Ideal Reversals
An ideal reversal usually possesses several characteristics that clearly separate it from other types of price reactions. An ideal reversal usually tests all of the numbers in a Potential Reversal Zone on the initial test. The predominant trend usually reverses from this initial test of the entire PRZ and continues in the reversal direction shortly thereafter. In an ideal reversal, the price bar that tests all of the numbers in the PRZ is called the Terminal Price Bar (T-bar).
Ideal Bullish Reversal
In an ideal bullish reversal, the price action should reverse after the entire range is tested (see Figure 10.1). Although price action may seem strong as it declines into the Potential Reversal Zone, the critical determining point is the reaction of the predominant trend at the completion of the pattern. The Terminal Price Bar should stabilize after completing the test.
Figure 10.1
Dow Jones Industrial Average(^DJI): Weekly
The Dow Jones Industrial Average formed this Bullish Bat after
retracing the initial rally of the
Figure 10.2
The index tested the entire PRZ on the week it completed the pattern. Although the weekly candlestick represented the Terminal Price Bar for the pattern, the following chart of the price action in the PRZ in Figure 10.3 shows an ideal reversal on the daily time frame.
Figure 10.3
Clearly, the index established the T-bar on the day it tested the entire PRZ. It is important to note that the sell-off was quite severe as the price action approached the harmonic support. Despite the extreme decline, the Dow Jones Industrials stabilized and reversed nicely after the Terminal Price Bar was established.
Ideal Bearish Reversal
In an ideal bearish reversal, the price action should reverse after the entire range is tested (see Figure 10.4). Although price action may seem strong as it rallies toward the Potential Reversal Zone, the critical determining point is the reaction of the predominant trend at the completion of the pattern.
Figure 10.4
The most ideal bearish 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.
Pepsi
(PEP): 15-Minute
Pepsi completed this Bearish Butterfly on the following 15-minute chart (see Figure 10.5). The stock rallied sharply into the PRZ but stalled after testing all of the numbers.
Figure 10.5
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 chart of the price action in the Potential Reversal Zone in Figure 10.6 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.
Figure 10.6
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 PRZ, price gaps and extreme
extension
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 PRZ. Despite these situations, the determining factor is the extent of the price gap as the action tests the PRZ.
Price Gap Through a Bullish Potential Reversal Zone (PRZ)
As price action approaches the harmonic support defined by the PRZ, it typically will “bypass” the entire range of numbers on a price gap that invalidates the pattern. A price gap THROUGH the PRZ, as Figure 10.7 demonstrates, is quite different from a price gap INTO the PRZ. The obvious price gap-warning signal occurs when the price action trades completely past the PRZ, failing to test any other numbers.
Figure 10.7
Wal-Mart
(WMT): Daily
The daily chart of Wal-Mart in Figure 10.8 demonstrates extreme price action that trades completely through the harmonic support established by the completion of the Bullish Gartley.
Figure 10.8
The blowout in this case exemplified the ideal price gap-warning signal. The stock opened below the PRZ, gapping down past the critical range of numbers at the completion of the pattern. The 52.20 level was an extremely critical harmonic support level, as the three numbers converged in a narrow PRZ. Since the stock opened below these numbers and rolled over quickly a few days later, the validity of the pattern was negated. Again, it is important to focus on the action on the initial test of the harmonic numbers. Although the stock bounced a few days following the violation, the price gap on the open through the entire PRZ exemplified this warning signal (see Figure 10.9).
Figure 10.9
Another important element of a blowout is the action that
follows the violation. Clearly, a price bar that blows out a PRZ,
trading completely past the numbers, invalidates the projected
completion point. However, it is common for price gaps to
materialize IN a PRZ but still yield
Blowout of Bearish Potential Reversal Zone (PRZ)
Bearish blowouts that gap through harmonic resistance zones commonly offer obvious warning signals, if the projected completion of the pattern is invalid (see Figure 10.10). In many instances, price gaps that blowout bearish PRZs can act as tremendous continuation signals to follow the predominant trend.
