Copyrighted Material VOLUME y

Harmonic
T R AD I N G
Reaction vs. Reversal
Harmonic Trading
Volume Three:

Reaction vs. Reversal

By Scott M. Carney
Copyright 2016

Harmonic Trader Press

Printed in the United States of America
 Digitized by the Internet Archive
in 2018

https://archive.org/details/harmonictradingr03scot
 COPYRIGHT HARMONICTRADER, L.L.C. 2016

Harmonic Trading Volume 3:

Reaction vs. Reversal

By Scott M. Carney

Library of Congress
Cataloging-in-Publication Data

This publication is designed to provide accurate and authoritative

information in regard to the subject matter covered.

It is sold with the understanding that the publisher is not engaged in

rendering legal, accounting, or other professional service.

If legal advice or other expert assistance is required, the services of a

competent professional person should be sought.

From a Declaration of Principles Jointly Adopted by a Committee of the

American Bar Association and a Committee of Publishers and
Associations.

This material is protected under all copyright laws.

This material may not be reprinted or reused in any manner without
written consent of Scott M. Carney. All rights reserved!

Harmonic Trader Press 2016

Printed in the United States of America
Table of Contents

Dedication

Acknowledgments

Foreword

Introduction

Chapter 1:
Core Principles of Harmonic Trading .p.33

Chapter 2:
Standardized Harmonic Pattern Identification.p.49

Chapter 3:
Advanced Harmonic Trading Execution Strategies .p.127

Chapter 4:
Harmonic Trading Reversal Types .p.159

Chapter 5:
Advanced Indicator Analysis in Harmonic Trading.p.187

Chapter 6:
Harmonic Strength Index (HSI) .p.235

Chapter 7:
Advanced Harmonic Trading Management Strategies ...p.255

Chapter 8:
Harmonic Trading Timeframes ...p.289

Conclusion

Bibliography
 Dedication

For Priscila,

If Not for You,

This Would Not Be.

Love,

Scott
 Acknowledgments
Throughout my journey of work, I have encountered many outstanding
Harmonic Traders - fantastic individuals whom are dedicated to the financial markets
and understanding how they tick. I have immense respect for those whom have
dedicated themselves to the study of harmonic phenomenon in the financial markets.
I encourage future generations to pick up the mantle of harmonic patterns and move
forward with this advanced material to continue to unlock even deeper relationships.
The most important acknowledgement to all Harmonic Traders is my appreciation to
the standard of character that most uphold. Harmonic Traders possess motivated
and pragmatic perspectives regarding the financial markets. They seem willing to
share ideas in good faith, promote a larger positive engagement and do the work
required to be successful. This represents the essence of the work that I have
presented and the core values of Harmonic Trading

I would like to thank all of the people that I have thanked in prior material again.
Many of these individuals - family and friends - continue to be tremendous influences
on my life and have helped directly and indirectly supported the development of
Harmonic Trading material since its inception.

I would like to thank all of the fantastic friends and family that I have in Brazil. My
experiences and connection to this amazing culture and these incredible people has
made a profound difference my life. Obrigado!

I must recognize Keegan McClellan for his overwhelming contribution and

collaboration throughout the past few years. I am indebted to you for helping me
automate these long-standing ideas and advance these complex environments into
quantifiable strategies. Thank you!

I want to recognize Stephanie Kramer for being one of the essential individuals who
"kept the lights on" and has been integral to the cause of realizing a larger effort
over the past several years. Thank you cuz'!

Raul Valin and Nadia Franca - If there was ever a way that I could permanently say
thank you, this is it. Thank you for all!

Robert Troy Hulmes - You lead by an example that has taught me much. Rooftop!

Michael Hausmann - It's always happening. Never forget!

Alan Kuenhold - It started because you opened your door. Much appreciated!

Mark Douglas, in memory. Your honest insights helped me bypass many avoidable
mistakes.
.

-
 Foreword

Next trade. Win, lose or draw - it is always about the NEXT TRADE!
This perspective keeps us open to new opportunities and helps to maintain a balanced
mindset with respect to current positions. As traders seeking to define market
conditions from a natural framework of price movements, we must always be open the
flow of opportunity available to us. There is unlimited opportunity in the financial
markets but it requires a comprehensive measurement approach to effectively define
clear possibilities. This has been my underlying purpose throughout my work with
Harmonic Trading.
It has been quite a bit of time since I have written a book. I never intended to
produce books and other resource material to this degree. But, my discoveries in
Harmonic Trading have continued to evolve. Over the past 20 years, I have expanded
upon the initial concepts that define unique technical situations. As more natural cyclical
relationships have been distilled, the basic tenets of pattern recognition have solidified
the foundation of measurements that comprises this methodology while integrating
advanced strategies to refine those characteristics that consistently provide reliable
signals and technical information.
Initially, trading was a personal endeavor that I experienced alone and was a
passion that few in my life shared. From time to time, I would meet individuals who had
experience trading markets or were employed in the industry to some degree. This was
a time before the Internet and all of the devices that now seamlessly connect us. For
someone whom most would not consider old, I find myself continually repeating things
that my grandparents said to me growing up about how the world has changed. But,
the world has changed, and it continues to evolve on a larger digital paradigm.
When I initially released The Harmonic Trader, the Internet was exploding but
only as fast as your dial-up connection would permit. In the early 2000's, I released
both Harmonic Trading Volume 1 and a few years later, Harmonic Trading Volume 2
that established the principles of Harmonic Trading. In my opinion, the amount of
technological progress in the financial industry since the release of Volume 2 - which
was nearly a decade ago - has surpassed the total of the preceding 25 years combined.
It is important to emphasize this phenomenon, as it is changing not only the way
information is disseminated in the markets but it has transformed how money is even
transacted. The barriers are gone. Anyone on the entire planet within reach of an
Internet connection can participate in the financial markets and attempt to be a
successful trader.

Harmonic Trading Volume 3: Reaction vs. Reversal

1
New Ideas and Applications of Harmonic Trading

Over the past two decades, I have experimented with combinations of

measurements to define unique situations that offer a great deal of reliable information
regarding the future probable price action of any market. Initially, these ideas were
founded in pattern rules which now have been readily accepted by traders as an
effective analytical framework. Once people are introduced to harmonic patterns and
apply the measurement strategies, they quickly realize the predictive value of these
techniques. Remarkably, the patterns and confirmation strategies enable an
understanding of natural limits of price action within any market. Although the trend is
always your friend, opportunities are omnipresent depending upon the timeframe
considered. The key understanding to getting the most out of harmonic patterns is
derived from their categorization and the expected outcomes to differentiate nominal
reactions versus larger reversals.
One of the greatest advantages measuring harmonic market movements is the
derived understanding and set of expectations that provide a framework to explain
price action. As we know, the market can only move so far within a period of time.
Therefore, a basic awareness of the market's trading history is a critical foundation for
any methodology that is looking to buy and sell for profit with some degree of
reasonable understanding of what is possible. Within the Harmonic Trading approach,
the measured strategies define unique and precise market conditions that validate
opportunities unlike any other approach. When combined with traditional Technical
Analysis, the entire structure of market movements can be identified, classified and
quantified accurately to define price levels that effectively price the opportunity.
The remarkable accuracy of harmonic patterns is well-known. Although I do feel
that some statistical claims have been manipulated by other online outfits for marketing
gain, I believe that the high degree of accuracy associated with harmonic patterns is
valid due to the sheer impact it has had on numerous traders' lives. One of the reasons
why these methodologies have grown so immensely over the years is because they DO
provide an accurate and effective framework to outline potential opportunities.
However, price pattern recognition requires an enhanced set of conditions to truly
capitalize on this phenomenon consistently.
Many have stated that harmonic patterns are 80 to 90% accurate. But what does
this mean? Does this mean that 90% of all harmonic patterns will make you rich? No -
90% of all harmonic patterns will not make you rich! 90% of all harmonic patterns will
give you a framework to analyze specific price zones that represent the completion of a
specific set of trading history that comprises a prescribed structural alignment to denote
a change in future direction. With all that being said, the only question to consider is
how far does the price action move in the desired direction before testing the
prescribed stop loss limit. This is an important consideration for any overall measure of
accuracy. There must be a measured parameter that explains how much of a price
move could be expected following the completion of harmonic pattern. Upon further

Harmonic Trading Volume 3: Reaction vs. Reversal

2
inspection, it is easy to see that a standardized assessment of multiple markets,
timeframes and pattern structures must be analyzed more specifically to offer
consistently accurate results.
As the creator of the harmonic patterns, it is difficult to quietly watch others
misrepresent the true value of these measurements. Yes, the patterns can be extremely
accurate but there must be a realistic and reasonable rationale to attempt to trade
these opportunities successfully. The notion that a trader can click a button and employ
a methodology that works 90% of the time is extremely suspect. Confirmation
variables are required to separate minor reactions from substantial trading opportunities
but the "home-run" outcome for every situation - unfortunately being circulated by less
informed actors in the industry - is simply not the norm.

So, What is the Harmonic Norm?

As a proponent of understanding market strategies that define precise

expectations, I am always looking for phenomenon in price action that can consistently
guide my decisions. My understanding of harmonic patterns and the realistic
expectations that I possess regarding possible outcomes facilitate my decisions and
dictate how I handle each situation. From the very beginning, I have stressed the
importance of a realistic perspective and the need to use the pattern structures as a
starting point. I am a firm believer that multiple confirmation of market analysis
frequently yields accurate and reliable signals. Therefore, I understand that not all
patterns are opportunities and the possible candidates that I consider must possess
multiple elements to be a valid consideration.
This perspective is derived from the basic assumption that harmonic patterns
offer a reaction on the initial test of a distinct pattern and usually experience a
secondary test before exhibiting a larger price move. I will discuss this in detail later in
this material however this is an example of just one expectation, and a standardized
model of how harmonic patterns exhibit definable and repeatable behavior. There are
other expectations involved with execution and trade management, as well as advanced
identification. All situations can be categorized and classified according to their
proportional structure. In my opinion, these are types of trading cycles that I consider
to be a type of "micro-price mechanisms within the overall functioning process of the
market.
We all know that the market ebbs and flows, moves up and down, and money
flows in and out. This is the market in action. This is the market's primary function - to
exist! It does not matter if the market trend is up or down. The basic function of the
market is to exist and prices must fluctuate to create such an environment. Therefore,
the fundamental function of markets is driven by cyclical trading phenomenon that
frequently exhibit harmonic pattern properties. When we identify these situations, there
are specific expectations that are associated with the completion of the structure. This
demands that we accurately measure and understand which ratios are significant,
especially within structures that may appear the same.

Harmonic Trading Volume 3: Reaction vs. Reversal

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 My main interest in this book is to establish a standardized measurement basis
that crystallizes the material initially presented in the first three books. These rules have
become the industry standard for harmonic patterns, although others have attempted
to present alternative interpretations that only distort the effectiveness of the natural
structural measures. I do not nor will I remark on these Harmonic Traitors other than to
say "Google it" but I have found that sooner or later most eventually learn the proper
way to measure the structures.
Personally, I have rededicated myself to the work to create a standardized start-
to-finish framework and provide the thorough explanation for traders to learn this
measured approach correctly. In particular, my focus with the material in this book has
been to clarify the proper expectations while explaining why harmonic patterns work.
The strategies presented throughout this material seek to foster this basic
understanding and share the insights to those situations where the patterns have
maximum significance.
Most traders learn that harmonic patterns possess the ratios that are exhibited in
nature and therefore, identify natural cyclical turning points. It is an ideal model but
quite accurate. It provides a price range with "natural limits" to assess execution
opportunities and profit objectives while reducing risk. These measurements serve as
the foundation for a potential opportunity to differentiate when price action will slightly
react from the targeted level as opposed to providing a significant reversal shortly after
completing the measured area. The key is to know what factors are critical at the
completion of distinct patterns to guide decisions and provide the proper expectations
of what will happen to optimize the opportunity.

Once You Know What to Look for...

As I have said from the very beginning - even in The Harmonic Trader back in
1998 - harmonic patterns are a starting point but an effective means to analyze price
movements that exhibit these properties. Of course, harmonic patterns are not going to
appear in every market all the time but these structures inevitability materialize time
and time again to mark important changes in the future price action. However, I must
stress that the proper measurements are required to realize such success. It seems that
other interpretations that been promoted as improvements are mere distortions from
immutable basic harmonic ratios that categorize price action as such. The key take
away from the whole pattern debate is to always apply those measures that are directly
related to the elements of harmonic opportunities. Simply stated, the harmonic
measurements serve as primary framework that cannot be skewed without distorting
results and destabilizing the essence of analyzing the markets from this perspective.
When I released the initial pattern rules in my first book, The Harmonic Trader,
the entire subject of Technical Analysis lacked respect. However, two vicious bear
markets and the advent of trading technology have changed the market's focus to chart
and quant-style computational analysis. These factors have altered "The Street's" focus
from reputation-based to more of a meritocracy where market perspectives are

Harmonic Trading Volume 3: Reaction vs. Reversal

4
assessed upon quality and not zip code of origin. I believe that the strategies have
proven themselves through challenging environments and continue to gain credibility in
the trading world. Incredibly, nearly 20 years has already passed and the once obscure
harmonic pattern discoveries are now common knowledge within the trading
community.
Most of the pattern discoveries arose from a great deal of research that identified
overwhelmingly clear technical situations that possessed defined structural signals. For
example, the importance in differentiating Bat patterns from Gartley structures was an
enormous breakthrough. However, it now seems to be a simple fact. In essence, the
pattern definitions made it easier for people to find trading opportunities once they
knew exactly what to look for. Through it all, the strategies have been tested to
provide statistically reliable expectations.
As the industry continues to migrate most of its operations online, market
participants will find themselves looking for advantages by analyzing price action and
chart history. As the community has embraced Harmonic Trading, the online discussion
and interpretations have expanded the total engagement to the point where my initial
work is now a separate entity from me. In my opinion, I encourage interpretations and
advancements that seek to improve the overall understanding of what I have put forth
over the past two decades. I can only stress that the primary pattern measurements
that are founded in the essence of what is harmonic remain as the standard for future
application. Otherwise, traders will find themselves attempting to identify random
movements as repeatable behavior that simply is not a true phenomenon.

Realistically Harmonic

Many traders often search for one tool or method that can tell them when to buy
and sell. It seems that these individuals are overwhelmed by the market in general and
are looking for a lottery ticket more than a logical approach to understanding price
action. Like anyone who has spent countless hours in front of the screen looking at
endless of charts, it becomes apparent that certain market conditions possess clearer
signals than others. I think one of the biggest misnomers of the market is that to be
successful one must understand everything that is occurring all at the same time.
Certainly, the news outlets attempt to tie all of the various market moves together to
package one big story. Real traders understand that not all markets can be traded all of
the time. In fact, successful traders are typically spending as much of their time
preparing for the trade than actual trading itself. If you're not spending as much time
preparing for trade than trading, you're probably going to make mistakes. This type of
discipline can be difficult for most as they are unable to be patient and wait for
opportunities to develop. A degree of selectivity is mandatory to focus on only those
opportunities that present overwhelming conditions for a successful trade. All of these
considerations are critical throughout the trading process and assessments must be
made to minimize risk and maximize profit. Most important, I believe that a realistic
perspective of what is possible is an essential trait to stay grounded and navigate a

Harmonic Trading Volume 3: Reaction vs. Reversal

5
professional course in your trading endeavors. In my opinion, most people who are
dedicated to measuring the market do realize that it takes more than one strategy or
simple tool to develop the skills necessary to succeed. Remarkably, there are broad
elements within the industry that still operate on this type of unrealistic hype. I do
believe that the larger public is becoming more aware of these unsavory elements,
especially as more traders are dedicated to learning the proven strategies to succeed in
the financial markets. I have spoken about this general disdain for the bad actors in
the industry in each of my books. I have been forced to address a variety of issues,
especially due to the unusual degree of disregard for fiduciary responsibility up and
down Wall Street. Ultimately, I want the work to speak for itself and always remain the
focus of what is important. Although sometimes these distractions must be dealt with,
the fiduciary responsibility that I maintain to consistently put forth the best work that I
can create is a driving principle of Harmonic Trading.

