Market Harmonic trading is a trading method that attempts to predict future price movements. It takes geometric price patterns, using Fibonacci numbers, to define turning points. It combines patterns and math into a trading methodology that is based on the premise that patterns repeat themselves. By finding patterns of different lengths and magnitudes, traders can apply Fibonacci ratios to the patterns and try to predict future price movement. The concept of Harmonic trading is largely attributed to Scott Carney. A full understanding of Fibonacci ratios is needed to trade Harmonics. To update your knowledge on these ratios click here. Let us look at some examples of how we can use harmonic price patterns to trade currencies.
Let’s start off by stressing on the fact that harmonic price patterns are extremely precise. Traders should stay disciplined when they see a pattern form that looks like a harmonic pattern, but where the Fibonacci levels do not align. Making such trade renders an unreliable pattern in terms of the Harmonic approach.
Also it is strongly advised not to take positions based on pattern formations that are not yet completed. These patterns follow strict reversal levels. With the clear structure of Harmonic patterns traders can predict how long current moves will last, but also to isolate reversal points. Traders should be cautious entering such trades halfway a potential pattern. Half completed patterns don’t have as good as predictability as the completed patterns. Therefore, there is a higher likelihood that a pattern fails and traders should control risk using stop-loss orders.
Within patterns other patterns may exist, these can be both harmonic as non-harmonic. Such situations can help improve your entry and exit targets.
Although there are more harmonic patterns, the most popular are: Gartley, Butterfly, Bat and Crab Pattern. The names of these patterns come from their shape once you connect the key levels with each other.
Starting off with the Gartley Pattern which was originally published by H.M. Gartley in his book “Profits in the Stock Market”. Later Scott Carney added the Fibonacci levels mentioned by H.M. Gartley in his book “The Harmonic Trader”.
A bullish Gartley pattern is often formed early in a trend. What this pattern symbolizes is that there is potential evidence that the corrective waves are ending and that an up-move is likely to take place once the pattern is completed. All the Harmonic patterns are built up from reversal or extensions on earlier price moves. The picture below shows the reversal and extension levels need to complete a Gartley pattern. Point B is a 0.618 reversal of the X-A move. Point D on the other hand is 0.786 reversal of the X-A move, and a 1.27 or 1.618 extension of the BC move.
Once a pattern aligns with all the requirements of the Gartley pattern and moves into the zone near Point D we call this a Potential Reversal Zone (PRZ). This is where positions could be entered when there is some price confirmation of a reversal. Stop-loss orders should be placed a little below the PRZ.
Figure 1: Gartley pattern
Source: blog.squaber.com (http://blog.squaber.com/the-gartley-pattern/?lang=en)
In shape is the Bat Pattern similar to the Gartley. The difference is in the measurement of the pattern. The bat pattern has a smaller corrective X-A move, 0.382 or 0.50 Fibonacci retracement. While Point D is a deeper retracement on X-A as we see in a Gartley pattern.
Figure 2: Bat pattern
Source: blog.squaber.com (http://blog.squaber.com/harmonic-pattern-bat/?lang=en)
The butterfly pattern is slightly different from the Gartley pattern. The difference is found in that the butterfly pattern focuses on finding the last reversal move (C to D) at new lows (bullish) or new highs (bearish). This pattern starts with a 0.786 corrective move on the X-A initial move. This corrective move is larger than the one found in the Gartley pattern. Different as the Gartley pattern, is that Point D is a new potential low in the Butterfly pattern. PRZ Entry is taken near Point D with price confirmation of the reversal. Stops should be placed slightly below (bullish) or above (bearish) the PRZ entry.
Figure 3: Butterfly pattern
Source: blog.squaber.com (http://blog.squaber.com/the-harmonic-butterfly-pattern/?lang=en)
The Crab Pattern
Similar to the butterfly pattern, it looks to capture a high probability reversal at a new low/high. According to Carney, the Crab pattern is considered to be the most precise of the patterns. The main difference between the Butterfly and Crab pattern is that the the Crab pattern has an initial corrective move towards Point B that is less than that of the Butterfly. For the Crab pattern it should be a 0.382 or 0.618 Fibonacci retracement on the X-A move.
Entries are placed near Point D with stop-loss just below or above the PRZ.
Figure 4: Crab pattern
Source: blog.squaber.com (http://blog.squaber.com/harmonic-pattern-crab/?lang=en)
Additional note on Entries and Stop-losses
All the Harmonic patterns have a Potential Reversal Zone (PRZ), which is found at Point D in the pattern illustrations. Like with everything we do with technical analysis, this is no exact level, but a zone. The location of the PRZ zone can be found using two measurements of extension or retracement of the X-A move and the extension of BC to create another level at Point D. With these two levels we get a zone in which price is most likely to reverse.
Stops should be placed outside the largest potential extension of the B-C move. For the Gartley pattern that is the 1.618 extension.
Trading Harmonic patterns correctly can be really profitable. Historical data shows that they have a high probability to indicate a price reversal. Although Harmonic trading is precise and got clear mathematical guidelines, it requires patience and practice from the trader. This is not a trading strategy for beginning traders, but it is an important one to understand for every chartist. Price movement that does not align with the pattern measurements invalidate the pattern and should not be traded. The four patterns discussed above, Gartley, Bat, Butterfly and Crab are the better-known patterns that traders should watch for.