups for shorter-term or day trades. It is also amazing that these methods work on longer-term charts, as well. Weekly or monthly charts are excellent measures of historically critical areas for stocks.
Harmonic Trading is a powerful area of technical analysis. Utilizing Harmonic Price Pattern Recognition techniques and Fibonacci ratios, trade opportunities can be discovered that capitalize on specific situations with respect to the natural buying and selling of the market.
The Gartley Pattern
Bullish
Bearish
The Gartley pattern was outlined by H.M. Gartley in his book Profits in the Stock Market, published in 1935. Although the pattern is named "The Gartley," the book did not discuss specific Fibonacci retracements! It was not until "The Harmonic Trader" was released that the specific retracements of the B point at a .618 and the D point at a .786 were assigned to the pattern. There are others who have assigned Fibonacci retracements to this framework. However, they use a variety of Fibonacci numbers at the B and D points. Despite these variations, the Fibonacci retracements that yield the most reliable reversals are the .618 at the B point and the .786 at the D point. Furthermore, the pattern should possess a distinct Amibroker=CD pattern that converges in the same area as the 0.786 XA retracement and the BC projection (either 1.27 or 1.618). The most critical aspect of the Gartley is the B point retracement, which must be at a 0.618 of the XA leg.
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