The History of Harmonic Trading

In my own life, I have experienced a variety of positive and negative

relationships that have had a profound impact on my personal trading journey as well
as my perspective of the industry that I love. I feel that I have created a special
foundation where individuals can actually learn predictive strategies that help them
understand future probable price direction. However, it is important to share the
personal journey that has shaped me to advance my work with harmonic patterns and
expand the knowledge base of Technical Analysis in general. It is an interesting story
and I believe it is an essential element to finally explain how the strategies were
developed, where I initially released my work and provide the proper citation of those
who came before me - the predecessors to what is now known as Harmonic Trading. It
is important for me personally to recognize these predecessors from the inception of my
initial discoveries to clearly delineate the Harmonic Trading advancements that have
been put forth over the past two decades.
So, let's start at the beginning. The history of Harmonic Trading has its roots in
my initial market endeavors nearly 30 years ago. It started with me at a time where I
was transitioning from primarily fundamental analysis to Technical Analysis. My
observations about financial fluctuations in fundamental values of companies led me to
focus on price action. In doing so, I was able to begin my formal study of all books
related to Technical Analysis of price action. I started with the older books from the
1930s and 1950s since I felt that these were they forefathers of modern Technical
Analysis. I also read numerous pop culture market books during this time. Probably the
most infamous of these was Peter Lynch's One up on Wall Street This was one of the
first books that clearly defined the ability to look at the market from an individual
perspective and begin to look for relationships that were outside of fundamental
numbers. Peter was always looking for that good story where he could make his "multi¬
bagger" on trades - that means making many times his money. However, his book
ignited an excitement where I started to pay close attention to what was happening in

Harmonic Trading Volume 3: Reaction vs. Reversal

6
the economy and the financial markets. I became an avid reader of any recommended
financial book. I found myself increasingly wanting to know more about the indicators
and other technical measures that were frequently discussed by traders more so than
brokers' recommendations. I always felt that the traders were more in tune with what
was happening in the markets than stockbrokers or financial advisors tied to a
recommended buy list. Regardless, I understood early on that the answers were not
going to be handed to me and there was much to consider when it came to the world
of trading.
This became ever apparent for me during a college summer internship on the
floor of the Philadelphia Stock Exchange. As a CRT operator, I was in the options pits
manually adjusting the quote prices displayed at the market maker's terminal as he
barked them out. I spent the first few weeks trying to keep up with the regular
employees whom had been there for a while. I was intrigued by the overall operation,
the excitement and the basic understanding that people were making large sums of
money working at a dynamic place of employment. For me, it was clear that those who
understood probable future price direction were able to successfully navigate the chaos
that was the trading floor of this time. Albeit a physically small exchange, the floor in
Philadelphia was as busy as any frenetic day in New York. I learned a lot during this
time and a few individuals took the time to teach me some complex option strategies
even though I barely knew what a put or a call was. It was all special and certainly
different from any other corporate environment that I had previously experienced. I
came away from that internship with a passion to further explore what this industry was
all about.
I rededicated myself to studying books on charting and Technical Analysis. The
more I investigated the measurement of the market using technical tools, the more I
realized that this was the true means to know when to buy and sell for profit. In those
early days, I was considering fundamental information but quickly into this discovery, I
also learned that most of it that attempts to describe what is unfolding in the market
actually has little value when it comes to determining price. Therefore, I finally made
the jump in the early 1990s to full Technical Analysis as my exclusive means of
determining trade opportunities in the market. Although this was the right move, there
were a few years of study required of all methodologies before I could fully grasp which
technical tools worked the best. In this research, I spent tens of thousands of dollars on
books and seminars to discover who had the real deal and who was able to clearly
define opportunities in the market.
I was fortunate to encounter a retired former floor trader as I was finishing my
college degree who mentored me on many old-school methods of Technical Analysis. I
have mentioned him before but I would like to recognize him again. Although he never
wrote a book and he was an extremely private person in nature, Bill Sourbey was my
primary mentor in Technical Analysis. He was a former floor trader in the Minneapolis
grains pit in the late 1950s. He shared many stories of the old days - and this was back
when they were still writing quote changes on a chalkboard! Regardless, he showed
me unique charting methods. And, he would create by elaborate charts by hand. He

Harmonic Trading Volume 3: Reaction vs. Reversal

7
stressed the importance of trendlines, channels and various price action phenomenon
that he painstakingly measured. His discipline and focus on measuring every data point
of individual price action showed me that charts were merely a collection of information
that told a story. He believed that specific points and price levels served as critical to
finding limits of possibility. These all helped to shape my predictive abilities and
understand that price action moves within definable constraints that can be measured
must be measured! In fact, I did not truly understand the nature of what he taught me
until I had a few years of experience studying his charts.
I met him at the University of Arizona where he was a volunteer. Bill and I
formed a friendship and we shared an interest of Technical Analysis. Bill was an old-
school market guy he kept meticulous notes, developed his own indicators and was able
to predict market moves with phenomenal accuracy. His methods were quite simple -
trendlines, price action analysis and clear break out and breakdown triggers. The other
side of Bill was that he developed indicators such as Viscosity. This is a very interesting
concept that tries to measure the thickness or thinness of support or resistance within
the market. Bill has since passed in my life and he never imparted to me the entire
formula of how to determine this. I do have numerous charts and I have been
analyzing for years trying to figure out exactly what he was talking about. He was
somewhat vague in his descriptions of his analysis but he was an influencing factor and
encouraged me to continue my technical studies which I did in earnest.
My first introduction to various pattern formations was simple wedge and triangle
formulations that denoted breakouts or breakdowns in trends. Trend analysis proved
quite accurate and quite effective as a starting point for my studies, as well. The simple
fact that I could analyze a price action by drawing a basic trendline along the general
direction was a breakthrough unto itself for me as simple as it may seem. It opened up
the perspective that actually monitoring price action is the most effective means of
gauging what potentially could occur. From this, I then began to focus on the
phenomenon that markets frequently trade within ranges and cycles. In my discussions
with my friend Bill Sourbey, he constantly reminded me of the importance of certain
trendline violations as important structural signals. In fact, he frequently cited Richard
Wyckoffs books from the early 1900s and another author named Ted Warren's
relatively unknown book How to Make Money in the Stock Market, which provided in-
depth resources that explain why the market is always in a process of moving through
stages. Armed with all of this information, I began to really focus in on the things that I
knew were consistently yielding the proper information and correct predictive value for
my trades. I made a lot of mistakes in those early years and lost quite a bit of money -
probably more money than I even had to lose but I knew that this was all in the
endeavor to eventually make breakthroughs to become a consistently profitable trader.
To do so, I needed a framework of strategies so I could understand market action in
any environment on any timeframe.

Harmonic Trading Volume 3: Reaction vs. Reversal

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 During this time, I started to encounter other traders in my area, especially as
the internet provided a direct means of reaching other traders unlike ever before. In
1995, I was living in Tucson, Arizona and I encountered a group of traders that met
once a month. Although initially intended as a local group support group for
Tradestation users, the discussion soon focused mostly on trading strategies relevant to
the unfolding bull market mania of this era. Founded by Alan Kuenhold who was a
broker with UBS Advisors, the initial group of 10-15 people met at the Williams Center
regularly to talk about the markets. It was a great discussion group and it is also the
first place where I publicly began to divulge many of the strategies that became
Harmonic Trading. After a few months, we officially named ourselves The Gartley
Group.
The pattern alignments, the trade management strategies such as the 38.2%
trailer, the discoveries with Relative Strength and general price action analysis were all
new ideas that eventually became the foundation of Harmonic Trading. I am grateful to
Alan and that group for giving me the format to present these ideas. Now, I must admit
this was during a time where the market was moving straight up so anything that you
bought had a good chance of actually working out. Almost every significant retracement
pattern led to a significant reversal. This made harmonic patterns look great. And, when
I was able to differentiate which patterns were the most significant and where to
execute the trades, the level of precision increased as did the number of people
attending the Gartley group. After about two years, the Gartley Group tripled in size as
we started meeting nearly every week. On average, we would see nearly 30 or 40
people show up. It was kind of funny because I would walk in there, they would hand
me the laser pointer and then I would go through any charts that people wanted to
look at based on the way that I was differentiating patterns. The whole experience
became extremely emotional as other individuals in the group began to talk about
certain penny stocks and talk about the future of technology. The NASDAQ Composite I
had increased 300% in a few years and was quickly on its way to the initial test at
5000. However, the mania had gripped the masses in soon several people in the group
were investing in speculative penny Tech stocks.

E-Digital (EDIG): The Epitome of Dotcom Mania

Well, there was one stock that actually worked. It was called eDigital - the
symbol was EDIG. There was one guy in the group who said that this was going to be
the next Microsoft and had recommended for everyone to buy the stock at about $.50.
Shying away from such penny Tech stocks, I was more accustomed to following the
leaders of the market and the more heavily traded issues. For me, I felt that this mania
was problematic and the fact that the group went from a constructive discussion of
technical methods to focusing on penny Tech stocks.

Harmonic Trading Volume 3: Reaction vs. Reversal

9
E-Digital (EDIG): Jumping the Shark

It was where the group "Jumped the Shark" and I knew the end was near.
Incredibly, it all culminated over the course of six weeks where this penny stock started
to move from $.50 to a $1 to $3 to $7 to $11 and higher. Soon, the stock was going
parabolic and the person who had initially recommended it said that he had put his
whole life savings into it because he predicted that this stock would go to $200. So,
according to him even though the stock was up 1000% in a short period of time, he
assumed it would continue. Well, nothing goes straight up! Wrecking day was near
and I stayed clear. Despite the post-crash squabbles, the entire experience was the
perfect case study in Dot Com mania!

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After some time, it was still recommended as a buy. And people bought!
Eventually, the stock went to $21 a share. I remember the exact meeting on the day it
hit the $21 mark. There were approximately 50 people there that night. I was late
arriving and there were so many that I couldn't even get into the room. I watched

Harmonic Trading Volume 3: Reaction vs. Reversal

10
from outside the door. At that point, I knew that the Gartley Group was over. I also
knew that this eDigital stock would not end well. People were asking me if I had
bought the stock and I said that I didn't touch those types of positions.

E-Digital (EDIG): The Meltdown

Despite my concerns, many people continued to buy. The stock peaked out at
the $21 level and then quickly lost half its value back to $10 a share. It was only a
matter of time before the whole stock would collapse and that's exactly what happened.
I won't even go into the other details of the post-crash arguments and squabbles that
ensued, including potential legal action from one person to the next but the clear lesson
to be learned from a mania like that taught me how to read the public and understand
when certain market periods are exhausted.

Weekly   EMA131.30 EMA201.36 B EMA501.93 SMA501.69 1: SMA200 2.53 Volatility Bands(20,2.0)

O- [jzz0.0010 O- zz0.01 ilh zz0.1 O- zz 1.0 in 10.0

22.50

20.00

17.50

12.50

10.00

EDIG28-OCT-16 Hamo idc Analyzer (TM)rti.()j Copyright® 2001-2008 HamoiucTraJer.com, LLC. All Rights Reserved

Harmonic Trading Volume 3: Reaction vs. Reversal

11
EDIG @ 3.14 Bearish Extension
Being known as the harmonic guy in the group, the only analysis that I could
provide was a simple 3.14 extension that projected immediate resistance at the $10
level. After the stock rallied vigorously through this price, I distinctly remember hearing
comments such as the fact that harmonic measurements don't work in situations like
this. Nothing have could have been further from the truth because the 3.14 extension
typically signals a parabolic state of price behavior. Even in the early days, I understood
that an extreme ratio measurement in a stock such as this would result in only one
conclusion. The stock peaked above $22 a share only to immediately lose half its value
within a few weeks. By the end of the year, the entire bull-run was over, as the stock
was back at the $1 level.

Weekly   0OW31?5 [] EMA201.48 I   E6BS0 8.76 H SM50 0.48 I SMA200 0.65 Volatility Bands(20,2.0)

EDIG 28-OCT-16 Haimoni£.4iudyier(TM)v6.05 Copj-iight © 2001-2008 HarmonicTrader.com, LLC. Ail Eight* Re.eived

Many of these people lost a ton of money. I felt bad. But, I had nothing to do
with it and I knew that things had to change. So, the remaining core Gartley Group
actually decided to disband and begin to meet "secretly." It was during this time that I
started to create the differentiations of all of the retracement and extension patterns. I
was even working on new harmonic structures such as the 5-0 pattern and the Shark

Harmonic Trading Volume 3: Reaction vs. Reversal

12
pattern. I also was beginning to investigate which indicators served as the greatest
confirmation techniques for the patterns.
I go out of my way to cite those real technical forefathers who have laid the
foundation for what modern Technical Analysis is today. Most of my inspiration for
these ideas has been derived from the "old-school" books. Based from this technical
foundation, I have created the system of trade identification execution and
management strategies that effectively defines the Harmonic Trading process. These
strategies create a framework so that traders understand what to do in every instance
of every trade. From this perspective, an entire skill set has been established based on
harmonic measures. Although these are some of the most accurate means of
measuring, the business of trading is not easy. If you do the work and you want to
understand which strategies are vital, a professional skill set that identifies harmonic
opportunities facilitates the ability to execute with an optimal efficiency. This
comprehension takes time. Furthermore, I urge everyone to do their own research, look
at the materials and assess what I have done as a unique system in way to look at the
market, especially now that it is now widely embraced.
After I released The Harmonic Trader people began to take notice. I was having
great success, and I was sharing my information and charts with many people freely.
Maybe this was a naive step of mine, but I believed in sharing the information with
people that I knew and others whom requested it. I felt that we were on the same
boat as traders trying to succeed in a challenging market environment. Everyone was
trying to figure out how to trade the market, especially during a time where the
Internet stocks were going through a historic bull market. Against the backdrop of a
frenzied market environment, my goal was to share the information and make it
available so that people could understand the power of harmonic patterns and realize
the importance of being as precise as possible. From this, I was motivated to explore
the subject, refine the strategies and develop the most accurate tools available. I was
confident from the start I was using the right measures to analyze price action.
Although it is easy to get caught up in the mystique, I was more focused on
relating the theory of these natural cycles with harmonic ratio proportions to define
turning points in the financial markets. It was my goal to take that knowledge to new
areas of experimentation and capitalize on the natural advantages of harmonic
measures. I wanted to refine it as far as I could to differentiate patterns structures,
interpret price action at those completion points and make larger assessments of the
trend. From this, Harmonic Trading thrived and led me to produce two more books
Harmonic Trading Volume 1 and Volume 2. In 2010, I received an offer from Financial
Times Press who was able to promote the material globally. Furthermore, the validity of
this strategy was reinforced as more traders became aware of harmonic patterns, their
popularity has grown.
On a final note, I want to stress that for me it is always about the work. I always
felt that if the work was excellent people would respond people. Traders have
responded! For that Harmonic Traders, I thank you. This is become something far
greater than I could ever imagine. I feel that with the limited time that I have left on

Harmonic Trading Volume 3: Reaction vs. Reversal

13
this planet that I want to share this knowledge. I want to leave behind a legacy where
people can not only trade the markets effectively but actually realize the amazing
natural wonders and natural cycles that are occurring in the universe and in the world,
every day.
For me, integrity and character is everything. My goal in this material is to
preserve the value of the Harmonic Trading approach to show people the correct way
to measure the markets not just the well-chosen examples. This has been something
that I have seen quite a bit in recent years. People are teaching harmonic patterns
based straight out of my book but they're doing it incorrectly and in most cases, are
unable to do it in real time. My goal is to bridge this faulty promotion and clarify the
ambiguity in the execution and trade management process that optimize trading
decisions.
By now, most people know the definitions of the ratio alignments in the patterns.
But as I've always said, the harmonic patterns are a starting point. They require a
precision and a dedication above and beyond what most offer. Yes, I have products to
sell. I have a software program, webinars, etc. But, I have made it my fundamental
goal to provide the bulk of this information that presents the foundation of Harmonic
Trading approach for free. Why would I do this? I have met so many people from
around the world who want to learn about the markets but they don't even have the
money to be able to buy my book. This is disheartening. I am not going to sit by and
dismiss these people because they can't afford to buy a $50 book. So, I offer numerous
resources online for free. Having lived abroad for a few years, I understand the
struggle that most people face when they must live on a limited amount of money.
However, with the advent of the Internet Age, we have an opportunity to reach people
in a way like we've never done before.
I believe this is the true accomplishment of Harmonic Trading - an open
dissemination of the information to educate people about the market to empower
individuals whom are willing to do the work, and ultimately improve their lives. I have
talked to people from Africa, Iran, China, Saudi Arabia and many other countries that
otherwise might have been previously out of reach. These interactions have been
inspiring to say the least. In fact, many of these people volunteered to translate my first
book The Harmonic Trader into their native language. Without this type of response, I
would never be able to have the first book translated into five languages. I am grateful
for these experiences and I feel confident that the work is reaching traders in a positive
manner. Most have related to me that they are able to avoid the pitfalls of the learning
curve that can often be quite expensive, as well as the confidence a defined
measurement framework instills. There is a profound comprehension in the
understanding of the phenomenon of these natural laws and the associated ratios to
define clear structural relationships.

