Harmonic Pattern

Ideal Bearish Reversal In an ideal bearish reversal, the price action should reverse after the entire range is tested. Although price action may seem strong as it rallies towards the Potential Reversal Zone (PRZ), the critical determining point is the reaction of the predominant trend at the convergence of numbers.

The most ideal bearish reversal situations continue immediately to the downside after the entire PRZ is tested and the T-bar is established. The Terminal Price Bar should close below the range of harmonic numbers in the best cases. Although this does not always occur, the price action should continue to the downside immediately following the test of the entire PRZ.

Pepsi (PEP): 15-minute Pepsi completed this Bearish Butterfly on the following 15-minute chart. The stock rallied sharply into the PRZ but stalled after testing all of the numbers.

The reversal in this case exemplified an ideal situation, especially with the Terminal Price Bar being clearly established after testing the entire range of harmonic numbers. The following chart of the price action in the Potential Reversal Zone (PRZ) marks the T-bar with the arrow. The dotted line marks the top of the Terminal Price Bar, defining the price level that would negate the harmonic resistance established by the pattern. Essentially, a violation above

this level would question the validity of the trade and it could even trigger a reversal of the pattern to get long on a breakout above this area. I will cover these strategies later in this material. For now, it is important to focus on the elements that define a Terminal Price Bar and the type of reversal that should occur after it has been established.

Warning Signs in the Potential Reversal Zone (PRZ) It is common for price action to exhibit extreme signs warning in invalid harmonic patterns. In many situations, as the price action enters into a Potential Reversal Zone (PRZ), price gaps and extreme extension moves can be the trigger of failed setups. Although valid patterns may possess price action that is extreme, warning signs like these must be considered when assessing the validity of a Potential Reversal Zone (PRZ). I refer to these situations as “blowouts,” since warning signs can frequently trigger blatant and convincing price behavior that invalidates the projected completion of a harmonic pattern.

Price Gaps through the Potential Reversal Zone (PRZ)

Price gaps at the completion of harmonic patterns are a common development that must be handled carefully. Patterns like the Crab frequently possess sharp price action in their Potential Reversal Zones (PRZ). Despite these situations, the determining factor is the extent of the price gap as the action tests the PRZ.

Reversing a Failed Bearish Pattern

In a failed bearish setup, the price action typically will experience some initial reaction to the completion of the pattern but quickly turn back up to retest the Potential Reversal Zone (PRZ), eventually violating the Terminal Price Bar. I like to refer to these situations as “harmonic breakouts,” where price action rallies above distinct harmonic zones of well-defined patterns. Harmonic breakouts above distinct bearish Potential Reversal Zones (PRZ) typically possess extreme price bars and convincing bullish continuation. These breakouts are especially

significant in retracement patterns like the Bat and the Gartley, and they can serve as excellent entry to signals to follow the predominant trend.

Intel (INTC): 10-Minute

The example a failed pattern Bullish AB=CD pattern on this 10-minute chart in Intel is an ideal intra-day pattern that yielded a brief reversal from the Potential Reversal Zone (PRZ), only to continue sharply higher in the direction of the predominant trend. After the stock stalled at the pattern’s completion, the Terminal Price Bar and the PRZ were violated convincingly. Illustrated on the following chart of the price action in the Potential Reversal Zone (PRZ), Intel rallied sharply above the initial test of the AB=CD completion, by gapping up on the open of the following day’s trading.

Such breakouts above defined harmonic patterns like this setup often can act as a trigger to reverse the initial trade idea and follow the predominant trend. After Intel broke out above the Terminal Price Bar, the stock steadily climbed, possessing a nice bullish continuation with a distinct trend line support that defined the rally. These situations occur frequently and this example demonstrates the ability of blown out patterns to act as signposts of future action. In this case, the violated AB=CD clearly indicated the strength of the rally in the stock. It is important to note that reversing a bearish setup must occur after the violation of the Terminal Price Bar. Typically, the sharp continuation anticipated in these setups usually does not occur until after the violation. In this chart of Intel, the stock did not significantly rally until the Terminal Price Bar was violated above $28.75. Again,

it is important to maintain a tight stop loss limit when attempting to play the continuation of the predominant trend, as the price action should continue decidedly above the prior PRZ.

Amazon.com (AMZN): Weekly

Amazon formed a very distinct Bearish Butterfly with an ideal alignment of Fibonacci ratios to validate the structure. The pattern defined a shorting opportunity in an approximate 2-point range between 25.75-27.80. Despite the clear bearish pattern, the stock rallied sharply on the week it tested the Potential Reversal Zone (PRZ). After the action stalled for several weeks in the PRZ, the stock rocketed above the Terminal Price Bar and the prior bearish PRZ.

The violation of the bearish pattern signaled a strong continuation of the predominant bullish trend. If the position was going to be flipped, where the short position was covered and a new long position was entered, the violation of the Terminal Price Bar above the $28 level was the determining area. This is another example of a decisive upside continuation following the violation of the Terminal Price Bar. These situations are common, as the violation of a distinct harmonic zone frequently triggers a sharp continuation of the predominant trend. In this case, Amazon rallied convincingly in the weeks following the Terminal Price Bar breakout, as the stock continued to rally into higher territory while holding the prior weeks’ lows.

Prior Harmonic Support and Resistance Static support and resistance levels have been a foundation of technical analysis for decades. Price action tends to trade in zones of support and resistance. When support is violated that price level becomes future resistance. When resistance is violated that price level becomes future support. Although this is a simple concept to grasp, when applied to the Potential Reversal Zone (PRZ) of harmonic patterns, this concept can identify critical price levels that otherwise might be overlooked. After clear harmonic patterns are violated, the price action usually continues in the predominant trend for some time. However, it is common for price action to retest these prior harmonic levels, as prior patterns frequently mark critical points within an overall trend.