Bearish and Bullish Complex Trend within Trend Channels: Harmonic Trading

COMPLEX PATTERNS WITHIN TREND CHANNELS

There are many cases when complex patterns form within well-established channels, signaling the continuation of the primary trend. Although many of these patterns do not possess distinctive high and low points, they are valid structures due to the proper alignment of harmonic ratios. These situations can sometimes be difficult to analyze because the patterns that form within the trend channels can seem insignificant. Sometimes, price action that adheres to the proper alignment to validate a harmonic pattern may even be difficult to see within the context of the larger trend. But these patterns possess even greater implications when they are located within the constraints of established trend channels.

There are two types of patterns to consider within channels. Retracement patterns such as a Gartley or a Bat typically develop in areas of consolidation in conjunction with the constraints of the channel. Extension patterns such as a Crab, a Butterfly, or an Alternate Bat frequently possess more extreme price action, as these structures include some type of extension to validate the setup. In this manner, the predominant trend will possess a few minor yet sharp corrective moves that will “threaten” the existing channel constraints.

BULLISH RETRACEMENT PATTERNS WITHIN BULLISH TREND CHANNELS

Bullish retracement patterns such as a Gartley or a Bat typically develop in areas of consolidation in conjunction with the constraints of the channel. Figure 4.12 shows a Bullish Gartley, but either retracement pattern can be applied to these situations.

FIGURE 4.12

CHICAGO MERCANTILE EXCHANGE (CME): DAILY

BULLISH GARTLEY IN A BULLISH TREND CHANNEL

The first example of the Chicago Mercantile Exchange shows an extended rally on the daily chart (see Figure 4.13). The Bullish Gartley that formed within this well-established channel completed several hundred points higher than it was the year prior.

FIGURE 4.13

This is a case where the pattern may seem to be developing at a point that is too far along within the bullish trend. Quite simply, since the stock has rallied several hundred points in the prior year, it might be difficult to believe that this pattern would yield a significant continuation of the predominant trend. However, the Bullish Gartley did just that, as the stock rallied another hundred points within a few months after completing this pattern.

CHICAGO MERCANTILE EXCHANGE (CME): DAILY

BULLISH GARTLEY IN A BULLISH TREND CHANNEL

The enlarged chart in Figure 4.14 of the Bullish Gartley within the uptrend channel clearly shows a distinct harmonic pattern, despite the fact that the stock rallied as much as it did prior to this setup completing.

FIGURE 4.14

The example of CME clearly presents the concept of looking toward harmonic pattern completions as continuation signals within established trends. In this case, the Bullish Gartley was distinct and completed at the lower end of the support channel. The price action reversed sharply after testing all the numbers in the PRZ. When patterns like these develop within the context of an established bullish trend, these setups frequently are technically significant signals with respect to the overall direction of the stock.

BULLISH EXTENSION PATTERNS WITHIN BULLISH TREND CHANNELS

Bullish extension patterns such as a Crab, a Butterfly, or an Alternate Bat typically possess more volatile corrective price action yet remain within the constraints of the established channel. Figure 4.15 illustrates a Bullish Crab, but any of the extension patterns can be applied to these situations.

FIGURE 4.15

Although extension patterns usually encounter more volatile price action, these setups offer unique trading opportunities. In many of these cases, the PRZ sits just below the lower range of the bullish channel, often resulting in volatile price action as the pattern completes. 

BRITISH POUND (GBP_A0-FX): 15-MINUTE

BULLISH CRAB IN A BULLISH TREND CHANNEL

The example of the British Pound in Figure 4.16 shows a Bullish Crab that completed just below the lower range of the trend channel. This pattern exemplifies the potential strength of a reversal that completes at critical trend channel support.

FIGURE 4.16

The pattern completed at 1.6325 area, despite the fact that this was a few pips below the support line of the trend channel. Although this may have seemed as if the channel was going to break down, the distinct Bullish Crab clearly indicated that the price action was testing a critical continuation area of the primary trend.

BEARISH COMPLEX PATTERNS WITHIN DOWNTREND CHANNELS

Bearish retracement patterns such as a Gartley or a Bat typically develop in areas of consolidation in conjunction with the constraints of the primary downtrend channel. When these patterns complete at or slightly above the upper trend channel line, they present a unique opportunity to execute trades at the completion of distinct harmonic patterns that have the benefit of the primary trend complementing the resistance area.