Harmonic Trading Volume 3: Reaction vs. Reversal

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 Introduction

A Reintroduction to Harmonic Trading

My main goal in this book is to set the whole record straight to reinforce the
established structural measures while emphasizing the need to precisely confirm
harmonic pattern opportunities with "environmental technical indicators" that optimize
all situations. I have been reluctant to write another book, as I knew that it would take
quite a bit of time to put together a comprehensive advancement of the existing
material. Although I have been aware of many of these techniques for years, I have not
shared these with too many people. Initially, I needed a great deal of time to test each
strategy and completely refine the rules to effectively complement the basic Harmonic
Trading approach. This book is comprised of nearly 80% new material that builds upon
the existing strategies and optimizes specific pattern situations to improve overall
results. The advancements presented in this material represent a new stage in the
evolution of the Harmonic Trading methodology. The material in this book picks up right
where Harmonic Trading Volume 2 left off, and defines unprecedented situations that
are as distinct as harmonic patterns themselves to improve the effectiveness of the
entire approach. Although many of these strategies can be learned as individual
concepts, I reference much of the material from Volume 1 and Volume 2. Simple
pattern rules, trade execution strategies and other guidelines serve as the essential
model for the trading process. This book represents an advancement of that process,
especially in the area of trade execution and trade management. Although the first few
books detailed effective strategies to comprise the identification aspect of the Harmonic
Trading approach, this material coalesces a variety of individual techniques to assess a
more comprehensive perspective of critical measures.
My evolution of measuring the market has led me to realize that my primary
source of material information for trading decisions must be derived from the price
movements themselves rather than any outside influences. Although most traders will
consider a variety of sources of information to formulate a strategic approach to define
opportunities, ultimately every participant is trying to profit from price movements.
Therefore, the business of trading is inherently a game of skill and strategy that must
predict future price direction and profit from the buying and selling of these defined
opportunities. Thus, financial reports and news stories become less relevant over time

Harmonic Trading Volume 3: Reaction vs. Reversal

15
as signals for trading opportunities. After reaching this point, traders begin to base
decisions upon the readings of the market.
Harmonic patterns provide a strategic approach to measure these opportunities
and they can define those exact price levels where to pinpoint the parameters of the
trade. Other technical measures can help us monitor secondary readings, where the
total market bias is reflected in something other than price. All of these techniques are
designed to gauge some sense of order within the chaos and randomness of price
movements. I believe patterns provide that order, especially since all parameters are
defined in advance and measured based upon the market's historic price action. In
addition, analysis of Relative Strength readings is one example that helps to monitor the
environment in which patterns complete. We will look at this integration in detail later
in this material. We will examine price behavior with measured technical environments
and show those conditions that possess the optimal characteristics for positive
confirmation.

The Harmonic Learning Curve

Personally, I still feel there is room to improve optimization but this actually
made one of the easier tasks within our process once the coordination of variables has
been established. Despite my attempts to simplify all of this, I know that I am
overloading everyone with a great deal of information. Please take your time to review
my notes and look at the resources provided for a greater understanding. For anyone
that is new to this perspective, I like to use the phrase "live with it for a little while"
where you walk through the analytical steps to create a greater awareness of these
relationships. The common experience for most is a "light bulb" that goes on and the
relationships become almost obvious. Therefore, I recommend a full comprehension-n
of identification strategies first to reach a level of basic awareness that is required to
integrate more complex measures. I will thoroughly explain details and finer
relationships that will answer most questions that typically arise in the discovery phase
of these strategies. The common experience for most Harmonic Traders is a clearer
comprehension of all relationships after mastering the identification of exact scenarios.

Consistency in the Application of Identification

One of the important broader principles always to be mindful of is the fact that
Harmonic Trading is a defined and quantifiable technical model to define opportunities
in the financial markets. This means that the prescribed measurements merely serve as
a minimum framework upon which the actual expression of real trading must be
compared. I emphasize this point in an attempt to reduce unrealistic expectations of
patterns as signals on their own and implore traders to intelligently assess other market
conditions that clearly contribute to the overall understanding of the harmonic
opportunity. Furthermore, the true advantage of these identification strategies is
founded upon the consistency in the definition of what is a potential opportunity.

Harmonic Trading Volume 3: Reaction vs. Reversal

16
Specifically, each pattern has its own set ratios. Regardless of the timeframe or the
price of the structure, each situation is defined by the relative harmonic measurements
that validate random price movements as specific opportunities.
It is important to note that these ratio alignments identify opportunities
differently than other structural approaches to the market such as Elliott Wave, which is
continually counting three and five segmented price structures. Unfortunately,
practitioners seem to be reworking wave counts all the time. This is a profound
difference than the identification of harmonic patterns. Valid harmonic opportunities
must possess the prescribed structure and ratio alignments to validate structure.
Regardless of size or price range, the proportional aspects of the structures are
uniformly measured and analyzed. In doing so, we can assess multitude of markets
that possess such ratio proportions and compare them uniformly across all time periods.
Furthermore, these rules create distinct classifications that are precisely quantified.
Harmonic Trading strategies can be applied to all markets on any timeframe
uniformly. That is, all techniques possess the same interpretive qualities and must be
applied in the same manner in every market and on every timeframe. From stocks to
futures to currencies, Harmonic Trading principles possess the same implications in all
markets. Although some argue that certain markets may behave differently than others,
our primary concern with analyzing price action is to discover consistent relationships
that can be derived without differentiation. This is critical because the strategies are
hence standardized, and define market opportunities in the same manner. Furthermore,
the same relationships that occur on a daily or weekly chart can be found on intraday or
even tick price movements.
Some structural market approaches have a tendency to adjust their analysis and
fit derived results to conform to the overall picture. This type of interpretive analytical
approach is dangerous when it comes to assessing price action because such variation
of measurements leads to inconsistent results. Harmonic Trading employs proportional
measurements that can be deciphered regardless of the price range. This is one of the
true advantages that separates Harmonic Trading from all other methodologies. Finally,
such universal application possesses enormous strengths in deciphering market
movements that can frequently diverge from the norm. When this happens, traders
tend to adjust their analytical findings and begin to create a biased assessment of what
is happening. Essentially, when a trader is confused they start guessing and nothing is
more expensive than trying to guess which way the market will go. Nine times out of
ten that guess will be wrong. Therefore, any market approach must have the ability to
be uniformly applied and assess price action from an unwavering basis. There should
never be any divergence or adjustment for the abnormal case, as these conclusions are
flawed and often wrong.
This has been one of the guiding principles throughout my research. I am always
looking for the market relationships that consistently and clearly present readings that
can reliably defined probable future price action. Many of the market methodologies
that I have studied make room for slight variation of the application of their principles.
However, I found that these circumstances led to incorrect assumptions and created

Harmonic Trading Volume 3: Reaction vs. Reversal

17
more confusion within the trading process. As I mentioned previously, Elliott Wave is a
prime example where traders will conform their structural counts to best fit the current
market environment. In fact, the "Elliott recount" that readjusts structural calculations
in the event that the market does not adhere to the ideal situation creates inherently
flawed structural signals.

Founders of M and W Structural Analysis

There are many people whom have discussed price patterns in the market.
However, few assigned ratios to the structures. Robert Prechter and A.J. Frost
advanced wave analysis and were among the first to discuss 61.8% and 1.618% ratios
with price structures. But, as most people know, Elliott wave counts are quite
subjective. For me, I never understood Elliott Wave sufficiently to use it as an accurate
and consistent predictive system to trade the markets. Yes, it's a great structural model
but it is very difficult to predict accurate waves and trade off that information.
Regardless, the real focus of the history of Harmonic Trading must credit those
predecessors that laid the foundation for simple structural analysis.
It is incredible to think that 100 years ago people first started writing about the
stock market and various strategies to profit from market movements. These were
more anecdotal stories but many of the basic technical methods such as Dow Theory
were the first to describe market movements and ratio measures. Later technicians
focused more on simple percentage moves and also try to identify simple trendline
formations.
It is important to understand that Technical Analysis has not evolved too far
from the simple trendline/channel analysis established over 100 years ago. Some of the
more prominent methods such as Relative Strength, Stochastics, harmonic patterns,
Elliott Wave, ratio analysis and other measured techniques have advanced strategies
that quantify market movements. Despite this history, I feel there is plenty of room for
advancement and for an evolution of Technical Analysis to focus on the realization that
market movements possess all of the answers traders need to facilitate trading
decisions. It is within this principle that I believe Harmonic Trading derives its greatest
strength.

XABCD->Harmonic Patterns
There are a number of technicians over the past century whom have presented
individual concepts that have inspired Harmonic Trading discoveries and provided the
primary foundation of market research to advance harmonic concepts. Harmonic
Trading encompasses parts of many theories and expands upon a variety of basic
technical measurement strategies. I have studied most of the prominent technicians of
the past hundred years and I have learned a great deal from their initial insights. I
believe that it is imperative to recognize these individuals for their contribution. They

Harmonic Trading Volume 3: Reaction vs. Reversal

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have created a basic science around the recognition of market movements, and these
works have created the body of knowledge that is Technical Analysis today.
Harmonic patterns are an advancement of a vague identification strategy that
labeled structures as five-point XABCD formations. Although the initial tenets of five-
wave price structures was first prescribed by R.N. Elliott, the notion that a complex
price formation contains relevant predictive value of future price action has been
refined by many other technicians since then. Furthermore, the application of ratio
measurements has evolved ever since Charles Dow first introduced his rules for Dow
Theory that analyzed the market in relation to 1/3, 2/3. Other practitioners of
Technical Analysis have added to this foundation and expanded the envelope of
understanding over the past hundred years.

Historic Technicians (1890-1970s)

Once I was committed to the study of Technical Analysis, I researched the oldest
materials I could find. Historic market insights that were presented decades ago have
relevance to modern-day markets. In fact, many of the forefathers of Technical Analysis
were keen to emphasize the importance of price analysis over advisor opinion. Illegal
speculation and manipulation were rampant 100 years ago and a motivating factor for
these pioneers to uncover the truth from price analysis.
The following technicians must be sought out and researched. Most are known for a
seminal book or method that distinguished their work from many others. In fact, most
people do not know that there are dozens of technical pioneers whom have presented
amazing work but they never realized much recognition. I mention a few of these
individuals throughout this material and recommend them as well.

• Charles Dow & Dow Theory

• R.N. Elliott
• Elliott Wave Principle (Prechter and Frost)
• W.D. Gann
• Richard Wyckoff
• H.M. Gart ley "Profits in the Stock Market"
• Arthur Merrill (& Edward Levy) = Merrill Waves
• Welles Wilder

Modern Day Technicians (1980-Present)

• Robert Miner "Dynamic Trading"

• Bryce Gilmore ”Geometry of Markets"

Harmonic Trading Volume 3: Reaction vs. Reversal

19
 There are numerous individuals whom have put forth a dearth of resources but
most have simply regurgitated the works of the past masters. It is important though
that I recognized two individuals whom have immensely inspired my work with
Harmonic Trading. Robert Miner's Dynamic Trading (1997) is an Elliott Wave
masterpiece that introduces new applications of the standard rules, including unique
time and price projections. I have had the pleasure of meeting Mr. Miner one time at a
presentation he generously gave to the Gartley Group. Bryce Gilmore's Geometry of
Markets (1989) is another must-have technical book that correlated ratios with wave
analysis in an unprecedented manner. Mr. Gilmore's application of Gann-style ratios and
trendlines were applied to his thorough explanation of the XABCD framework. In fact,
he presented some interesting combinations of the structures but did so to identify
multiple types of complex five-wave Zig-Zag formations. Additionally, his Wave Trader
was the first program to scan for M & W-type formations. Bryce Gilmore deserves the
primary credit for establishing the general measurement principles for XABCD
structures. I am immensely grateful for his contributions and I recognize his work as a
direct forerunner to Harmonic Trading.

HT Combines Two Schools of Technical Thought

It is important to outline the basis of measurement for harmonic structures. The

strategies borrow from two general categories of technical analysis. Harmonic Trading
employs ratios with structural analysis in a unique manner but resembles many of the
primary strategies from the past masters.

1. Wave Theory-Market Structure

(R.N. Elliott/Charles Dow+Others)

Charles Dow was among the earliest of technicians who categorized market
movements and proposed general percentage retracements (1/3, 1/2, 2/3, etc.) in his
articles for The Wall Street Journal. A few decades later, the writings of R.N. Elliott
were some of the most comprehensive structural analysis ever presented of his time.
His classifications of three and five wave price phenomena were the first prescribed
structural analysis that identified the importance of multiple segments. Although the
initial work with these structures lacked precise ratio measures, the general wave
count rules provided an effective framework to assess the state of the larger trend.
In the same manner, Harmonic Trading distinguishes structural opportunities in
the markets. The refinement of M&W-type patterns was a significant step forward in
the structural analysis of five-wave price formations. The proprietary concepts of
harmonic patterns advanced the primary body of knowledge as it relates to structural
analysis of price segments in the same simple differentiation principle as the following:

Harmonic Trading Volume 3: Reaction vs. Reversal

20
 Does this look like this

Does this look like this

I have outlined this concept in prior books but this key recognition of structural
differences is the essence of harmonic pattern analysis. When validated by specific
ratio alignments, these structures quantify all relevant parameters in the determination
of the trade.

2. "Sacred Geometry" Ratios (W.D. Gann)

William Delbert (W.D.) Gann presented numerous measures that have become a
primary foundation within Technical Analysis. Tools such as Gann angles, Square of 9,
Hexagon, and Circle of 360 became his primary market forecasting methods. Although I
agree with many of his Geometric principles, Harmonic Trading has nothing to do with
his other areas of study, most notably Astrology.
Although cyclical in nature, Astrology has little relevance to exact prices
structures, regardless of what its proponents might argue! In my opinion, the Gann
mystique is overblown while I feel his basic technical measures do not receive the credit
due. W.D. Gann can be considered as the forefather of ratio differentiation, as he
effectively refined concepts from Ancient Mathematics into trend analysis. In this
regard, harmonic patterns and their measurements respect the natural phenomenon of
cyclical movements of growth and decline in the same manner as Gann's principles.
When related to the market, Harmonic Trading also considers trendline analysis
similarly, as well. Therefore, immense respect is due to Mr. Gann.

H.M. Gartley

Most popular of all harmonic patterns, the origins of the Gartley have been mired
in a haze of misinformation and misrepresentation. I have discussed this previously in a
variety of materials, including an article entitled "The Great Gartley Controversy."
(Google it) First let me say, I have the utmost respect for his book, Profits in the Stock
Market {1935). This masterpiece was ahead of its time and it is one of the most
detailed technical resources I've ever read. The problem that I had with the initial
interpretations of the Gartley pattern was the lack of precision to define exactly what

Harmonic Trading Volume 3: Reaction vs. Reversal

21
constitutes valid trading opportunity. This was not Mr. Gartley's fault, especially since
he mentioned little in regards to patterns and did not integrate ratios with their
measurements, despite contrary opinion. The Gartley pattern that many improperly
attribute to his book does not resemble anything to what the industry standard is today.
Since I have been unable to obtain permission to feature a copy of the entire page from
his material, I have presented the following illustration that resembles his initial
structural presentation from his book, Profits in the Stock Market (1935). I encourage
all serious students of the market to invest the money and buy this rather expensive
resource. The painstaking detail and explanation provide accurate technical insights
that are still relevant to this day.

Place Stops

Profits in the Stock Market (1935) Gartley, H.M. Lambert-Gann Publishing, p.222.

This illustration represents what he presented in his book. No harmonic ratios.

No AB=CD. This was the extent of his identification of patterns structures. I have
studied this book intensely and learned much from his work. However, the core focus of
his material has been more on cycles and general wave structures. This is immensely
important as a clarification of the source of harmonic patterns. Although others have
presented various interpretations, the personal breakthrough in my first book, The

Harmonic Trading Volume 3: Reaction vs. Reversal

22
Harmonic Trader integrated the M and W-type structures on an unprecedented level.
Whether I fully understood the uniqueness of this integration or not, the complex rules
that defined harmonic opportunities advanced the general XABCD knowledge to convert
this structural analysis into predictive trading capabilities.

