Bullish and Bearish 5-0 Pattern Violations: Harmonic Trading

BULLISH 5-0 PATTERN VIOLATIONS

Despite the failure of the pattern, these situations offer a specific opportunity to execute a trade that follows the predominant trend. In this case when the 5-0 pattern fails, the price action typically declines decidedly lower. In many cases, the breakdown in the price action usually declines to at least the relative 0.886 retracement beyond completion of the pattern. The illustration in Figure 3.23 shows the ideal PRZ of a 5-0 pattern.

FIGURE 3.23

When the 50% retracement area has been exceeded, the breakdown of price action frequently signals a trade opportunity. It is important to note that the trade opportunity does not develop until the entire PRZ has been tested and price action has clearly violated the initial test. Although this is more of a general guideline than a specific rule, the breakdown typically extends to the 0.886 retracement at a minimum. Regardless of whether the initial starting point of the 5-0 pattern is violated, this unique technical zone creates an opportunity to sell after this violation with a minimum target of the imminent 0.886 retracement.

GENERAL MOTORS (GM): DAILY

FAILED BULLISH 5-0 PATTERN

This daily chart of General Motors clearly demonstrated how a failed Bullish 5-0 pattern led to a downside continuation to the 0.886 retracement—and beyond (see Figure 3.24).

FIGURE 3.24

The distinct structure established this pattern as an excellent potential trade opportunity. Although GM stabilized initially as it approached the PRZ, the stock eventually declined sharply after testing the entire range of support and violated the setup. In fact, the failure of this daily pattern was technically significant, as it marked an acceleration of the long-term downtrend that eventually resulted in the demise of the company.

GENERAL MOTORS (GM): WEEKLY

FAILED BULLISH 5-0 PATTERN POTENTIAL REVERSAL ZONE (PRZ)

The enlarged chart in Figure 3.25 of the price action in the failed Bullish 5-0 PRZ clearly shows how the stock declined dramatically after violating the projected harmonic support.

FIGURE 3.25

It is important to study the example of GM because the price action follows a typical pattern—if you will—when the PRZ is violated. Most violations will experience some type of nominal reaction on the first test of the PRZ. However, price action that fails to continue to the upside and clearly lags will typically signal that a failure is imminent. The trigger for the failure occurs when the PRZ is violated after all the numbers are tested. Although this model can vary depending upon the situation, the example of General Motors illustrates the ideal situation.

BEARISH 5-0 PATTERN VIOLATION

In much the same manner as the Bullish 5-0 violation, the bearish situation offers a specific opportunity to execute a trade on the breakout above the PRZ, attempting to capitalize on the continuation of the predominant trend (see Figure 3.26). In this case, when the 5-0 pattern fails, the price action typically rallies decidedly higher. In many cases, the breakout in the price action usually rallies to at least the following 0.886 retracement beyond completion of the pattern. The next illustration shows an ideal violation of the 5-0 PRZ.

FIGURE 3.26

When the 50% retracement area has been exceeded, the breakout above this area is the decisive signal for the trade. It is important to note that the trade opportunity does not develop until the entire PRZ has been tested and the price action has clearly violated the initial test. Although this is more of a general guideline than a specific rule, the breakout typically rallies to test the 0.886 retracement at a minimum. Regardless of whether the initial starting point of the 5-0 pattern is violated, this unique technical zone creates an opportunity to buy this violation with a target of the critical 0.886 retracement.

INTERCONTINENTAL EXCHANGE (ICE): DAILY

BEARISH 5-0 PATTERN VIOLATION

After an extended decline, ICE formed a fantastic Bearish 5-0 pattern on the daily chart (see Figure 3.27). This is another situation where the price action experienced a nominal reaction on the first test of the PRZ. The stock stalled in this PRZ for a few weeks before breaking out to the upside. Again, the trigger for the failure occurs when the PRZ is violated on the second test. In this case, ICE accelerated to the daily 0.886 shortly after violating the pattern.

FIGURE 3.27

This example provided a great deal of evidence of the impending failure. Although the stock pulled back slightly on the initial test of the pattern completion, the price action held firmly in this area and slowly “drifted” higher. This is another ideal situation where the decisive price action violated a distinct pattern and marked an important continuation in the predominant trend of the stock. ICE rallied sharply to the 0.886 and gave a nice 20-point pop within a month after the pattern violation.