BEARISH COMPLEX RETRACEMENT PATTERNS WITHIN DOWNTREND CHANNELS

Again, bearish retracement patterns such as a Gartley or a Bat typically develop in areas of consolidation in conjunction with the constraints of the channel. Figure 4.17 illustrates a Bearish Gartley, but either retracement pattern can be applied to these situations.

FIGURE 4.17

AUSTRALIAN DOLLAR (AUD_A0-FX): 15-MINUTE

BEARISH GARTLEY IN BEARISH TREND CHANNEL

In Figure 4.18, the Aussie $ formed a Bearish Gartley after declining steadily over the previous few sessions. The price action held firmly within the bearish channel and formed a distinct pattern that marked the dramatic continuation of the established downtrend.

Despite exceeding the top range of the downtrend channel, the price action sold off sharply after completing the pattern. This example demonstrates the effectiveness of bearish patterns as critical continuation signals within established channels. In fact, patterns like these that complete slightly beyond the constraints of the established downtrend frequently can provide significant reversals.

BEARISH COMPLEX EXTENSION PATTERNS WITHIN BEARISH CHANNELS

Bearish extension patterns such as a Crab, a Butterfly, or an Alternate Bat typically possess more volatile corrective price action yet remain within the constraints of the established channel. Figure 4.19 illustrates a Bearish Crab, but any of the extension patterns can be applied to these situations.

FIGURE 4.19

Although extension patterns frequently experience more volatile price action, these setups offer unique trading opportunities. In many of these cases, the PRZ sits just above the upper range of the bearish channel, often creating volatile price action as the pattern completes.

APPLE (AAPL): 5-MINUTE

DEEP BEARISH CRAB PATTERN WITHIN A BEARISH CHANNEL

Apple formed a Deep Bearish Crab within a defined downtrend (see Figure 4.20). In fact, the stock declined steadily within a defined range that contained the price action before it formed the pattern that marked the significant continuation. The Deep Bearish Crab that developed at the top range of this trend channel clearly illustrates the importance of harmonic patterns as “signposts of future price action.

FIGURE 4.20

The stock completed the Deep Bearish Crab, as it retested the top range of the channel. Apple stalled at this resistance and sold off sharply following the reversal.

APPLE (AAPL): 5-MINUTE

DEEP BEARISH CRAB PATTERN WITHIN A BEARISH CHANNEL

The enlarged chart in Figure 4.21 clearly shows the combination of the top range of the downtrend channel and the pattern’s PRZ converging to define critical harmonic resistance in the $212 area. Again, this pattern signaled yet another continuation in the persistent bearish trend on the daily chart.

FIGURE 4.21

Apple demonstrated the importance of patterns that form in the direction of the trend. Well-defined trend channels should be clear and confine price action in a precise range. Within these constraints, patterns can form to signal the strength of the price action and identify optimal entry points for trade executions that attempt to follow in the direction of the predominant trend.

FAILED PATTERNS AGAINST THE TREND

There are many cases where distinct harmonic patterns form within an established channel but they are challenged by the predominant trend. For example, a bullish pattern that forms within a defined bearish trend channel can present a challenging situation from a technical perspective. If the bullish pattern yields a valid reversal and the price action can rally beyond the downtrend channel, the PRZ would represent a critical support point. However, if the price action continued to decline and violate the bullish pattern, this area might be regarded as another continuation of the established downtrend. Again, this is a situation where harmonic patterns must be regarded as signposts of potential future price action. These setups—whether they fail or not—are critical make-or-break pattern completions that reveal a vast amount of technical information within a few price bars of its realization. Although a failed pattern might not yield the initial desired result of a valid reversal, such price action often signals a significantly deteriorating technical state of the primary trend and it must be respected.

BULLISH FAILED COMPLEX PATTERN AGAINST THE TREND

The overwhelming failure of patterns that act as clear continuation signals was exemplified in the historical examples of the bear markets of both 2000 and 2008. The violated Monster Bullish Gartley and the failed weekly Bullish 5-0, respectively, were two historic examples of this phenomenon. Both situations personally ingrained the significance of these failures for me as a vital element of the Harmonic Trading approach (see Figure 4.22). Although it is easy to spot the best examples in hindsight, the importance of such failures must be considered in real-time situations as opportunities unto themselves. The failure of a pattern’s anticipated completion commonly indicates that something technically more significant is developing, especially when the trend is well defined. In fact, these types of continuation trades can yield decisive moves that offer accelerated declines following brief consolidation periods.