Arthur Merrill & Merrill Waves

Arthur Merrill in his book, Filtered Waves; Basic Theory: A Tool for Stock Market
Analysis (Analysis Press, 1977) presented illustrations of a few dozen different M&W-
type structures these were more Zig-Zag formations and lacked any ratio
measurements. The number of classifications that Mr. Merrill presented seems to have
the intention of structural differentiation. It seemed to me he was trying to identify
those wedge and consolidation formations that resemble the rules of Elliott Wave. In
fact, on page 11 of the book, Mr. Merrill outlined one of the earliest definitions of an
ABCD Filtered Wave. Although others have presented this illustration around the same
time, I have yet to find a more precise presentation that preceded this work.
Regardless, his work has been an important bridge between the writings of R.N. Elliott
and the modern-day advancements of the XABCD structure.

"Filtered Waves, Basic Theory: A Tool for Stock Market Analysis"

pg. 46 Analysis Press, 1977

Harmonic Trading Volume 3: Reaction vs. Reversal

23
Welles Wilder

I believe it is important to clarify the focus of the meaning of "technical

environmental measures" as more than just indicator analysis. I have long cited Welles
Wilder for his ground breaking work with the Relative Strength formula. He presented
the indicator in his book New Concepts in Technical Trading Systems (1978). He is a
pioneer in the field of indicators and developed some of the most popular tools used
today. In that one book, he presented Average True Range, the Relative Strength
Index, Directional Movement, Parabolic Stop & Reverse, Pivot Points, and
Volatility among others measures that are available on every major software platform,
including my own. His work has been an immense inspiration to me and it was a
driving force behind the creation of the Harmonic Strength Index.
The Relative Strength concepts were revolutionary when he released it nearly 50
years ago. He is to always be lauded for these remarkable contributions. Although it
may have been difficult to foresee the magnitude back at this time, he did freely share
a wealth of knowledge that has been a game changing perspective on the markets. You
could call him a disruptor long before disrupters existed. Furthermore, I personally
learned from his work that an integrative perspective will always find new relationships
and clarify analysis moving forward. It is essential to learn upon mistakes and
proactively optimize these measures, especially with the technology capable today.

Harmonic Patterns > Harmonics

The evolution of my research led me to realize that a more precise classification

of market movements was required to further my understanding and improve
consistency of my analysis. From a technical side - that is, the pure analysis of price
action - I was disappointed in the vagueness of many well-popularized methods of the
day. Over the past 30 years as a student of the market, I adapted concepts and
combined new ideas to create a greater standardization of price structure. As they say,
"Necessity is the mother of invention." For me, I realized that price action history could
be measured and categorized. Initially, the categorization of price structures as
harmonic patterns created specific guidelines for the identification of a trade
opportunity. Beyond this, my analysis evolved as I was able to further define unique
states of price action, especially relative to measured price environments. This has
defined a larger analytical science of structural wave behavior of price action in the
financial markets that possesses unique technical conditions as measured by harmonic
ratio formulae. These pattern rules and larger technical measures have become
collectively known as the study of Harmonics in the financial markets.

Harmonic Trading Volume 3: Reaction vs. Reversal

24
Theory of Market Mechanisms

My journey into Technical Analysis was the result of following daily stock prices.
This was long before the internet and for most beginners if you wanted to create chart
analysis you had to track the prices by hand and plot the results manually. As charting
technology was introduced in the late 80s and early 90s, the ability to quantify market
movements expanded rapidly. Well-known concepts such as Elliott Wave, wedge
patterns and standard indicators could finally be automated. I know that sounds like
talking about ancient history but in relation to what is happening today, yes those were
antiquated markets. Now, the awareness has shifted. Traders are more statistically
driven to look at those strategies that can be mathematically proven. Anything that can
have a definable edge is of value. Gone are the days of gossiping stock tips. Technology
has removed many blatant inefficiencies and the next generation of online trading will
eventually replace the need for a physical exchange. Maybe someday the New York
Stock Exchange will be a museum? The pace of technology is helping to facilitate this
revolution and the focus of market analysis has shifted to unlock those characteristics
that define consistent situations that have predictive value.
There is some standardization required in markets analyzed - mostly is important to
stick with the markets with the highest liquidity. However, the price action in most
major markets expresses unique technical conditions that define predictive
opportunities. Market mechanisms such as pattern structures, RSI BAMM combinations
and other distinct confirmation strategies provide the analytical tools to interpret price
history for an accurate assessment of future prices.
Harmonic patterns are one example of a multi-segmented structure that possesses
unique expectations unto the pattern. Other singular measurements provide technical
insights especially when combined with distinct indicator strategies. All of these
definable phenomena are micro price action mechanisms that facilitate the functional
buying and selling that makes the market go. The collection of various technical events
manifested by the population of price data provides the relevant signals to define the
possibilities of future trend direction. Remember, it is not essential to have every
possible harmonic phenomenon to validate an opportunity but the recognition of the
primary elements regardless of type will always confirm a trade opportunity.

The Natural Harmonic Reaction Principle

The Natural Harmonic Reaction is the mechanical response of trading behavior at

prescribed measurements of ratios that are related to the Fibonacci sequence, and the
structural assessments that possess basic wave properties in the same manner as
manifested throughout nature. I believe this to be the common characteristic all
Harmonic Traders initially realize but it is a concept that needed to be labeled to better
understand this phenomenon. Simply stated, correctly measured harmonic patterns
provide important inflection points - whether temporary or permanent in their strength

Harmonic Trading Volume 3: Reaction vs. Reversal

25
- defining material cyclical points that affect natural growth processes and trend
changes in the market. Depending upon the structures themselves, the simple
phenomenon of the Natural Harmonic Reaction exhibits a pausing behavior at the
completion of patterns that can be quantified to determine its potential in advance.
That is, there are important structural areas that measure the extent of how far any
market can go in one direction without some type of countertrend. This is simplifying
the theory. However, this is the basic structural harmonic measurement technique to
provide a uniform means of quantifying random price structures. The key to
determining patterns with the greatest potential begins with the understanding that all
price moves can be categorized to technical classifications. A potential opportunity as
defined by harmonic patterns will always provide either an early signal of impending
failure or demonstrative confirmation in most harmonic states of price action.

The Reaction Mechanism

In the financial markets, this harmonic reaction is the natural mechanism of

buying and selling that makes it possible for the entire system to exist. This natural
mechanism that makes the financial markets go is the exact process that creates
opportunity. A market can only move so far in one direction within a certain period of
time. Price action must go up to go down and vice versa. Price action must fluctuate to
create opportunities for participants to buy and sell. This behavior is cyclical and finite.
This price action exhibits a frequency over time that can be charted, analyzed and
categorized to define opportunities that possess our probability reactive properties.
What does that mean? Essentially, it is possible to look at a market's trading history,
analyze critical turning points that have previously dictated predominant trends and
seek to capitalize on this repetitive nature.
Within the framework of harmonic patterns, these ratio measurements effectively
quantify the finite nature of price action. It is possible to measure the market within
such a model and optimize those situations that possess the ideal technical elements to
define those price levels that precede significant profitable moves. The patterns present
"signposts of future price action" that provide a framework to separate the noise from
the meaningful signals in the market. In fact, most price action is merely a reaction
within the larger reversal or continuation of a predominant trend. The reaction of price
movements can be affected by a number of technical levels that define mini-cycles that
play "Tug-of-War" between buyers and sellers as the market attempts to discover
equilibrium. The culmination of all my years of work has led me to realize the market
provides measurable natural reaction opportunities, where the market can move only so
far within a certain period of time. These patterns and larger measurements encompass
that limitation and exploit the "finiteness" of any market situation within a certain
period of time.

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Reactive Rates

This has led to the ability of programmers and researchers to quantify

statistically what we can expect from each pattern. This has been a goal of mine for a
long time. The technology has progressed to the point where we have the functionality
and access to data that makes it easy to crunch these numbers. I spent a great deal of
time analyzing and specifying situations that provide proof that certain conditions are
more favorable than others. There are many combinations of technical factors that can
be considered in an attempt to find the best situations. This too has been apparent
process. Nothing is absolute and the understanding of statistics like these must be
mindful of the importance in considering any real-life event. That is, anything can
happen at any time during the trading process. Therefore, if an aberrational event
occurs affects you positively or negatively, it is essential not to lose sight of the fact
that nothing is 100% guaranteed. With that in mind, the research that I sought out was
geared with the notion that it is important to provide some type of reliable baseline of
EXPECTATION regarding the rate of success for each pattern. In addition, other
complex conditions do offer higher degrees of accuracy but require patience since these
situations take time to develop.
The major breakthrough that Harmonic Trading presented was the notion that
the market can be structurally measured to a more complex degree. The differentiation
of price formations that appear similar but possess different ratios resulted in a
specialization that identified pattern-specific strategies. In essence, the refined
structures needed to be treated differently. Once categorized, it was important to
discover exactly which measurements were most important for each pattern. The
classification of harmonic patterns provided this. After many structures were
distinguished, other complementary measures were discovered and optimized to
improve the accuracy of the patterns. Throughout all of the refinements of this
methodology, the ability to decipher information more effectively has been the primary
goal.
Historically, market opportunities were defined by two basic types - fundamental
and technical. When we examine all of the news disseminated about the markets
including analysts' reports, media commentators and company announcements, there is
no clear-cut analysis of these information sources. They can be interpreted and twisted
to fit whatever analysis is desired. In particular, fundamental information such as
earnings and business forecasts may possess the same progress report but their
meaning depends upon the market environment. The markets are easily influenced by
news headlines and media coverage. Regardless of the exact trading history, one
consistent conclusion of such commentary seems to always point to the next potential
problem - whether real or imaginary - that could tank the market's current progress.
These varying assessments influence market participants who continually argue a
biased bearish or bullish opinion. But, this is what makes a market! The most intriguing
part from this process can be found in the prevailing wisdom derived from the
recognition that certain sources of market information do not necessarily represent the

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true trend of the price action. This is where the comparison of actual analysis of trading
history deviates from media mantra. In terms of technical expectations, the importance
of measuring the history of price action has less variability and greater reliability.
Although accurate technical information may be applied improperly, the purity of the
mathematical expression that the harmonic perspective encompasses provides a more
unbiased means of assessing the character of the market than relying on subjective
data sources.

The Quest for Equilibrium

The market is always seeking to find value. Buyers and sellers are competing
against each other because of perceived value. One participant may believe that a
certain asset is worth more in the future while another may believe that same asset will
be worth less. This is what drives the market's pricing mechanism in action. Therefore,
the willingness of buyers and sellers to put a value on to the market comprises the
process of price action where the equilibrium value that satisfies all participants is
constantly pursued. I say pursued because equilibrium is never actually fully achieved.
If it was, there would be no price movement and no desire to participate due to lack of
potential opportunity - or even better stated, perceived opportunity. This is the eternal
market struggle. The market moves up and down seemingly in a random manner while
other times it does nothing at all. This can be confounding to those market participants
who do not understand that these are merely phases that have definable characteristics
within each opportunity.
Some of the most fundamental impacts on the way that trading is executed and
assets are allocated are derived from the perceived expectations of market conditions.
Within the entire trading process, the importance of defined possibilities and what to
expect specifically from any opportunity is what dictates the outcome. This is an
important basic concept that most traders fail to realize. Whether they know it or not,
every person has a prescribed set of expectations when they come to market. This can
be based on life experience, education or other factors that shape our world. The
problem lies within the distortion factor that such preconceived outlooks present. For
most, the general expectations of market performance are shaped by what they hear
from other people. It may be a financial news channel or an investment advisor.
Regardless, there is a problem that arises from a regurgitated analysis that does not
properly assess the true possibilities within any situation. Therefore, professional
traders develop their own skill sets and rely on their own decision framework to define
opportunity in the financial markets. Besides, I have not met too many people whom
have relied exclusively on others for investment advice with much success without
needing to learn some trading skills.

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Defining Bias

The collection of Harmonic Trading measurement strategies is all designed to

provide insight to the probable future price direction of the market being analyzed. One
of the advantages of basing decisions upon measurements of the market's movements
is the defined categorization of expectations that are derived from each ratio. For
example, a price segment that reaches a 1.618 extension can be deemed as having
moved too far in one direction. Although the price action can continue beyond a 1.618
level, the expectation to favor some type of retracement within this general vicinity will
typically guide the proper trading decisions It is important to remember that these
ratios are employed within the Harmonic Trading approach because they best reflect
the natural growth cycles within many of life's processes. There are numerous examples
of such natural cycles that manifest these ratio relationships. Applied to the markets,
the analysis of price action considers the "living organism" that is the market.
Comprised of buying and selling, the total sum of these actions possesses natural
cyclical elements that can be measured. It is in this purest application of Harmonic
Trading measurements that we can consistently define the state of the market and
relevant targets that are comprised from future price action possibilities. As defined by
the rules within the approach, each measurement possesses its own meaning to the
overall technical picture. Whether it is a distinct harmonic pattern structure, a
significant retracement/extension level or a combination of both, certain price
formations and their relevant technical readings define an environment of what is
possible within the realm of possibility.

Technical Entities

A harmonic pattern must be regarded as a specific technical entity that

possesses precise numeric ranges, where all elements, such as execution points, stop
loss limits and profit objectives, are defined relative to the set-up. Reversals must be
allotted a certain time period relative to the size of the pattern. In addition to the price
parameters, all patterns possess ideal harmonic time constraints - as measured from
the structure - that create a defined range of duration to gauge the action following the
reversal. I have discussed this concept in previous material and have always stressed
the importance of defining expectations within a specific limit to guide trading decisions.
I believe this transition of converting analysis into concrete scenarios is an important
aspect of Technical Analysis in general. Essentially, we must search for those
overwhelmingly clear situations as defined by prescribed strategies that define future
market movements in a consistent and effective manner with a high degree of
certainty.
One of the biggest mistakes by most students of the market is that they only
look for the one the tool or one big software program that might lead them to the Holy

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Grail. My perspective has always been realistic. In that vein, I have avoided those types
of pursuits and have always sought to develop an arsenal of skills that are comprised of
precise measurements that signal common characteristics that precede the most
substantial price movements. Many of these confirmation strategies are often smaller
complementary measurements that can tell a great deal more about the probabilities of
a potential pattern. At a minimum, patterns with price levels that have multiple readings
that are confirming each other provide a substantial advantage than a random
structure. In fact, the harmonic pattern opportunities with the greatest potential are
technical entities that include a conglomeration of market measurements that
distinguish a unique environmental scenario. Later in this material, we will outline the
exact conditions of that distinguish these distinct opportunities with favorable risk-to-
reward parameters.
Harmonic patterns can be considered as the primary technical entity of the entire
methodology. In this regard, the structural measurements represent the starting point
for any opportunity and define the general price range that encompasses the totality of
the pattern signal. However, other price action mechanisms such as trend
considerations, indicator calculations and timeframe applications are essential in further
categorizing these unique technical entities. In concert, the conclusion derived from the
structural information provided by harmonic patterns can be clarified to an advance
degree.
One of my early challenges was simply respecting the information that the
harmonic measurements provided. In fact, I frequently found myself in situations where
my analysis of certain patterns tended to indicate price objectives and ultimate
possibilities that were seemingly unattainable. For me, I had to change what I thought
might happen and focus on the possibilities that the measured harmonic scenario
presented to me. I know that many others have shared a similar learning experience.
For many individuals learning these techniques for the first time, the basic ability
to calculate harmonic patterns and predict their resulting possibility ignites an
awareness of possibility. This typically leads to an experience where their ability in
measuring these scenarios motivates them to further understand the harmonic
phenomenon. I have seen this in numerous students and I have received many emails
from people who begin to realize the importance of understanding these market
mechanisms. Once they begin to put together the foundation of measurements, a
broader understanding quickly emerges.

Confirming Structural Readings

There are distinct signals that help define when to capitalize on structural
opportunities but the general focus should always be on the immediate environmental
scenario at hand relative to the price levels established by the pattern. In actuality, the
entire concept of technical confirmation in Harmonic Trading is relatively new. Much of
my work in this technical area did not begin until several years after the basic rules for
harmonic patterns were defined. Once I was able to integrate effective measures, the

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importance of confirming pattern structures in this regard became more apparent. In
the beginning, I was somewhat of a staunch purist - stating the importance of price
action alone. However, the "student-of-the-market" in me always sought to research
other perspectives and refine those consistent identifiers that provided reliable
predictive capabilities.
It is important to note that although many market measures can be applied to
harmonic patterns, I have found most lack a consistent ability to filter the best
opportunities. In Harmonic Trading Volume 2, I detailed the advantages of Relative
Strength and presented new ideas that integrated harmonic measurements with basic
structural interpretations. Furthermore, the concepts of Divergence and Confirmation
have been expanded to quantify the exact technical environments that best foster the
valid reversal of a harmonic pattern. This is achieved through the complex integration
of indicator readings, individual price action and trendline assessments. These
strategies serve the basic identification principles well, as they define unique conditions
where pattern signals are most likely to yield profitable moves.

