Harmonic Patterns Relative to the Trend

HARMONIC PATTERNS RELATIVE TO THE TREND

PATTERNS WITH THE TREND

When analyzing patterns within a defined trend, it is important to be mindful of the general principle that all patterns are primarily signposts of potential future price action. Regardless of what type of pattern may form, a complete structure represents some type of corrective price action within the context of the larger trend. Such patterns provide clear signals of continuation points that confirm the predominance of the existing trend. These formations are critical because they can indicate execution areas within well-established trends that otherwise might seem futile.

There are many situations where a well-established trend has persisted for such a long time that a potential opportunity may seem to have passed long ago, only to experience price action that continues in the predominant direction for a substantially greater move. Many times I have analyzed a particular chart that possesses a well-defined trend and passed on the potential opportunity because it seems that I was late in the move. For example, a stock that has rallied from $10 to $50 a share has increased 500% and may seem to possess limited upside. From a psychological perspective, it can be difficult to convince yourself that there is a great deal of further gain only to watch the stock rally from $50 a share to $100 or more. In situations like these, the formation of complex harmonic patterns within the limits of the established trend can act as a signpost or signal of a significant continuation at hand. Furthermore, the Potential Reversal Zone (PRZ) of the pattern within the trend can serve to measure and pinpoint where these continuation areas complete.

AB=CD PATTERNS AS CONTINUATION SIGNALS WITHIN ESTABLISHED TREND CHANNELS

AB=CD patterns within established channels are typically utilized in conjunction with other measurement techniques to define the approximate continuation area for the predominant channel. The simplest structure within established trend channels is an AB=CD pattern. In fact, many AB=CD patterns serve as a minimum requirement before a trend can continue in its predominant direction. Although distinct complex patterns frequently provide more accurate PRZs, a simple AB=CD pattern in combination with the limits of a trend channel is typically sufficient enough to define a continuation opportunity.

BULLISH AB=CD PATTERNS AS CONTINUATION SIGNALS WITHIN ESTABLISHED TREND CHANNELS

Bullish AB=CD patterns frequently act as a significant continuation signal within the uptrend channel (see Figure 4.1). In combination with the rising trend line support, the pattern’s completion serves as a minimum requirement from a harmonic perspective to trigger a long position within the context of the channel.

FIGURE 4.1

Regardless of how far the trend has progressed, a small correction within a larger bullish move represents an opportunity to execute at the completion of a harmonic pattern with the power of a strong predominant bias favoring further upside. Quite simply, executing a trade in such a manner attempts to put “the wind to your back” and to capitalize on the continuation of a distinct bullish trend.

NASDAQ COMPOSITE (^IXIC): DAILY

Throughout 2004–2005, the NASDAQ Composite formed three distinct Bullish AB=CD patterns on the daily chart within the context of the predominant bullish trend (see Figure 4.2).

FIGURE 4.2

In each case, these daily Bullish AB=CD patterns acted as distinct continuation signals of the predominant trend. Although the price action nominally exceeded the completion point of each pattern, the PRZ clearly pinpointed the continuation of the bullish trend. In combination with the support line of the channel, the completion point of each AB=CD pattern served as an effective entry point to get long within this long-term trend.

NASDAQ COMPOSITE (^IXIC): DAILY

BULLISH AB=CD #1: COMPLETED AUGUST 2004

The first Bullish AB=CD pattern completed in August 2004, as shown in Figure 4.3. Although the price action sold off sharply as it tested the completion point of the pattern, the bullish trend resumed after briefly exceeding the PRZ.

FIGURE 4.3

NASDAQ COMPOSITE (^IXIC): DAILY

BULLISH AB=CD #2: COMPLETED APRIL 2005

The second Bullish AB=CD completed in April 2005 and resulted in the continuation of the primary uptrend (see Figure 4.4). The price action reversed more precisely from the PRZ than the setup from the prior August, and it rallied significantly higher after completing the pattern.