ALTERNATE BAT PATTERN

The origin of the Alternate Bat pattern resulted from many frustrated failed trades of the standard framework. The standard Bat pattern is defined by the B point that is less than a 0.618 retracement of the XA leg. Typically, the best structures employ a 50% retracement at the midpoint. Although there is room for interpretation to incorporate other ratios in the standard Bat pattern, I began to notice a peculiarity in those M- and W-type structures that possessed a 0.382 retracement or less at the mid-point (B). These variations frequently resulted in an eventual completion that was slightly beyond the expected 0.886 retracement of the standard framework. In many cases before I became aware of this alternate alignment, I would execute trades at the 0.886 retracement only to close the trade for a loss due to the lack of a reversal in the projected harmonic area. After slightly exceeding the initial point at X of the pattern and triggering my stop loss, many of these reversals would turn shortly thereafter, usually at the 1.13 extension of the structure.

Again, the defining element of these situations was directly attributed to those M- and W-type structures that possessed a retracement that was a 0.382 or less at the midpoint. It took some time to differentiate the structures, but the more I was “whipsawed” by these patterns the more I realized that further differentiation was required in these cases. Although the special situations for this pattern will be covered in greater detail later in this material, it is important to understand that such specification is required to differentiate these similar structures. It can be frustrating to try to trade these two types of patterns without differentiating their structures.

Although the Alternate Bat employs a 1.13 XA extension as a defining element of the PRZ, the 0.886 retracement is still a consideration within this range of harmonic numbers, as it serves as a minimum requirement for this pattern to be valid. In essence, the Alternate Bat typically completes in the area beyond the 0.886 retracement, but it should not exceed the 1.13. In fact, valid reversals in this pattern frequently reverse precisely at this level. The BC projection is typically an extreme harmonic number that complements the 1.13 extension. Although the Alternate AB=CD pattern is included in the standard Bat, this PRZ normally possesses just two harmonic measurements to define the completion of the pattern. In combination with a minimum 0.886 retracement, the Alternate Bat possesses several critical structural elements to define excellent trade opportunities.

The Alternate Bat pattern is an extension structure that is mostly utilized in combination with other technical factors to define specific trading opportunities. I will outline the application of the Alternate Bat in these situations—in particular, the RSI BAMM. In addition, the structure must possess the prescribed alignment of ratios to validate the pattern, as this dictates the eventual execution of the potential trade opportunity.

ALTERNATE BULLISH BAT PATTERN

The Alternate Bullish Bat pattern, illustrated in Figure 3.28, is a specific M-type structure that utilizes a 1.13 XA extension, as the defining support level in the PRZ. The BC projection utilizes an extreme harmonic ratio that is at least a 2.0 extension but more frequently appears as a 2.618 or 3.14.

FIGURE 3.28

Although the Bullish AB=CD is not included in this setup, the 0.886 retracement serves as a minimum support level to help define the completion of the pattern, while the convergence of the 1.13 XA and extreme BC projections pinpoint the PRZ. Again, the 1.13 XA extension should not be exceeded, as most valid reversals rally shortly after testing this area.

DOW JONES INDUSTRIALS ETF (DIA): WEEKLY

ALTERNATE BULLISH BAT PATTERN

In this example, the Dow Diamonds possessed a distinct M-type structure that possessed a 0.382 mid-point (see Figure 3.29). The alignment established the structure as an Alternate Bat pattern instead of the standard version.

FIGURE 3.29

This structure was remarkable due to the size of the pattern. The Diamonds developed over the course of seven years on this weekly chart. The 1.13 extension marked the critical low of the 2008 bear market. The convergence of the 1.13 XA and the 3.14 BC projection pinpointed the long-term support.

EURODOLLAR (EUR_A0-FX): 5-MINUTE

ALTERNATE BULLISH BAT PATTERN

The Euro possessed a distinct Alternate Bullish Bat on this intra-day chart that reversed sharply after testing both numbers that converged in the same exact area to define the PRZ (see Figure 3.30). This is another case where the structure of the Alternate Bat pattern indicated a deeper retest of the initial support point and marked the ultimate reversal for the price action.