Triggers and Signals

As I have defined the strategies within the Harmonic Trading approach over the
years, I realized that certain points and specific subsets of data history frequently
marked important turning points that signal potential future price action well in
advance. One of the earliest strategies that I developed was the identification of
individual price bars. Specifically, the Terminal Price Bar relies on one specific interval
for the determination of behavior at that measured price level. I defined the Terminal
Price Bar in Harmonic Trading Volume 1, primarily as a means to define the exact point
where the opportunity becomes a LIVE TRADE because the execution process can be
tricky at the completion of harmonic pattern. Also, it can be difficult to know which
exact number is the most important within the specific range of Potential Reversal Zone
(PRZ).
Although I believe specific numbers in certain situations are more significant than
secondary measures, the importance of analyzing the entire zone comes down to the
ability in knowing exactly when the pattern has completed. In doing so, this definitive
price point establishes expectations that go a long way to guiding the overall decision¬
making process. In the same way that defined patterns provide specific price levels to
execute a trade, other aspects of this process must be defined to clarify the parameters
and the probability of the opportunity. If the price action does not act properly at the
initial completion of a pattern, the nature of this behavior in the area of these important
technical measures usually provides a warning sign of something other than what is
expected that is actually unfolding. It can be difficult to trust that individual price bars
can have such an impact and signal potential future price action but the evidence is
quite clear. We will look at precise situations that define these levels and the signals
that initiate the anticipated price behavior.

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 It is important to note that the significance of the price action depends upon the
nature of the structural measurements in that area. The best examples are found when
extreme price action is realized at the completion of multiple important structural
measurements. Other conditions that are not essentially at extremes still can describe
the true character of a particular anticipated move based upon monitored readings and
specific price objectives. In this regard, the arsenal of measurements used to explain
the character of a particular market's action considers more than price conclusions.
Therefore, the categorization of these situations provides a framework of substantial
technical information that can reasonably define finite possibilities in any situation.

Conclusion

As we examine the advanced material - especially trade execution and

management strategies, the importance of uniformly defining pattern structures will
become more apparent. I go to great lengths in this book to outline exact specifications
for each pattern in an unprecedented manner. Much of this information I have not
disclosed in any previous material, although I have been aware of these distinctions
since the inception of harmonic patterns. It is important to share these details to define
these structures as precisely as possible. Not to mention, the categorization of harmonic
structures has effectively defined the proper expectations of price behavior. It is
imperative to learn the pattern-specific strategies that require different treatment of
situations depending upon the measures at hand. From an identification perspective,
this book outlines those advanced measurements and goes to great lengths to describe
why these specifications work in each situation.
As you begin to study the following material, it is important to be aware from the
start that we are quantifying immutable mechanisms of price action in the financial
markets. The perspective of harmonic measurements provides a natural framework to
assess market movements. Although markets can be influenced by a variety of factors
and even manipulated for finite periods of time, the natural function of buying and
selling experiences a variety of price behavior phases that are immutable. Simply
stated, the market manifests harmonic pattern-related measures without regard to
external influences including news events, analysts' reports and even artificial trading
behavior. Any trader who understands the basic measurement parameters of harmonic
patterns does realize this fact regardless of timeframe or market traded. The most
important insight to it all is that our ability to succeed depends upon a framework of
measures that reflect the very natural element we are trying to define. Therefore, the
harmonic strategies employed cannot be altered or modified because they represent the
essence of identifying these natural opportunities in action.

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 Chapter 1
Core Principles of Harmonic Trading

The Foundation of Harmonic Trading

This book establishes the foundation of the entire methodology to define each
step in the trading process. The new strategies are designed to work seamlessly with
the identification principles that establish trading opportunities. I think it is important,
and I want to take a minute to review the established Harmonic Trading material. My
initial work with harmonic patterns required a great deal of manual research to discover
the optimal ratio combinations that defined structural signals. Although many of these
techniques are common knowledge today, the basic measurement tools were quite
limited back then, while few even back-tested their ideas to validate their sstrategies.
The Harmonic Trader and Harmonic Trading Volume 1 were similar in nature, as
they focused on the identification rules for harmonic patterns. Although there were
concepts that provided strategies for execution and management, most of the initial
material covered only identification of patterns. After nearly ten years of Harmonic
Trading, I released Harmonic Trading Volume 2 in 2007. This was an important
advancement of the identification rules. In fact, I was concerned during this time that
many were overlooking the importance of confirmation strategies to validate harmonic
patterns as trading opportunities. I wanted to share these insights as I discovered more
about the relationships of harmonic measurements with respect to price action in the
financial markets. In fact, I have been refining many of the new ideas presented in this
book for the since then. As I tested new combinations of technical possibilities, I was
able to unlock deeper relationships that function like automatic price mechanisms. Of
course, many of these situations require a variety of conditions to be satisfied but the
derived analysis has become as reliable as harmonic patterns.
From a general standpoint, I have been able to clarify some important concepts
within my own journey of market research that has guided my trading decisions in a
more efficient manner. Starting from the primary assumption that the market can be
measured, the more complex situations that were unfolding manifested characteristics
that continually repeat. Many of these conditions were outside of the basic pattern
strategies but have proven to be extremely effective when pattern structures are
present.

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The Market's Signal
The important consideration in this pursuit is to understand that the market is
providing its own answers every day. As traders, we must measure and define such
price action phenomenon that consistently repeats. Understandably, it can be easy to
get overwhelmed within this process but we must never forget that these signals can be
unlocked. As I have previously mentioned, we can measure the market to discover the
necessary signals of probable future price action. Although this is not an easy task, as
many are overwhelmed by the pace of the financial markets, it is this type of chart
analysis that separates the everyday noise from the decisive signals within price action
trading history.
All participants should be aware of the relevant price history of whatever market
they want to trade. Although fundamental and quantitative analysts frequently cite
disdain for technical methods, it seems short-sighted for these individuals to overlook
the trading history of a particular market as irrelevant. Within this record of price
history, charts clearly exhibit the material trading events that help to define important
levels support and resistance. In my opinion, any technical information that helps clarify
the total picture to facilitate the trading decision-making process must be considered.
Beyond this, the collection of harmonic measurements provides this framework of
reliable indications of future probable price targets. While other conditions must exist to
confirm what any price measurement indicates, Harmonic Trading's predictive ability to
define levels of support and resistance makes the difference between success and
failure.

The Process of Reaction versus Reversal

I think this one dilemma, one challenge, one conceptual framework - analyzing
the difference between a price reaction and a price reversal - describes how to gauge
the strength of any harmonic pattern opportunity. That is, what is the likelihood the
pattern structure will yield a profitable reaction while assessing the potential for a larger
result? I believe there are fundamental tactics that facilitate these assessments and
effectively guide decisions in an effective and disciplined manner that optimizes the
process. It is this extent of precision that I must emphasize to those traders whom are
relying on harmonic patterns as a sole decision module for trade opportunities.
It seems that many - especially traders with less experience whom encounter
the harmonic pattern community, seem entrenched in the singular possibility of a
"magic box" - a one trick pony approach to easily uncover the "home-run" trades unlike
any other approach. Whether this is some hot story from The Wall Street Journal or a
"Wolf of Wall Street" type scam outfit, it is easy for the uninitiated to fall into the trap
of false claims. Although many of these people are actually promoting the harmonic
pattern cause, they are doing more harm good by broadcasting unrealistic expectations

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34
with incomplete trading strategies. Yes, harmonic patterns provide some type reaction
at the completion of the most distinct structures. In my opinion, this has a tendency to
create an image of higher success than what is truly happening. Furthermore, the
failure to adequately handle these situations will certainly lead to disappointing results.
Much of the material in this book is geared towards the clarification and specification of
precise scenarios to help traders understand the importance of a comprehensive
execution and management plan as well as identification.
I will cover the strategies in detail however, I must emphasize that blind
execution of any harmonic pattern without regard to other technical considerations
sows the seeds of failure. To truly distinguish those opportunities with the best chance
for success, it is essential to analyze the larger picture relative to the pattern being
considered. Furthermore, those who promote the notion of "Set-and-Forget"
automatically executed trades ignore the majority of factors that must be considered to
navigate the entire process profitably. A trading plan that is designed to automatically
sell or buy a position based solely upon identification rules ignores the essential
execution and management strategies that are required to understand when price is
merely reacting as opposed to establishing a more substantial reversal. I go to great
lengths to clarify these issues in this book but it is a fundamental issue that many new
Harmonic Traders face. Obviously, traders will make mistakes as they integrate new
strategies and this trading plan. However, I feel that many of the errors committed
today are a result of distorted information rather than one's ability to execute the
prescribed strategies. Therefore, I will emphasize these important points and stress a
clear understanding of the concepts that distinguish smaller reactive moves versus
substantial reversals. Without properly instructing or educating the full realities to turn
this analysis into profitable trading, I believe that the identification strategies would
eventually become distorted due to others' inaccurate interpretations.
Throughout the process of writing this book, I have realized "how" traders are
learning this material as much as "what" they are focused on. I have spent the past
several years talking to dozens of traders to improve my own communication of the
strategies that I have initially presented. Clearly, there were many things that I had yet
to discuss in any book previously that I considered every day in my analysis. Some of
the ideas were proprietary that I wanted to keep to myself but I realized there were a
number of other factors that I needed to communicate to traders so they could see the
same picture I was envisioning in my mind. Of all of the additional strategies that I
assess, I realized that the most important aspect of what I do is to FIRST position
myself to benefit from the natural reaction that the market exhibits every day.
As price action "breathes" to buy and sell as its basic functional mechanism, I
utilize harmonic measures to define the finite limits of possibility. Since the market can
only move so far so fast, the signals that are generated at the completion of a harmonic
opportunity will typically provide a pausing phenomenon which represents the initial
change in character of the current trend. No matter what time interval is traded, this is
the starting point for every opportunity where I seek to capitalize on this limit as I
assess other confirmation factors to manage the larger reversal that may be possible.

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 These situations must be quantified and classified further but these conditions
can be measured with precision. Most Harmonic Traders are able to quickly incorporate
identification strategies and predictive capabilities. However, most fall short in
confirming reactions to ascertain the larger reversal potential at hand. However, I feel
that over the years and now in this material, I have closed this gap to pinpoint the early
signs that provide insight to know when to be aggressive in profit anticipation versus
allowing more time for positions to materialize. Again, this is an area that all traders
must deal with but I believe that computer technology has optimized these variables to
make high probability decisions with the proper input variables even more efficient.

The Harmonic Trading Process

The steps that outline the Harmonic Trading approach present a simplistic but
effective means in navigating any opportunity. I discussed this three-step trading
process in my Harmonic Trading Volume 2, and I always emphasize the procedural
importance that these steps engender. Within each step, a set procedure defines the
decision-making process throughout the entire trade. From the identification of an
opportunity to the closing of the position at a particular profit target, these are the
defined rules that engender consistency and promote success over the long-term.

Three Steps to Harmonic Trading

1. Trade Identification
2. Trade Execution
3. Trade Management

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Phases of Trading

Each stage in the trading process possesses its own framework of decision¬
making guidelines to facilitate and optimize actions. It is important to break down the
trading process and define various segments that focus on important sequential events
that must occur to ensure success. First, the trading opportunity must be identified
accurately. Second, the execution must be determined with coordinated confirmation
tactics. Finally, the management of that trade must be defined in advance to optimize
results. Anything outside these three considerations is meaningless. From a Harmonic
Trading perspective, I have been always focused on those strategies that decipher and
highlight the overall picture of each stage in the process and the relevant confirmation
strategies along the way.

1. Trade Identification: The prescribed measurements define unique conditions

that possess overwhelming predictive capabilities. In fact, any trading system
must possess uniform requirements that identify particular market conditions as
a potential opportunity. These techniques utilize historically proven and
repetitive price patterns that capitalize on overbought and oversold signals
generated by the market's technical price action. The consistent ratio framework
facilitates identifying and differentiating harmonic price patterns as quantified by
their structural alignment aspects. Understanding these identification
parameters is critical in defining the proper expectations among the various
harmonic patterns as an essential trading skillset to capitalize on specific
opportunities.

2. Trade Execution: At the completion of the harmonic structure, a hyper-focused

perspective must assess immediate factors that provide the confirmation of the
actual trade. Several considerations must be assessed within a specific time
period that is defined by the potential opportunity. The validity of the pattern
must be determined and the final action of executing of the trade or not must be
considered.

3. Trade Management: A prescribed set of guidelines and price objectives dictate

actions once a position has been executed with a variety of general
considerations involved within the process. The position must be managed with
specific rules to maximize the profit while minimizing the risk. Most harmonic
pattern situations require a degree of responsive management to maximize the
result from the featured opportunity.

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Breaking Down the Process

Throughout the evolution of my research, it has always been my goal to clarify

the existing principles of the Harmonic Trading approach and to integrate the new
concepts that enhance the effectiveness of the entire methodology. I have stressed in
each of my books the importance of understanding the three steps of the trading
process. Trade identification, execution and management are the three primary steps
for the decision-making process. In this book, I go to extensive lengths to discuss
trading within the three-step process of identification, execution and management
because it represents the fundamental process that all market participants experience -
win, lose or draw. More importantly, this is the framework we must revisit when
performance is lacking and mistakes are experienced. It is only through such
examination can we break down the process of trading to analyze each element of the
experience to isolate issues and devise specific strategies that corrects faulty behavior.
In the past, students have mentioned to me that they felt like these
classifications were not necessary and confusing for beginners. I typically respond that
such terminology helps to distinguish elements of the decision-making process where
traders can examine each stage as a building block within a larger sequence of events
required to realize a profitable move.
Quite frankly, I feel that there is a lack of understanding regarding these
technical processes that are evident every day, in all markets and on all timeframes.
Also, it has been helpful in my own understanding, as each concept has coalesced into
a larger comprehension that has transformed complex analytical situations into clear
and concise conclusions. In fact, when mistakes are made and trading results are
negative, it is possible to examine the behaviors and applied strategies that were the
cause of these losses. Moreover, these can be identified over the course of a population
of trades to isolate issues and integrate improvements in future opportunities.

Measure the Market

More than being a proponent of Harmonic Trading, I am an avid fan of

recommending to all Harmonic Traders to measure the market. It is the singular phase
that I repeat for anyone interested in any technical style of trading. It is critical to
make sure traders measure the market's movements and be aware of important trends
that can easily be traced out within the overall outlook the particular timeframe. In fact,
the phrase "Measure the Market' is important for anyone trying to understand the
framework of price action the financial markets for profit.

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Measured Expectations

Expectations are essential when assessing price action of the financial markets.
It is essential to analyze the markets movements within the relevant range no matter
what. The measurement of Harmonic Trading strategies such as the Potential Reversal
Zone (PRZ), RSI BAMM and reversal types for example, establish common
characteristics that repeat within each scenario and help to define where the anticipated
price action should unfold. At a minimum, patterns and the other confirmation
strategies guide expectations during times in particular when price action behaves
unexpectedly or varies from what is anticipated. These expectations associated with the
completion points of patterns and the other relevant confirmation strategies facilitate
the execution and trade management process by establishing price objectives in
advance that are outlined quite clearly. When all actions are defined in advance, the
collection of measured moves defines the situation and facilitates analysis to interpret
specific technical events that can be anticipated. This approach effectively defines the
critical "action spots" within any trend that indicate the future potential direction.