Figure 10.10
As was the case with the bullish illustration, the blowout of a bearish PRZ should trade through the entire group of harmonic numbers and continue in the predominant trend. These situations should be practically obvious, as the price action should rally sharply above the projected resistance area.
Microsoft
(MSFT): 60-Minute
Microsoft blew out this Bearish Crab on the 60-minute chart, as
the stock gapped through the
Figure 10.11
The blowout in this case exemplified the ideal price gap-warning
signal that typically invalidates setups. After the stock opened
above these numbers, the validity of the pattern was negated.
Again, it is important to focus on the action on the initial test
of the harmonic
Figure 10.12
It is uncanny how frequently these situations occur, signaling an invalid pattern completion. These warning signs should appear nearly obvious, as the price action should convincingly take out the PRZ.
Extreme Price Expansion Through a Potential Reversal Zone (PRZ)
Frequently, an invalid setup will be indicated by extreme price expansion moves that quickly trade through the PRZ and continue in the predominant trend. Although it might be difficult to validate such an extreme expansion until after the fact, the critical factor is the general momentum that the initial test possesses as it trades into the PRZ. Such extreme price expansion should be followed by a clear continuation of that predominant trend.
Extreme Price Expansion—Bullish Potential Reversal Zone (PRZ)
In an extreme price expansion through a bullish PRZ, the trading should clearly and decisively break down through the support zone on the initial test and continue lower in the predominant trend after the violation (see Figure 10.13).
The breakdown should occur quickly and be practically obvious during the test of the PRZ. As is the case for most PRZ tests, the determining factor is the price action after the entire range of numbers has been tested. If the price action continues sharply lower after the dramatic violation, the completion point of the pattern should be considered invalid.
Coca-Cola
(KO): Weekly
The weekly chart in Figure 10.14 shows a Bullish Gartley that possessed a sharp decline as it tested the entire Potential Reversal Zone.
Figure 10.14
Figure 10.15 of the price action in the PRZ exemplifies the extreme price expansion that clearly signaled an invalid setup. As the stock traded into the PRZ, it quickly violated the critical numbers at the completion of the pattern. After the initial test violated the entire range of the harmonic numbers, Coke continued decisively lower.
Figure 10.15
The setup was clearly violated, as the severity of the violation was overwhelming. The validity of the harmonic support defined by the PRZ revealed itself quickly after the pattern completed.
Price Action Expansion—Bearish Potential Reversal Zone (PRZ)
Extreme price expansions that break out above bearish PRZs frequently signal a continuation of the predominant trend (see Figure 10.16). The price action should trade decisively through the resistance area and continue to rally following the violation.
Figure 10.16
Again, it might be difficult to validate such an extreme expansion until after the fact. The deciding factor is the price action immediately after the entire PRZ has been tested. If the price action rallies with strong momentum, it is likely that the warning sign is indicating an invalid pattern setup. Any trading that continues higher will confirm this signal.
Dow Jones Industrial Average
($INDU): 15-Minute
Figure 10.17 is an ideal example of the extreme price expansion
warning of an invalid setup. The Dow Jones Industrials formed this
Bearish Gartley on the following 15-minute chart that rallied
through the entire PRZ as it tested the convergence of harmonic
numbers just above
Figure 10.17
Figure 10.18 of the price action in the PRZ shows an ideal blowout of the extreme expansion bar. It is important to note that the index closed above the top range of the PRZ and continued higher immediately following the confirmation of the blowout of the bearish pattern.
Figure 10.18
Price Action in the Potential Reversal Zone (PRZ) Conclusion
One of the key principles of Harmonic Trading is analyzing the
price action within precise zones as defined by a convergence of
Fibonacci calculations of specific 5-point structures. The type of
price bars that form at the completion of a pattern can provided
extensive information regarding the potential state of the future
trading action. In this example, the price action in the
Dow
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