FIGURE 3.30

If this unique differentiation did not exist, the execution in this situation would have likely been stopped out for a loss, as the price action would have violated the 0.886 retracement and the initial point X before the eventual reversal. However, the 0.382 retracement at the pattern’s mid-point clearly indicated that the price action would dip slightly below the initial point at X to the 1.13 extension.

ALTERNATE BEARISH BAT PATTERN

The Alternate Bearish Bat pattern, illustrated in Figure 3.31, is specific W-type structure that utilizes a 1.13 XA extension, as the defining resistance level in the PRZ. The BC projection utilizes an extreme harmonic ratio that is at least a 2.0 extension but more frequently appears as a 2.618 or 3.14.

FIGURE 3.31

Although the Bearish AB=CD is not included in this setup, the 0.886 retracement serves as a minimum resistance level to help define the completion of the pattern, while the convergence of the 1.13 XA and extreme BC projections pinpoint the PRZ. Again, the 1.13 XA extension should not be exceeded, as most valid reversals start to decline shortly after testing this area.

EURODOLLAR (EUR_A0-FX): 5-MINUTE

ALTERNATE BEARISH BAT PATTERN

This Alternate Bearish Bat in the Euro shown in Figure 3.32 exemplifies the structure of the pattern. The 0.382 retracement at the midpoint (B) was the indication of an extended 1.13 XA projection as the defining harmonic resistance level in the PRZ.

FIGURE 3.32

This is another case where the extreme BC projection effectively complemented the 1.13 XA extension to define the precise area for the pattern completion and eventual reversal. Both extensions defined the 1.4440 area as an excellent short-term selling opportunity.

NIKE (NKE): DAILY

ALTERNATE BEARISH BAT PATTERN

The daily chart in Figure 3.33 shows a distinct Alternate Bearish Bat that reversed decisively after the stock tested the completion point of the pattern. The W-type structure possessed two numbers that converged in the same area. Both extensions defined the PRZ as the make-or-break harmonic resistance. The 0.382 retracement at the mid-point of the pattern distinguished the setup and indicated a complete retest of the prior peak of the trend. This structural element defined the upper range of the harmonic resistance and pinpointed the eventual completion of the setup at the 1.13 XA extension.

FIGURE 3.33

Although this trade may have been a challenging execution since the stock reversed immediately after completing the pattern, the 1.13 projection was the optimal entry point for the short position. The PRZ was clearly defined, as the extreme BC leg complemented this area just above the initial point at X. Also, this underscores the importance of the 0.886 as a minimum technical level in the completion of the alternate version of the pattern. Although the price action reversed quickly after hitting the 1.13 XA extension, the differentiation of structures in situations like these prevents an early entry and helps to optimize trading decisions. In this case, the ideal entry for the trade was just above the standard Bat PRZ, as the low B-point in the pattern’s structure indicated an eventual reversal slightly above this area. Although these two types of Bat patterns appear similar, such understanding and comprehension immensely improves executions and reduces overall risk by pinpointing reversals as precisely as possible.

NEW HARMONIC PATTERNS CONCLUSION

The new patterns presented in this chapter help to further the existing identification strategies within the Harmonic Trading approach. The 5-0, Reciprocal AB=CD, and the Alternate Bat are slightly different in structure than the existing array of patterns. Furthermore, these patterns should be employed only in specialized situations, as they require precise conditions to validate their structures.

Patterns such as the Alternate Bat continue to underscore the importance of exact specification within the Harmonic Trading approach. Although the standard version and the Alternate Bat look similar, the critical differentiation at the pattern’s mid-point clearly identifies the proper corresponding execution area and filters out many inherently flawed trading opportunities. In this case, the 1.13 extension dramatically improves the accuracy of the overall Bat pattern setup. Furthermore, such differentiation broadens the general comprehension of price action with respect to M- and W-type retracement patterns.

These patterns are among the most precise within the entire Harmonic Trading arsenal. Although many of these situations require new measurement techniques, the same principles are still applied to each situation. As is the case with all harmonic patterns, the exact alignment and precise rules that define each structure is critical in determining the best trading opportunities.