Expectations in the Harmonic Trading Process

In general, properly identified Harmonic Trading opportunities that possess ideal

structural measurements and other confirmation elements provide a tradable execution
within a definitive price limit will yield some type of anticipated and measurable
REACTION in nearly 80% of all cases. Clearly, this is a generalization but represents
accurate rate of affected price behavior at the completion of properly defined harmonic
opportunities. Sometimes, the initial reaction is temporary or merely consolidates at
the completion of a harmonic price level. The degree of this reaction will vary but the
pausing phenomenon is one of the basic expectations once a properly pattern is
pleaded.
It is important to emphasize that the quantifiable limits that ascertain a
successful result of a measured harmonic pattern must be delineated clearly. However,
the initial reaction phenomenon related to these measures is nearly one example that is
consistently reliable and provides valid assumptions in properly prescribed situations.
Other prescribed expectations in the execution and management phases employ
predetermined measures, as well. Complementary confirmation strategies and standard
price objectives formulate proper expectations in these states of the process.
These are general expectations of the overall process that we will discuss in
detail later in this material. The important take away before we even measure is to
understand that we are following a step-by-step procedure where all actions are
defined. After mastering the framework of expectations that best guides trading

Harmonic Trading Volume 3: Reaction vs. Reversal

39
decisions, most traders are able to assess complex harmonic environments within the
natural measured limit possibilities. It is important to note that these assumptions do
not account for human error nor other external issues. In fact, if traders are having a
problem even being in the "ballpark" of being right in a majority of their positions, they
are likely doing something fundamentally wrong and/or need to take a look at how they
are identifying trading opportunities. This is extremely important because any system
that is unable to even quantify the uniform variables that comprise their method of
determining what represents a potential opportunity is inherently flawed. Not to
mention, there are few methodologies that are able to produce the results these
measures provide, especially when all parameters are defined in advance. Again, the
ability to analyze each step within the Harmonic Trading process and assess decisions
to improve future results is a unique conceptual advantage that helps to analyze one's
performance. Harmonic measurements distinguish that phenomenon in their ability to
not only read the natural cyclical movements that most markets manifest but establish
limits of possibility where the opportunity is finite relative to the completed pattern.
More on that later however, it is possible to define precise individual price points that
establish reliable markers of direction even in the most confusing situations.
Although this is a simplistic outline of the general trading process, it is important
to note a few general conditions regarding each phase. When harmonic patterns form
the foundation trading opportunities, those price levels serve as a finite possibility of
price on which other measures can be important. The importance of a pattern's
completion point is another profound example of determining proper expectations,
especially since he anticipated change in price action is one of the fundamental
phenomenon we are attempting to predict. Again, the strategies speak to the ability to
categorize price movements as specific entities and the measurability of the market to
generate its own relevant signals of future product price direction in general.
Within the framework of a harmonic pattern, we see that each phase varies in
time which requires the basic awareness unto itself. For example, the execution phase
of the most harmonic patterns is typically much shorter than the identification and
management phases. The recognition of this fact alone underscores the importance of
preparing in advance to properly measure the market, identify all variables relevant to
the trade and manage the position optimally. Furthermore, the identification phase of
the trading process can vary immensely depending upon the price action for completion
point. Therefore, there are instances in the process where one must be more diligent
while at other times passive as opportunities develop. This type of "flow chart" analysis
is simplistic but it will serve as the foundation for even the most advanced strategies, as
all decisions will be related back to the trade identification, execution and management
framework.

Harmonic Trading Volume 3: Reaction vs. Reversal

40
Bullish Phases of Trading

The following illustration of a Bullish Gartley outlines the procedural stages of the
Harmonic Trading process. As a pattern begins to form, the final leg of the structure
will not trigger an opportunity until the B point has been violated. Many people attempt
to project patterns immediately from the C point but fail to realize the larger complex
structure is not officially become a valid opportunity until four of the five price points
have been established.

Copyright Harmonic Trader

In nearly every instance, the trade execution phase will be the shortest aspects
within the process but there are as many things to consider as identification rules and
management parameters. I recommend studying trade execution strategies and slowly
integrating these techniques into your trading plan to fully grasp these concepts. The
identification parameters are now optimized with the latest trading software but still
require a basic understanding to ensure proper pattern measurements. Meanwhile, the
prescribed trade management approach must be studied in advance to incorporate

Harmonic Trading Volume 3: Reaction vs. Reversal

41
effectively the more complex strategies. In each phase, the strategies are not complex
but require comprehensive understanding to develop an effective framework of
expectations to optimize trading decisions relative to real-world circumstances.
This chart of the US Dollar/Japanese Yen exemplifies the phases of the Harmonic
Trading process. Regardless of timeframe, the identification of the opportunity is
uniform. In this case, it was quite clear and unfolded over the course of a few hours
during an intraday session on the following 5-minute chart. The price action tested this
area and reversed relatively quickly in comparison to the total amount of time required
for the pattern to complete. In fact, the pattern required nearly 4 hours to develop
while the reversal unfolded over the course of less than 30 minutes.

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Although current software programs do make it much easier to signal when

these situations are developing, the understanding of this constraint facilitates
executions and creates a perspective where the analysis of price action at the
completion of the pattern must occur within a specific period of time. Meanwhile, the

Harmonic Trading Volume 3: Reaction vs. Reversal

42
management of position was fairly straightforward, as it accelerated shortly after
completing the pattern and continued higher after a brief period of consolidation.

Bearish Phases of Trading

We will examine each stage of the trading process utilizing harmonic

measurements. For this material, it is assumed that you have a basic knowledge of
harmonic patterns. Each process has definable and repeatable decisions that must be
assessed from start to finish. Regardless of the methodology, all traders must correctly
navigate confusing environments to the fine profitable opportunities.

Of all the other approaches that I have reviewed throughout my life, I have
noticed that there are common elements each of these methods employ in their
strategic plan to be consistently successful. The goal of this book is to impart many of
these strategies from a harmonic measurement perspective as well as a more precise
framework for traders to assess price action. At a minimum, harmonic pattern provide
this framework. Whether a trader bases their decisions on harmonic patterns or not,
most agree that the information provided by these structures cannot be ignored. In
conjunction with other methodologies, most traders come away with a heightened
awareness from the measurements employed within Harmonic Trading.

Harmonic Trading Volume 3: Reaction vs. Reversal

43
 The following example of the Australian Dollar/Canadian Dollar shows a distinct
Bearish Gartley on a 15-minute chart. Clearly, the execution phase was quite narrow.
Although these can be tricky at times, the simple awareness of a finite window of
opportunity facilitates decisions when the price action reaches the measured harmonic
level. This is one example of how expectations can dictate decisions. Although a rapid
execution may be required, traders whom are prepared for such realities will be able to
pull the trigger when the pattern completes without hesitation. In the case of AUD/CAD,
the larger reversal ensued after an initial reaction and consolidation phase. This is
common in many reversals as the change in the primary trend frequently requires more
time to realize a larger price move.

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Regardless of your level of Harmonic Trading comprehension, I encourage all

traders to assess the specific strategies that define opportunities. There are other well-
established and credible analytical approaches to quantify price action. I have reviewed
most of them in detail. For me, the research with Harmonic Trading is my interpretation
of a variety of prior technical authors integrating a broad array of strategies that I have

Harmonic Trading Volume 3: Reaction vs. Reversal

44
developed over the course of my career. It is important to note that not every measure
is applicable in every situation. However, an arsenal of reliable signals provides the
framework required to understand what is possible in most situations. I will present
several detailed scenarios that exemplify these conditions but the most important
consideration is the clear delineation of what validates an opportunity. These
measurements are defined in advance and provide a prescribed framework that is not
subjective. Compared to other market approaches, Harmonic Trading is quantifiable and
measurable to a detailed degree that is unparalleled. This is a common distinction that
new traders realize quickly, especially as they are able to discover their own strengths
and weaknesses within each step in the process. Most important, it is essential to take
a thorough review of your current trading skill set and compare the Harmonic Trading
strategies to discover the synergies that will guide your decisions in an optimized
manner. Again, it is not necessary to integrate every aspect of each strategies
presented herein. Rather, the broader comprehension of price action and the critical
measurements that define important targets will outline a larger framework that is most
effective when the clearest technical readings confirm the primary structural
measurement.

Price Reaction

One of the initial breakthroughs in my early work was to provide explanations for
specific measurements. Although the most substantial discovery was the differentiation
of M and W structures, the larger breakthrough of providing a reliable framework of
anticipated price behavior based upon harmonic measurements. Furthermore, the direct
link of prescribed expectation with an exact measurement started to create a detailed
understanding of what is possible in any trading scenario. Of course, anything can
happen in the markets but the majority of the time, the markets will exhibit normal
price behavior that will be contained within the harmonic limits of what is possible
within any period of time.
For me, I realized the combination of price measurements was the key to
accurate assessments and expectations. The patterns are one example of these
combinations of measurements. These initial breakthroughs were quite effective but
their focus was predominantly measuring the price reaction. Any simple harmonic
measurement - a projection or a retracement - possesses the potential to be a material
level of support or resistance enough to provide a minimum reaction that can be
profitably defined. Important ratios such as the 61.8% or 161.8% measures frequently
will realize some degree of consolidation. This is the natural harmonic price reaction
phenomenon experienced by these measures. At a minimum, Harmonic Traders are
able to understand what these measurements mean, incorporate them in their existing
strategies and begin to realize the larger dynamic that this approach provides. We will
look at specific price reactions in further detail but it is important to distinguish this type
of market mechanism as its own phenomenon.

Harmonic Trading Volume 3: Reaction vs. Reversal

45
Technical Environmental Measures

Much of my work has focused on the factors that consistently materialize that
provide the highest degree of confirmation to validate opportunities that seek to
capitalize on harmonic reactions in the markets at a minimum. The strategies analyze
price and other relative measure to define how far any particular price action has traded
in one direction. As I mentioned previously, all markets must "breathe" as the buying
and selling fluctuates throughout each session. Price action can only move so far in
one direction within a limited period of time. Although structural signals of harmonic
patterns are powerful, my research has shown that the environmental measures
required differentiating where these patterns form on the chart is as important as which
pattern forms. So, the combination of both of these measures properly integrates the
price and environmental reaction that can be anticipated.
Although the price action of most reversals provides a minimum reaction - the
harmonic pausing effect offering immense predictive capabilities in its own right, the
larger integration of environmental assessments such as Relative Strength and now
harmonic strength indicators refine those structural possibilities to highlight the best
situations. There are certain alignments and retracements that are more effective,
especially when you need technical conditions exist. The research shows that this
integration is essential in all trade decision optimization.

Harmonic Trading Expectations

One of the most important concepts that I will emphasize throughout this book
stresses the use of expectations to facilitate trading decisions in definable situations.
Some of my earliest discoveries were relationships that identified that consistently
provided the proper set of expectations of probable future price action when precise
measurement conditions were present. If it was a pattern, important ratio measurement
or a clear confirmation trigger, all of this analysis must yield uniform results and provide
consistently reliable measurement parameters to assess any situation. For example, one
of the benefits of employing ratios to identify opportunities is that the analysis is
derived from proportional assessment of the total market action rather than an
individual price measurement. Personally, the assignment of expectations and
guidelines associated with specific measurements provided me with a plan to handle
nearly every situation. Although anything can happen in the markets, the realm of
possibility in most situations is actually quite small. In fact, the catastrophic "Black
Swan" situation (big loss) and the "Home-Run" situation (big win) are often feared but
rarely realized.

Harmonic Trading Volume 3: Reaction vs. Reversal

46
Misunderstood Expectations

Other people can employ different confirmation methods and have preferences
regarding technical measurement strategies. I want to encourage "The Whatever
Works" theory but I have my preferences as well. I think that the public has tested
harmonic patterns and found them to be interesting but not satisfied with statistical
evidence. I have my own case studies and statistics - proprietary and otherwise - that I
have shared over the years. Others have misrepresented results in unauthorized
software that has questioned the effectiveness of these measurement techniques.
Furthermore, there has been an unrealistic expectation that has been promoted in other
courses that does not represent the proper mindset for converting patterns into trading
opportunities. I always stress a conservative approach to Harmonic Trading and
integrate these strategies only after they are clearly understood to avoid mistakes.

Harmonic Confidence

Although it may take some practical experience for building confidence in these
measurements, it won't take long before their effectiveness is realized. Over time, the
spread of ratios that help measure structural formations consistently provides reliable
price levels to consider. Although not every pattern will unfold as expected, the critical
reality that price action does tend to adhere to these natural ratio levels provides an
immense degree of certainty to measure where a market may be headed. Harmonic
ratio measurements can be used to identify trading opportunities, confirm executions
and optimize management decisions. Furthermore, distinct pattern formations have a
high degree of pinpointing ultimate price objectives as measured by the complex
structure. Again, these situations do not happen all the time but when they do,
especially in the clearest of circumstances, the technical possibilities that define the
trading opportunity are quite clear.

Harmonic Trading Volume 3: Reaction vs. Reversal

47
Core Principles of Harmonic Trading Conclusion

The core principles of the Harmonic Trading approach are founded in realistic
expectations. This realism comes from a thorough recognition of what is possible in the
markets as well as defining exactly where the trader is relative to the opportunity. It is
essential to develop trading skill sets first before trying to navigate the markets with
real money in order to achieve long-term success. One of the primary means to
understand price behavior in the financial markets is to develop a framework of
expectations that defines opportunities and guides trading decisions. I have outlined a
few examples. The material in this book will detail other complex strategies that are
designed to identify those consistently reliable factors that outline unique opportunities.
Many of the strategies that I have created to describe the phenomenon of
Harmonic Trading measurements arose from great deal of trial and error. My goal was
to create a framework that describes the unique market mechanisms that were
manifested in price action. However, the simple acknowledgment of this phenomenon
has been thoroughly reviewed in my previous efforts, especially as it relates to
harmonic ratio measures. Therefore, I will not review any basic Harmonic Trading
concepts such as the Fibonacci sequence or other examples in nature. I encourage all
Harmonic Traders to investigate the numerous examples of harmonic phenomenon
throughout the universe. I share numerous resources on my website including a basic
foundation of pattern measures. These resources provide overwhelming substantiation
of this phenomenon and reaffirm the importance of basing all measures from a
harmonic

Harmonic Trading Volume 3: Reaction vs. Reversal

48
 Chapter 2
Standardized Harmonic Trading Identification
Measurements

What Makes Patterns Harmonic?

In my first book, The Harmonic Trader, I outlined a trading checklist and

guidelines for a trading plan that validated harmonic patterns as definitive
opportunities. I believe that book is an excellent resource, especially for new traders as
they learn the importance of specific rules for every step of the trading process. I
actually make that available for free as a PDF download on my website
www.HarmonicTrader.com so that traders can learn the basic foundation of this
approach the correct way. It is an important measurement foundation that I would like
to review in this material before addressing more advanced strategies. It serves as the
starting point for a more complex integration of other harmonic measures that validates
structural signals as significant. When we combine distinct harmonic patterns with
overwhelming technical readings, a clearer opportunity can be defined and the
anticipated reaction from the pattern completion can be gauged for a larger reversal.
I think it is important to understand the measurements and technical
considerations that validate certain trades as highly probable opportunities in advance.
Also, I think it is important to emphasize the exact measurements that constitute
appropriate price levels associated with the tenets of Harmonic Trading. These
measurements are part of the skill set that must be studied and carefully reviewed
before being put into real action. As I have mentioned previously, it is important that
structural signals contain multiple elements to define the situations as reliable
opportunities more than focusing on a single measure or pattern. This comprehension
comes with experience and practice. Although the strategies can be integrated quickly,
the larger understanding and real trading experience take time to coordinate the
various aspects of the entire process. So, I recommend going slow until a thorough
recognition of all expectations throughout the trading process is fully understood. Once
obtained, the insights and framework of these measures outlines those hidden areas of
support and resistance that cannot be ignored.

Harmonic Trading Volume 3: Reaction vs. Reversal

49
 As the Harmonic Trading techniques have become more popular, I have noticed
that others' interpretations have failed to include certain required harmonic elements
that validate these situations as unique. In fact, it seems that many people are
attempting to simply combine multiple ratio measurements without much regard to
other structural considerations. The general notion that any combination of ratio
measurements can define a potential opportunity is a dangerous proposition. When
random ratios are continually attributed to price action, the only possible result is a
skewed performance that possesses undefined risk parameters. There are reasons why
the harmonic patterns I presented work. At a minimum, their general acceptance
throughout the trading world has substantiated the basic framework to quantify these
structures when they possess the proper characteristics.
If these price structures do not possess the proper elements that make these
situations Harmonic Traders are comparing apples to oranges. I believe this is a subject
that deserves further discussion but I will simply stress that traders follow the
prescribed measurements that make patterns harmonic. Although others may argue
differently, as creator of the standard rules for the patterns, I understand the reason
why particular elements of trading behavior quantify the structures as harmonic.
Specifically, the relation of price proportions within the scale of harmonic ratios cannot
be altered. We utilize the 1.618 and 0.618 measures due to their relation to the
Fibonacci sequence. I have outlined these reasons in previous works and I offer
numerous resources on my website for more information. I will not present a Fibonacci
review here. However, I will stress the importance of using only those ratios that are
derived from this foundation. Otherwise, defined trading opportunities will be based on
random measurements which are a recipe for disaster.