FIGURE 4.4

NASDAQ COMPOSITE (^IXIC): DAILY

BULLISH AB=CD #3: COMPLETED OCTOBER 2005

The third Bullish AB=CD pattern within this 18-month time frame completed in October 2005, as shown in Figure 4.5. The price action exceeded the completion point of the pattern but reversed quickly after testing the entire PRZ. Moreover, the completion point for the pattern served as the defining support level for the continuation of the predominant uptrend, as the price action failed to test the rising channel. Situations such as these underscore the importance of pattern completions to indicate the continuation of a predominant trend.

FIGURE 4.5

BEARISH AB=CD PATTERNS WITHIN TREND CHANNELS

Bearish AB=CD patterns frequently act as effective continuation signals within established downtrend channels, as illustrated in Figure 4.6. Also, Bearish AB=CD patterns in combination with the declining trend resistance serve as a minimum requirement from a Harmonic Trading perspective to trigger a short position within the context of the channel.

FIGURE 4.6

Sometimes, these situations may be difficult to execute because the trend has persisted for quite some time. Although the price action may seem to not have much farther to go, Bearish AB=CD patterns that materialize in these situations are extremely effective structural signals of significant trend continuations.

TOLL BROTHERS (TOL): WEEKLY

BEARISH AB=CDS

The example of Toll Brothers in Figure 4.7 illustrates the principle of the Bearish AB=CD pattern acting as a critical continuation signal, regardless of where it develops within the context of the weekly trend channel.

FIGURE 4.7

The interesting thing to note about the completion of these patterns is that they occurred more than halfway from the stock’s all-time peak. Although these patterns completed at the mid-point of the bearish trend, they were extremely effective in marking the continuation of the stock’s long-term decline.

BULLISH RECIPROCAL AB=CD PATTERNS WITHIN TREND CHANNELS

Bullish Reciprocal AB=CD patterns are most effective when they are present within established uptrend channels. In fact, the AB leg often is the first corrective leg within a new bullish trend (see Figure 4.8).

FIGURE 4.8

It is important to note that the completion of the Reciprocal AB=CD pattern is more of an approximation than an exact reversal point. Ideally, it is essential that the CD leg test the equivalent completion point. However, it is common for the price action to exceed this area before eventually resuming the predominant uptrend. Although the Reciprocal AB=CD may not yield as precise a PRZ as other patterns, it is effective as an approximation measure that complements other technical readings to define important continuations of predominant bullish trends.

DISNEY (DIS): DAILY

BULLISH RECIPROCAL AB=CD PATTERNS WITHIN TREND CHANNELS

The chart of Disney in Figure 4.9 clearly demonstrates the concept of an approximated completion point of the Reciprocal AB=CD pattern within the established bullish trend.

FIGURE 4.9

In this case, the stock consistently reversed at two-point corrective declines within this established bullish channel on the daily chart. Although the stock exceeded the two-point limit, the price action reversed after briefly exceeding the completion point of the CD leg in each case.

BEARISH RECIPROCAL AB=CD PATTERNS WITHIN TREND CHANNELS

In much the same manner as the bullish version, Bearish Reciprocal AB=CD patterns within established trend channels provide excellent approximation points of corrective moves (see Figure 4.10). When such repeated corrective price action manifests itself, the estimated measurement technique is effective as long as the established bearish channel remains intact.

FIGURE 4.10

Well-established bearish channels frequently provide sharp reactions within their respective downtrend. But it is important to note that the completion of the Reciprocal AB=CD pattern is more of an approximation than an exact reversal point. Ideally, it is important to see the CD leg test the equivalent completion point. However, in many cases, the price action exceeds this area before ultimately resuming the predominant bearish trend. Although the Bearish Reciprocal AB=CD may not yield as precise a PRZ as other patterns, it is effective as an approximation measure that complements other technical readings to define important continuations of predominant bearish trends.

STANDARD & POOR’S 500 INDEX (^GSPC): WEEKLY BEARISH RECIPROCAL AB=CD PATTERNS WITHIN TREND CHANNELS

One of the most interesting aspects of the bear market of 2008 was the continual corrective rallies within the established downtrend that were approximately 200 points each. The chart in Figure 4.11 clearly shows the weekly bearish channel that possessed the repeating Reciprocal AB=CD patterns.

FIGURE 4.11

Beginning with the first corrective wave in 2000 (A), the S&P 500 repeatedly bounced approximately 200 points each time it tested the lower range of its weekly channel.