Harmonic Trading: The Bearish 5-0 Pattern

THE BEARISH 5-0 PATTERN

The Bearish 5-0, illustrated in Figure 3.14, starts at the 0 point, representing the low of an extended rally up to the initial point of the pattern at X. The initial point X sets up the failed breakout area, where the rally from the A point to the B peak, nominally takes out the prior high at X. Again, this is the failed wave 3 or wave 5—in Elliott Wave terms—that establishes the rest of the structure.

FIGURE 3.14

Remember, this X, A extension must be at least a 1.13 but not greater than a 1.618. After that impulsive failed wave is established, the BC leg declines to at least a 1.618 extension of the AB length, but it does not exceed 2.24. Again, this tight range of 1.618–2.24 is a defining element of the structure. If the 1.618 limit is not reached, the structure is not a valid 5-0. After the BC leg has reversed from that zone, the bearish 50% retracement is measured from the B point to the C point. In addition, the Bearish Reciprocal AB=CD is projected from the C point (an equivalent length of the AB leg) to complement the PRZ.

AMEX OIL INDEX ($XOI): 5-MINUTE

BEARISH 5-0 PATTERN

Figure 3.15 is a fantastic intra-day example of a Bearish 5-0 structure that possessed the ideal Fibonacci alignment to validate the pattern. After a long rally, the index made an initial peak at the X point, pulled back to point A, and reversed sharply at the B point, establishing the failed wave of the 5-0 structure.

FIGURE 3.15

The chart in Figure 3.16 of the price action in the PRZ clearly shows the sharp reversal following the test of the 50% level. The Bearish Reciprocal AB=CD complemented the 50% retracement and defined a tight range just above the psychological 1100 level. The $XOI tested the 50% level and stalled immediately. After completing the Reciprocal AB=CD, it started to reverse.

AMEX OIL INDEX ($XOI): 5-MINUTE

BEARISH 5-0 PATTERN POTENTIAL REVERSAL ZONE (PRZ)

It is important to mention the C point on the chart in Figure 3.16. The mandatory 1.618 requirement was met in this case, but it was close. If the C point had not tested the 1.618 or fell just shy, it would have invalidated the structure.

FIGURE 3.16

Unlike other patterns, the 5-0 allows no discretion outside the prescribed parameters for the structure. Although such strict application reduces the number of potential trading candidates, it serves to distinguish the best opportunities.

STANDARD & POOR’S 500 SEPTEMBER 2009 MINI-CONTRACT (ES_U9): 5-MINUTE

BEARISH 5-0 PATTERN

This 5-minute chart in the ES shows another ideal intra-day structure with a perfect 50% retracement, calculated at 1030 with the completion of the Reciprocal Bearish AB=CD slightly below this level (see Figure 3.17).

FIGURE 3.17

The following chart of the price action in the PRZ clearly shows the sharp reversal following the entire test of the 5-0 resistance (see Figure 3.18). The Bearish Reciprocal AB=CD complemented the 50% retracement and defined a tight intra-day range. The ES rolled over sharply after testing the entire range of the harmonic resistance. This example required some consolidation before reversing, but such situations underscore the importance of waiting for the entire PRZ to be tested before executing the trade. In this case, the 5-0 pattern pinpointed the 1030 area as the ideal price level for the completion of the setup.

STANDARD & POOR’S 500 SEPTEMBER 2009 MINI-CONTRACT (ES_U9): 5-MINUTE

BEARISH 5-0 PATTERN POTENTIAL REVERSAL ZONE (PRZ)

This Bearish 5-0 possessed an ideal reversal and downside continuation, which is a common trait of valid structures (see Figure 3.18). The best trading opportunities usually provide a quick indication of the validity of the reversal.

FIGURE 3.18

In this case, the ES stalled exactly at the entire range harmonic numbers and rolled over shortly thereafter. Again, this example demonstrates the importance of waiting for the entire range to be tested before executing the trade. Despite the brief consolidation required to resolve the setup, the 5-0 pattern accurately pinpointed the intra-day reversal. Whether it’s a 1-minute, 5-minute, 60-minute, daily, or weekly chart, the principles remain the same, as clear opportunities like these will present themselves on all time frames.

DOW JONES INDUSTRIAL AVERAGE ($INDU): 1-MINUTE

BEARISH 5-0 PATTERN

The 1-minute chart in Figure 3.19 shows a distinct Bearish 5-0 that stalled immediately after testing the harmonic resistance and reversed precisely at the 10,175 level. Setups such as these form regularly, as 5-0 patterns can mark important intra-day continuation points. In this case, the Dow Jones Industrial Average reversed sharply after testing all of the numbers in the PRZ of this pattern.

FIGURE 3.19

The Bearish 5-0 pattern is an excellent harmonic structure that typically possesses a precise PRZ. Most valid reversals exhibit definitive price action that continues decidedly lower after testing the entire PRZ. It is important to note that the 50% retracement is typically the most significant harmonic resistance level within the PRZ. As this 1-minute example of the Dow Industrials demonstrates, the index reversed quickly after completing the pattern. Clearly, the 5-0 is an effective tool within the Harmonic Trading arsenal, but it is even more accurate when the structure possesses a smaller ab=cd pattern in the CD leg.

BEARISH AB=CD WITHIN CD LEG OF 5-0 PATTERN

Although the 5-0 pattern requires only two harmonic numbers to define the PRZ, there are many situations where a smaller ab=cd pattern will form in the CD leg of the Reciprocal AB=CD (see Figure 3.20). These are unique situations because the ab=cd is usually distinct, and the structure can be effective in complementing the other numbers of the 5-0 pattern.

FIGURE 3.20

Although the other numbers of the pattern are more significant in defining the completion of the setup, the smaller ab=cd acts as an effective structural signal that validates many successful reversals. Furthermore, I believe that a Bearish 5-0 with a smaller ab=cd is a technically more significant harmonic structure than a pattern without one.

NATURAL GAS MARCH 2010 CONTRACT (NG_H0): 15-MINUTE

This 15-minute chart of the March 2010 Natural Gas contract shows a distinct Bearish 5-0 that possessed a smaller Bearish ab=cd within the CD leg (see Figure 3.21). The addition of the smaller ab=cd was a key signal that this pattern would yield a valid reversal.

FIGURE 3.21

The structure was distinct on this 15-minute chart. The sharp reversal precisely at the completion of the pattern was a clear sign of the strength of this harmonic resistance. The following chart shows the price action in the PRZ (see Figure 3.22).

NATURAL GAS MARCH 2010 CONTRACT (NG_H0): 15-MINUTE

BEARISH 5-0 PATTERN POTENTIAL REVERSAL ZONE (PRZ)

The Natural Gas March 2010 Contract reversed immediately after testing all of the numbers in the PRZ. The Bearish 5-0 possessed four harmonic numbers in a tight range (see Figure 3.22). The addition of the smaller ab=cd pattern served as an important confirmation point within the PRZ. Furthermore, the fact that the smaller ab=cd pattern completed above the actual 50% level helped to indicate that the price action would reverse in the upper range of this area.

FIGURE 3.22

It is important to note that the PRZ of the 5-0 pattern should possess a precise reversal such as the one in this example. In fact, most valid reversals from 5-0 patterns should occur immediately after the entire zone has been tested.

5-0 PATTERN VIOLATIONS

More than any other pattern, the structure of the 5-0 presents a unique opportunity when the price action violates the PRZ. As with all 5-0 patterns, the best setups depend upon a distinct alignment of ratios within the structure. Therefore, when attempting to execute a trade based upon a failed setup, it is still imperative to look at those candidates that possess the most distinct structures.