Harmonic Trading Identification Strategies

The first step in the Harmonic Trading process is to properly identify structural
possibilities and validate them as harmonic patterns. The validation process involves
several critical measurements that must exist to define the opportunity. It is important
to review the basics of trade identification. My first two books covered the majority of
the measurement techniques that define structures as harmonic patterns. In this
material, I introduce new measures and effective combinations that quantify structures
to differentiate random price movements from valid trading opportunities. I have stated
previously that I have not address execution and management situations sufficiently.
Harmonic Trading: Volume 2 expanded on these areas and complemented the system
of pattern identification strategies. This material presents new strategies that
complement the identification system within the Harmonic Trading approach. Beyond
the ratio measurements, there are other general considerations that help quantify and
classify structures as harmonic.

Harmonic Trading Volume 3: Reaction vs. Reversal

50
Harmonic Pattern Size

Throughout the years, I have been frequently asked about the proper size for a
pattern. It is quite common for smaller structures to form and yield reactive moves but
the situations often do not possess the sheer size in terms of number of price bars or
the entire range to be a profitable opportunity. As I previously stated, harmonic
patterns are specific sets of data points that comprise a collective signal. However, the
minimum size of the structure must be established to measure patterns of significance
and ignore irrelevant formations.
Each individual price bar represents the recorded history of trading within a
certain time interval. Although the completion of most patterns includes several price
bars, there are definitive data points that define the opportunity. Further in this
material, we will examine some precise strategies that capitalize on these individual
price bars. For now, the general question of how many price bars any harmonic pattern
should possess must be answered with respect to a basic scientific assessment of what
constitutes a sufficient sample size. For statistical studies, most require a minimum
sample size of 30 data points. Related to harmonic patterns, this means that each
pattern should possess 30 price bars regardless of the timeframe. Founded in the
principle of the Central Limit Theorem, the 30-sample size is designed to ensure a
normal distribution of probable outcomes. That is, we can expect a normal reaction at
the completion of harmonic pattern opportunity more so in the structures then those
that possess less than the ideal sample size amount.
In The Harmonic Trader, I established basic guidelines about pattern sizes. For
example, I put forth the notion that the larger the pattern the more significant possible
reversal. In another instance, a market opportunity that has multiple calculations
converging in a specific area will likely favor the largest measured price leg is the most
significant over smaller sized formations. Those are valid. However, I feel it is
important to establish a standardize means of determining the proper sample size for
harmonic patterns. If we postulate that 30 price bars will satisfy the requirements of
normal expectations, it serves us to this those opportunities with at least this amount if
not more. The problem arises when multiple time intervals have the same pattern. For
example, a pattern that forms on a 60-minute chart will also be visible on a 15-minute
chart. Of course, the 15-minute chart will have four times the number of hourly bars. If
the hourly chart has 20 bars, the 15-minute chart would be favored having 60 bars and
being closer to the 30-statistical minimum. However, when an hourly chart has 30 bars
or something close to the minimum, sometimes the 15-minute chart more accurately
reflects the possibilities of the situation. Simply stated, it is important to utilize that
timeframe which is closest to 30 bars as the primary time interval to analyze
parameters of the harmonic pattern.

Harmonic Trading Volume 3: Reaction vs. Reversal

51
Central Limit Theorem

I personally feel that the future of all market approaches will be optimized
statistical analysis that emerges as the primary source of decision variables. As
technological improvements put more power into the hands of the individual trader, a
more scientific approach to assess market strategies is now possible. I have presented
some research regarding harmonic phenomenon financial markets previously but I have
withheld a great deal of statistical discoveries because these findings represent the
ultimate realization of decades of work. Although one does not need to be a PhD
statistician to incorporate these concepts into your decision framework, it is essential to
understand principles of statistical probability as it relates to trading behavior.
Ultimately, we are all executing definable market conditions that will someday be
quantified and categorized into mathematically proven processes.
Since we have established harmonic patterns as a collection 30 or more
individual price bars that possesses prescribed ratio proportions, we can focus on
distinct price zones where normal expectations of possible outcomes can be realized.
Simply stated, this means that patterns and harmonic measures consider will rarely get
"blown out of the water" reducing vulnerable conditions that may arise from more
random structures. Therefore, the principles of the Central Limit Theorem provide the
basis of establishing some basic expectations of price behavior.
According to Wikipedia, "...the Central Limit Theorem (CLT) states that> given
certain conditions, the arithmetic mean of a sufficiently large number of iterates
of independent random variables, each with a well-defined (finite) expected value and
finite variance, will be approximatelv normally distributed, regardless of the underlying
distribution. To illustrate what this means; suppose that a sample is obtained containing
a large number of observations, each observation being randomly generated in a way
that does not depend on the values of the other observations, and that the arithmetic
average of the observed values is computed. If this procedure is performed many
times, the Central Limit Theorem says that the computed values of the average will
be distributed according to the normal distribution (commonly known as a 'bell curve')."
https://en.wikipedia.org/wiki/Central limit theorem

Theory of Normal Distribution Returns

All patterns should possess at least 30 bars on the timeframe that they are
identified. In fact, I find myself utilizing the 30 number to approximate a sufficient
number of bars can encompass any trading situation. As I stated before, the pattern
that is closest to 30 bars on any timeframes should be considered the most suitable for
the primary pattern. Since all patterns serve as the basic measuring basis for entry
points and stop loss considerations, we can assess the completion of patterns within
this 30-bar limit as a minimum time constraint to allow the reversal to take hold. There

Harmonic Trading Volume 3: Reaction vs. Reversal

52
are other examples where this approximation does work but the principle is founded in
expectation of normal price behavior no matter what.
Albeit quite simple, this 30-bar limit has helped to confirm smaller patterns on
shorter timeframe for that effectively optimize entries of larger structures. It is only in
the past several years that I have been able to effectively explain the need for a
minimum pattern size. However, as I have experimented with its application over the
years, I know that this basic rule of 30 price bars has been quite effective as a means in
differentiating those structures that are smaller and insignificant. If you are a long-term
trader, I believe it is important to be aware of the last 30 days at 30 months no matter
what the market. If you are a short-term trader, I would suggest always be aware of
the prior day's action - that is, the last 30 hours. Finally, the simple technique is yet
another important principle to effectively analyze and monitor pattern progress.

Potential Reversal Zone (PRZ) Review

The Potential Reversal Zone was the most important breakthrough concept that
put harmonic measurements on the map in general. The Potential Reversal Zone (PRZ)
represents a definitive statement of structural analysis where the measured movements
pinpoint an exact price level with clear anticipated behavioral change is expected to
occur. Although I have stressed that this is merely a starting point, the precision of the
measured levels provides a framework in a unique manner.
This concept was one of the first measured means to define some type of
expectations with respect to future price action. In this matter, the collection and
convergence of measurements defined levels of support and resistance in a unique
framework that provided tremendous insight and consistently accurate possibilities
relative to the structural assessments being considered. Furthermore, each pattern
possesses combination of measurements that the fine a character for each opportunity.
A Crab pattern for example would have different trading expectations as opposed to a
Shark pattern. These measures have served to become the foundation of harmonic
patterns. Although there are a variety of statistical reports regarding the accuracy of the
patterns, I have presented the alignments based upon an exact sequence of ratios as
well as an assumed tolerance level for each pattern point. Although discovering this
tolerance level momentarily, it is important to note that he structures are founded upon
the requirement that they possess specific and limited proportions. Collection of ratios
used to certify these movements as harmonic patterns comes from a result of years of
research that helped unlock many of the measurement discoveries, particularly in M and
W pattern analysis.

The Three Elements of Harmonic Trading Opportunities

The original breakthrough that I realized 20 years ago was the importance of
applying proper ratio measurements and structural analysis to define cyclical behavior
of any quantifiable frequency over time. I must emphasize that certain minimum

Harmonic Trading Volume 3: Reaction vs. Reversal

53
timeframes are preferable to exploit these opportunities as well as understanding basic
liquidity requirements of any market. Certain minimum requirements are important to
avoid those markets which can be prone to irrational volatility swings. In essence, not
every market interval or instrument should be traded. For example, tick charts can form
distinct harmonic patterns but they typically do not provide a sufficient price range to
capitalize on the opportunity relative to the required stop loss limit. These situations
are obvious but if in doubt stay out. For most major markets, the elements of harmonic
patterns should exhibit ideal relationships and adhere closely to the prescribed
definition of the opportunity. The ability to validate these opportunities depends on the
following three conditions - Ratios, Sine Wave structures and "environmental"
indicators.

1. Harmonic Ratio Relationships

Related to the numerous examples throughout nature, the importance of which

ratios are employed is critical to define the natural cycles in the market. Many people
are aware of the importance of the "Golden Ratio" phenomenon throughout nature. The
61.8% and the 161.8% proportions are merely a starting point. My initial work tinkered
with variations of these ratios - most notable, my discovery of the 88.6% and 113%
measures - and other related reciprocal proportions.
The following is a list of the harmonic ratios employed to define retracements
and projections within pattern structures. We will review each of the pattern elements
later in this material but the singular measurements do not need to be reviewed. If you
would like to review more material on individual ratio measurements of retracements
and projections, please visit my website at www.HarmonicTrader.com where you will
find a great deal of information on basic subject matter such as this. Furthermore, the
derivation of these numbers and the significance of the Fibonacci numeric sequence can
be reviewed there. I want to focus more on the complex scenarios that these ratio
measures encompass in this book.
The important concept is not to get caught up in the mystique of these numbers.
It is true that the relationships and properties they identify are quite interesting.
However, these are the measures that best define natural cyclical properties in a variety
of other examples outside the market. This is natural phenomenon. As I stated in
previous discussions, I am more focused with what works, testing those ideas and
refining them for complete optimization. We also know that certain numbers work
mostly in certain situations. Therefore, a universal application of the same assumption
for every measure is just not realistic. But, some type of predetermined expectation at
each does provide an analytical framework to assess price action.
One of the most remarkable historic examples of a singular ratio affecting a
major market that I've ever witnessed unfolded over the past few years. Ever since the
bear market low that was established in 2009, the recovery of the past decade has
been questioned continually. I believe this is typical of any market at any period of time
in history but the severity of the prior bear market has certainly left an indelible mark

Harmonic Trading Volume 3: Reaction vs. Reversal

54
which remains to this day. Simply stated, people are still skeptical after what happened
during that decline. Regardless, harmonic measurements defined that bear market in
advance, the eventual low of that move and they have effectively gauged the progress
over the past 10 years. Despite these overall negative sentiments, the Standard &
Poor's 500 ETF rallied sharply from the bear market low. Although the decline from the
2007 peak was quite severe, it has served as a significant and relevant measurement
basis to define long-term targets. A fantastic example of this behavior unfolded on the
weekly chart where the 1.618 extension served as a clear target throughout the
recovery and an important technical target. I had been monitoring this measurement
for nearly 18 months prior to its realization, as I covered it over the course of many of
my monthly reports.

SPY 28-OCT-16 HarmonicAjialyier (TM) v6.05 Copyright© 2001-2008 HamonicTrader.com, LLC. AH Rights Reserved

Harmonic Trading Volume 3: Reaction vs. Reversal

55
 The ETF possessed a 1.618 extension that completed at 213.40. After nearly 8
years of trading history, the price action tested this level and reversed on the exact day
that it reached the 1.618 level. Over the next 15 months, the market slowly declined
and eventually lost 15% from the initial completion of that projection. Although the
price action has since rebounded, the initial reaction provided a significant opportunity.

Daily   EMA13 208.30 EMA20 208.15 1 EMA50 207.51 SMA50203.19   SMA200 201.85 Volatility Bands(20.2.0|

SPY 28-OCT-lfi HannoiucAnalyter (TM)v6.05 Copyright© 2001-2008 HaimonicTrader.com, LLC AllRights Reseived

I must emphasize that this is more than an excellent well-chosen example. I

know that the industry is ripe with people showing well-chosen examples that fit the
idea they're trying to present. However, phenomenon like this occurs every day on all
timeframes but the most fascinating structures and measurements that materialize on
long-term weekly and monthly patterns are truly remarkable. The measurement
strategies work the same no matter what the timeframe or market. We are analyzing
price action in a uniform manner where the framework of measurements provides a
consistent basis to analyze trading opportunities.

Harmonic Trading Volume 3: Reaction vs. Reversal

56
3.The AB=CD Phenomenon: Sine Waves in the Financial Markets

One of the most misunderstood concepts about harmonic patterns is they are based
upon ratio measurements alone. There have been a number of interpretations that
attempt to focus on different ratio combinations without respect to the primary
structure required to make patterns harmonic. When we realized that the nature of
price movements mostly is expressed as a sine wave, it is easier to understand that all
price movements have finite possibilities. When we apply the basic assumptions that
sine waves possess, we see that the larger mechanisms of buying and selling go
through various stages that exhibit these properties. Each price movement - a rally or a
decline - possesses particular features that dictate the parameters of their respective
move. We don't need to get into a deep mathematical discussion on the physics of sine
waves. However, the simple expression of understanding of the force of price
movements possesses important expectations and helps to clarify price direction.
Of all the concepts in this book, the understanding that the basic element for all
harmonic pattern structures - the AB=CD pattern - is simply a type of sine wave price
formation that has limited implications. First and foremost, this structure represents the
minimum cycle in the financial markets. There are Zig-Zag type formations that do
represent more random trade movements. However, the most liquid markets that
possess fluid and normal conditions continually manifest various sine wave structures
that pinpoint important price levels of support resistance.

"Market Sine-ature"

The AB = CD element is a simplified term for what I call the phenomenon of in

price action that I have termed Market Sine-ature. This concept encompasses the study
of all AB=CD structures as independent price signals. The ability of the structures to
define important levels of harmonic support and resistance serve as the minimum price
objective in most scenarios. Furthermore, the additional ratios in harmonic pattern
structures serve to complement what these minimum levels establish.
This concept also espouses a certain set of expectations in regards of what this
technical entity is all about. If we can identify the structures early and measure their
completion points, there is a great deal of clarity that can be attained especially when
price action tends to be attracted to completion points of clear patterns like a magnet. I
have talked about this "Magnet Effect" of price behavior as it relates to the final leg of a
harmonic pattern. In combination with complex patterns, there are defined acceleration
situations where the CD leg of the structure highlights a highly probable completion
point.
One of the magnet phenomenon that I described in my Volume 2 was the BAMM
strategy that outlined clear harmonic breakouts /breakdowns. BAMM is an acronym
that means Bat Action Magnet Move. Simply stated, when a pattern begins to enter the
final leg, it accelerates to the Potential Reversal Zone when it exceeds the midpoint at

Harmonic Trading Volume 3: Reaction vs. Reversal

57
B. This one phenomenon is the basis for a variety of automatic reactions that occur
beyond harmonic limits.
One of the most remarkable examples in recent memory of a singular the AB=CD
structure defining critical price levels in impressive fashion was the long-term peak in
the weekly chart of the iShares Energy ETF, the XLE. This remarkable sine wave
structure defined the area just under $98 as the weekly harmonic resistance. The price
action reversed within two weeks of completing the structure.

XLE 28-OCT-16 HarmonicAaalyier (TM) v6.05 Copyright © 2001-2008 HamoiucTndjr.com, LLC, All Rights Resend

The basic structure possesses this phenomenon as well when the price action in
the AB=CD enters the final leg. As the CD leg begins to form and exceeds the B point,
the projected minimum of the AB=CD structure acts as the targeted point. These
situations become much clearer as you review the specific pivot points within the
structure. In essence, the equivalent AB=CD structure represents one completed

Harmonic Trading Volume 3: Reaction vs. Reversal

58
harmonic cycle. When the formation is properly identified, it is possible to use this
knowledge to your advantage and position trades accordingly.

I
Weekly   EMA1386I4 EI4A20 86.27   IEMA50 33.68 [j SMA50 83.85 1 SMA200 72.72 Volatility Bamls{20.2.0)

zz 0.0010 O- zz 0.01 O- zz 0.1 O- zz 1.0 O- zz 10.0

102.50-

100.00
n
w MMm 97.50
f-Li
95.00
I

92.50

90.00
I

I
I
87.50
|
85.00

82.50

XLE28-OCT-16 HamionicAnalyzer (TM) vfi.05 Copyright© 2001-2008 HinMiucTradei.com, LLC. All Righti Reserved

AB=CD patterns must be analyzed with respect to the situation upon which they
are forming. They can materialize as consolidation structures or they can mark
important inflection points. In any incarnation, they serve as the minimum limits to
define potential inflection points when the basic structure is nearing completion. When
we can identify the structures especially with harmonic ratios, we are defining important
natural limits that must be considered at a minimum.
The basic AB=CD structure implies an assumption where the market will at least
take a breather no matter how strong the trend. Although it is common for the
minimum pattern to be exceeded, this recognition helps to clarify those situations when
the objectives for a particular move are unclear. These strategies create a means to
define basic expectations and minimum price objectives in any market on any
timeframe.