FIGURE 4.22

STANDARD AND POOR’S 500 JUNE 2009 MINI-CONTRACT (ES_M9): 5-MINUTE

BULLISH GARTLEY IN A BEARISH TREND CHANNEL

The intra-daily chart of the S&P 500 June 2009 mini-contract clearly illustrates the concept of a failed bullish pattern within an established downtrend (see Figure 4.23). In the case the ES, the price action declined steadily for the entire session before forming the Bullish Gartley.

 

FIGURE 4.24

After a brief period of consolidation, the trend continued lower, violated PRZ, and dropped another 1% after the pattern’s failure. The dramatic sell-off exemplifies the type of accelerated action that can be expected after a pattern is violated.

STANDARD AND POOR’S 500 JUNE 2009 MINI-CONTRACT (ES_M9): 5-MINUTE

BULLISH GARTLEY POTENTIAL REVERSAL ZONE (PRZ) IN A BEARISH TREND CHANNEL

The enlarged chart of the Bullish Gartley PRZ in Figure 4.24 clearly shows the decisive downside continuation that resulted following the failure of the pattern.

FIGURE 4.24

This is another case where the obvious failure of a bullish harmonic pattern within the context of an established downtrend acted as a critical continuation signal. Again, the continuation signal is triggered in these situations when the price action exceeds the PRZ and follows through to the downside within a few price bars after the violation.

FAILED BEARISH PATTERNS IN A BULLISH TREND CHANNEL

Failed bearish patterns within an established bullish channel typically signal an important continuation of the predominant trend. Again, failed harmonic patterns in these situations underscore their importance as continuation signals. This technical information is usually critical to the future direction of the price action, as bearish pattern failures within an established channel can lead to an acceleration of that trend.

Although Figure 4.25 only shows a retracement pattern, the same principles apply to extension structures. However, Bearish Gartley and Bearish Bat patterns typically yield the best moves following a decisive failure of their respective PRZ.

FIGURE 4.25

DOW JONES TRANSPORTATION AVERAGE ($TRAN): DAILY FAILED BEARISH GARTLEY PATTERN IN A BULLISH TREND CHANNEL

After rallying for quite some time, the Dow Jones Transportation Average formed a distinct Bearish Gartley within the constraints of an established bullish channel (see Figure 4.26). Although the pattern yielded an initial reversal, the price action quickly rebounded and rallied above the PRZ.

FIGURE 4.26

This example demonstrates how a distinct pattern can define critical technical levels within an established trend. In this case, the violation of the Bearish Gartley in the Dow Transports marked an important breakout and upside continuation of the predominant trend.

DOW JONES TRANSPORTATION AVERAGE ($TRAN): DAILY FAILED BEARISH GARTLEY POTENTIAL REVERSAL ZONE (PRZ) IN A BULLISH TREND CHANNEL

The enlarged chart of the pattern’s PRZ in Figure 4.27 shows how the price action reversed nominally on the initial test of this area. The index consolidated in the PRZ for a short while before continuing higher.

FIGURE 4.27

The decisive breakout above the prior harmonic resistance established by the pattern was the technical entry point within this setup. Although not all failed patterns will possess such decisive price action, as is the case with the Dow Transports, most valid continuations will adhere to the predominant bias established by the primary uptrend.

HARMONIC PATTERNS RELATIVE TO THE TREND CONCLUSION

When analyzing harmonic patterns relative to the trend, it is important to keep in mind the general principle that patterns are primarily signposts of potential future price action. Regardless of what type of pattern may form, a completed structure represents some type of corrective price action within the context of the larger trend and provides significant information regarding the potential future price direction.

These patterns rely on precise ratio alignments within the constraints of an established trend to define the potential continuation points. These formations are critical because they can indicate execution areas within well-established trends that otherwise might be overlooked. Also, harmonic patterns provide reliable technical signals, regardless of the extent that a trend has persisted.

Not to be overlooked in its own merit, failed harmonic pattern PRZs define the exact price level within the overall predominant trend for the entry of a trade. Although a pattern’s completion may not yield the anticipated result of a change in trend, the price action in this area will typically offer evidence of the strength of the move well in advance. Furthermore, the PRZ of a pattern that completes within an established trend can clearly outline the make-or- break price level for the entry point of a trade. The immediate action after a pattern completes often can provide an enormous amount of technical information regarding the state of the future price action unlike any other methodology.

The analysis of harmonic patterns relative to the trend is an important consideration when looking to execute a trade. Regardless of the time frame, price action has a tendency to adhere to certain channels. Although this is not the case with all price action, situations that exhibit defined channels can present clearer trading opportunities, especially when harmonic patterns are present.