Harmonic Trading Volume 3: Reaction vs. Reversal

59
3. Environmental Indicator Bias: Relative Strength, Harmonic
Strength Index

Although I am known for harmonic patterns, my work - much of what I have not
released involves an advanced understanding of measuring market movements to
determine oversold and overbought conditions. I spent a great deal of time refining and
categorizing Welles Wilder's Relative Strength Index, which I feel is one of the most
accurate indicator measures available today. I credit this technical measure for opening
my eyes to many relationships and without Mr. Wilder's contribution, I would not have
been able to integrate price movements with environmental measures to the degree
that I have. Upon this foundation, I have introduced several new perspectives on the
indicator itself and I have expanded the premise of the indicator to define new
measures that better reflect harmonic price behavior.
Most traders are aware of the standard indicators aside from RSI, most platforms
include Stochastics, MACD, Market Profile and many other technical methods. In fact, it
is incredible to see the number of proprietary programs that have been developed by
individual traders. I believe that technology has been a positive factor on the industry,
as greater mathematical substantiation is now as important as reputation. For most of
Wall Street's history, asset allocation was more of a matter of zip code than capabilities.
In today's world where all transactions are online, the focus has shifted to chart
analysis and statistical back testing. It seems that the industry is on the edge of a
renaissance in terms of how it will determine asset allocation in the future. Individual
advisors are certainly an endangered species in the decades to come.
With that being said, the measurements employed within Harmonic Trading
continue to advance the overall understanding of what characteristics define the best
opportunities. Most of my research has focused on advancing the understanding of
harmonic environments that possess both indicator measures and structural price
levels. However, I feel that the gamut of potential patterns that can be measured has
been exhausted and sufficiently covered by the structures I have presented in the
identification section. Other price measurements that involve management projections
and execution triggers beyond identification define the state of the market within the
stages of the trade from a harmonic perspective. In this book, there are a number of
strategic scenarios that are outlined that incorporate both patterns and indicator
analysis. Although the measurement strategies may vary, it is the combination of
elements where integration yields the clearest information. We will look at these
situations later in this material.

"Market Sine-ature"

One of the problems that I have with people who are attempting to analyze
opportunities based strictly on ratio measurements is that they failed to incorporate
other critical elements that comprise valid structural signals. It is very easy to measure

Harmonic Trading Volume 3: Reaction vs. Reversal

60
from various points and outline those levels where multiple ratios converge. Sometimes,
these measurements can dictate support or resistance levels but this is usually short¬
lived. The more substantial opportunities come from a combination of defined ratio
measurements and clear structural elements that comprise more than a simple
calculation. In fact, the biggest drawback of the Harmonic Trading approach is the
inability of people to be thorough in their measurements and entirely assess all the
elements that are required to define valid situations. As a trader, the clearest path to
success starts with eliminating the majority of situations that lack potential for any
move.
Another sobering fact about harmonic patterns is that it is easy to find the best
examples that worked out ideally in prior charts. I know I would benefit personally by
saying that Harmonic Trading is the greatest method and that all of the opportunities
work out incredibly well. My research reveals that this is simply not the statistical truth.
The truth is that most patterns to yield some type of reactive moves following the initial
test of the structural completion point but require a means of technical confirmation to
yield more than a nominal reaction. This causes problems for people who are able to
identify these situations, measure the exact price level but lack the trading skills
required to take advantage of this information. It can be difficult to know how to handle
the trade if most of the patterns yield only a minor reactive price move and continue in
the predominant direction. It is very easy to find yourself in losing positions based on
the wrong expectation regarding harmonic patterns.

Sine Wave

Harmonic Trading Volume 3: Reaction vs. Reversal

61
 In the same way that we are comparing harmonic ratios to those remarkable
cycles in nature, we analyze price action and relate to the behavior and expectations
that sine waves provide. Again, it's not my point to get into a long scientific discussion
about the mechanics of wave frequencies. I believe that these relationships can be
applied in the financial markets because price behavior is just one other expression of
an energy wave. If we know that all frequencies (price movements) that possess a
measurable variable that can be plotted over time, we can assume that the wave
properties that these formations possess will remain relatively constant in a normal
environment (think Central Limit Theorem). Since the AB=CD pattern is a type of
minimum energy wave in the financial markets where each leg represents a component
of one complete vibration, the associated price objectives and completion targets can
be accurately measured. These are the basic assumptions that help us define price
behavior, especially when conditions seem erratic.

Cosine Wave

This is the "phase-shift" of a sine wave where multiple component waves

comprise a complete frequency.

Harmonic Trading Volume 3: Reaction vs. Reversal

62
Cosine Waves in the Financial Markets

The combination of buying AND selling in the markets combines to produce a

multi-component chartable frequency that possesses clear minimum price objectives.
Although the equation mathematically explains the wave structure and the constraints
of the move, the key concept is to be aware of the minimum structural parameters for
any price segment. Of course, not every movement in the financial markets is going to
form this structure. However, it is an effective approximation tool when distinct
movements possess the properties to validate its structure.

AB=CD Pattern Element

The AB=CD pattern is extremely important because it serves as a cyclical

structural signal expressed within a defined trading period. For me, patterns represent
various types of cycles. Price action that forms clear structural patterns is signaling a
special type of consolidation, where the data set of trades forms a unique mechanical
phenomenon. Like leaves that turned their color during the fall to signal the onset of
winter, the most distinct patterns consistently signal the correct probable future price

Harmonic Trading Volume 3: Reaction vs. Reversal

63
action in this regard well before their fruition. The AB=CD is that cycle to comprise the
basic element of the structural phenomenon that has formed. The ratio measurements
are extremely important but without the element of the AB=CD structure, they are
nearly meaningless.

• The AB=CD pattern is a 4-point price structure that is a minimum

requirement for most harmonic pattern setups.
• The AB=CD pattern is a structure comprised of two equidistant price
segments that possess harmonic ratios.
• The exact completion point of the AB=CD is the most significant price
level, while the BC projection complements the area.
• The C point will be a defining level for the completion of the pattern,
establishing the Reciprocal Ratio.

Bullish AB=CD Pattern

Harmonic Trading Volume 3: Reaction vs. Reversal

64
 The Bullish AB=CD structure is a minimum element in all patterns. The ratios
that comprise the structure are critical in complementing the completion point.
Although the AB=CD completion point is the most important minimum for any pattern
consideration, the BC projection measurement is critical in confirming the completion
for the opportunity.

Bullish AB=CD Pattern

This 60-minute chart in the Euro/Dollar exemplifies what an intraday AB=CD

pattern looks like. The structure possesses two distinct legs that were each
approximately 125 pips in length. On the exact hour that the price action tested this
zone, the market reversed. The most important point of this chart is to notice the
distinct structure. These are the type of formations that must be considered. There are
many nominal Zig-Zag type formations that do materialize but if you find yourself
forcing the search then the price action you're looking at is probably not a valid
structure.

60min - EMA131.36 EMA20 1.36 1 EMA50 1.35 SMA50 1.36 1 SMA200 1.31 I VolaUBty Bancls(20.2.0)

<S >- zz 0.0010 110.01 <t »- 110.1 4 J>- 11 1.0 <? zz 10.0

1.3750-
Euro Dollar (EUR_AO-FX): 60-Minute
0
Bullish AB=CD Pattern
i/i 1.3700
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1 22 Mar 1 23 Mar 1 24 Mar ! 25 Mar i 26 Mai-


yr '

EUR A0-FX 22-JUN09 26:00 Harmonic Analyzer (TM) v6.05 Copyright 2601-2008 HarmonicTradfr.com. LLC. All Right* Reserved

Harmonic Trading Volume 3: Reaction vs. Reversal

65
Bearish AB=CD Pattern

The following bearish illustration serves as an important minimum target in all M

and W formations. The structure is quite distinct and possesses a limited range of BC
ratio projections to complement the exact completion.

Harmonic Trading Volume 3: Reaction vs. Reversal

66
Bearish AB=CD Pattern

The following 15-minute Euro/Dollar chart exemplifies what an ideal structure

should look like. The symmetry of the pattern was quite distinct and the exact AB=CD
completion point capped the strong intraday rally. The structure was projected to
complete at 1.4933 and the reversal topped out at 1.4940. Also, the price action stalled
immediately after testing all the numbers in the Potential Reversal Zone. After a few
sideways individual price bars, the reversal accelerated.

15nsn   EMA131,48 EBA201.48I EMA501.48 SMAM 1.481 SMA200 1.48 VoWdity Bantfe<20.2.0)

>- Z70.W195 O- H0.0121 iy ZZ0.1 zz0.50S4 <>  2425.16705

1.4950
L4B=CDf $1,493

.4925
EuroDollar (EUR_A0-FX): IH
15-Minute
1.4900
Bearish AB=CD

1.4800

1.4775

14 16 18 20 22 00 02 04 06 08 10 12 14 16 18 20 22
1 4 Mav

Settings V#0) 9,537 HVROB0-6S 0.54 RSK14j 47.65 S1odt(14.3}22.9 f.1ACD(12-269) 0.00 Hist: 400 ADX(14)22.54 15.33 18.86 CHf(21)0.062 AccumDiss(20)

EUU8FX W MAY-IHMI Hjmciut.Oduff (TMhiO? Copyii-lii* .'Oil M HmwiutTndmora. LLC. .U1 Riskts Rwenri

Harmonic Trading Volume 3: Reaction vs. Reversal

67
Harmonic Ratios -> Reciprocal Ratios

Reciprocal Ratios are based upon the inverse relationships of retracements

versus extensions. These are generally employed to measure and complement pattern
completion points. In terms of the AB= CD structure, the retracement ratio can identify
the expected extension measurement. We will look at these relationships in detail when
we review the 5-0 pattern but for these purposes, we will review their significance.

Retracement Extension

0.382 > 2.24, 2.618, 3.14, 3.618

0.50 > 2.0
0.618 > 1.618
0.707 > 1.414
0.786 > 1.272
0.886 > 1.13
1.0 > 2.0

Perfect AB= CD

The most symmetrical and harmonic of all structures is the perfect AB=CD
pattern. Although other ratio combinations to signal valid starting points, this particular
structure was initially identified in my book Harmonic Trading Volume 1. I presented a
number of perfect pattern alignments but the most important of all of these is the basic
AB=CD structure with the 61.8% and 161.8% harmonic ratios. The perfect pattern
alignments do present the most ideal structures as they relate to the harmonic ratios.
Clearly, the AB=CD element is critical to all structures but without the harmonic
proportions of the 0.618 and 1.618 measures for example, we would simply be
assessing random structures. We know that these elements are essential to define
structures as harmonic. Again, without the standards and constant torsional
requirements, all assumed relationships are random assumptions.
The premise of capitalizing on the natural cyclical phenomenon requires that we
respect the measurements and execute their prescribed levels. The perfect structures
give us the ideal symmetrical model that is closest to what the natural model is
exhibited. From general standpoint, these measurement structures can be overlaid with
real-time scenarios with a tolerance for some deviation from the ideal. But, it is an
effective means of guiding decisions and providing accurate information regarding the
predominant trend to optimize executions, reduce risk and maximize profit. So, these
perfect structures give us unique situations that possess greater potential than other
patterns. However, there will be typically less opportunities.

Harmonic Trading Volume 3: Reaction vs. Reversal

68
BC Layering Technique

One of the secondary measurement considerations that is useful is to assess the

larger possibilities utilizes a secondary BC measurement in each pattern. This might be
slightly different with each ratio combination but there are other complementary
measures that help create more defined execution zones when two BC measures are
employed.
When we are talking about primary BC measurements, in most cases it will be
focused upon the completion of a basic AB=CD structure. These are helpful in the
clearest of cases and best integrated with the clearest ratio combinations. For example,
an AB=CD structure that possesses a 1.13 extension will be rather tight. However, the
1.27 level effectively complements these pattern types. Although the AB=CD point is
frequently exceeded in most pattern cases, the layering measurement defines the
permissible level of tolerance for price action to exceed this area. Although the
technique can be applied to all harmonic ratios that define patterns, specific measures
are more effective than others. I will show some basic relationships and try to keep it
simple. I could go through dozens of combinations but I feel that the basic concept can
be best represented in the perfect harmonic ratio situations.

Bullish AB=CD Pattern with BC Layering Technique

Employing the most common BC layer situation that utilizes a 1.618 and a 2.0 BC
extension with the AB=CD pattern, we can create an effective tolerance to facilitate
decisions at support/resistance. In the bullish harmonic support zone, the 1.618BC

Harmonic Trading Volume 3: Reaction vs. Reversal

69
extension will precede the exact completion point pattern. In these situations, the
AB=CD is the most important point within the range but the real-world trading action
can exceed this area. This is when 2.0 BC measurement serves to gauge how far the
opportunity can tolerate this trading action beyond the ideal measured level. In other
situations, the BC layering technique can help to optimize stop loss measures as well.

Bullish AB=CD Pattern Potential Reversal Zone (PRZ)

with BC Layering Technique

Since the AB=CD is a mandatory minimum, it is common for price action to

exceed this area on the initial test and indicate that the Potential Reversal Zone will not
be valid support. We will look at confirmation strategies later in this material. However,
the additional BC layer at the pattern's completion point adds a degree of precision to
these situations.

1.618BC

AB=CD
2.0BC

Harmonic Trading Volume 3: Reaction vs. Reversal

70
 The following chart of the British Pound/US Dollar exemplifies how real world
trading action can exceed ideal patterns. This situation exemplifies how price action can
be somewhat skewed and reverse in irregular fashion. Clearly, the AB=CD structure
defined support at the 1.4430 level yet the price action stabilized below this area before
reversing significantly. The AB=CD structure possessed a 2.0BC extension and the next
harmonic level of the 2.24 serve to gauge the excessive action beyond the ideal
support.

15m * EM13U5 EMM I EMM SUM I M

h all 11-
.i 22 0.01 %} 
. 110.1
... 
il 271.0 if.
|.. 2210.0

1.4540

i* M British Pound/U.S. Dollar (GBP_A0-FX): u»

f* 15-Minute 1.4520
1
l •M
Bullish AB=CD Pattern
r- • \ n/x 1 I  11.4,19
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ii! !

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1.4460

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n no 02 04 05 08 10 12 14 18 IS 29 22 90
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r.w> tLmure.u ia-tt ^ir^ft»rUilwrfTVfh^r<tttTwl>t£ 'Ill.'llSWinndBtfTpUpffAtt Ilf 411

Harmonic Trading Volume 3: Reaction vs. Reversal

71
Bearish AB=CD Pattern with BC Layering Technique

In the bearish harmonic support zone, the 1.618BC extension will precede the
exact pattern completion point. In these situations, the AB=CD is always the most
important point within the range. This is when 2.0 BC measurement serves to gauge
how far the opportunity can tolerate this trading action beyond the ideal measured
level.

Harmonic Trading Volume 3: Reaction vs. Reversal

72
Bearish AB—CD Pattern with BC Layering Technique
Potential Reversal Zone (PRZ)

The AB=CD is a mandatory minimum but it is typically exceeded. The initial test
will validate the Potential Reversal Zone as important resistance. The additional BC layer
creates an additional tolerance to gauge the price action at the completion of the
pattern.

2.0

AB=CD

1.618

The following example of a Bearish AB=CD in the NASDAQ 100 index possesses
a 1.618 and 2.0 BC extension with the AB=CD completion point in the middle.
Although this is a perfect AB=CD structure, the 2.0 BC layer provides a critical gauge of
tolerance beyond the ideal measure. Both the completion point of the pattern and the
1.618 BC extension defined the area just above 4700 as critical harmonic resistance
while the 2.0 measurement serve to define the limit of the structural possibility.

Harmonic Trading Volume 3: Reaction vs. Reversal

73
 "NDX 28 OCT-16 HamoiikAiulncr (TM)rf.05 Copyright® 2001-2008 HoimomcTrador.conL LLC. All Righti Rtiem-d

Daily   EMA134.319.92 EMA20 4,327.09 i EMA50 4.386.26 [ SMA50 4.43724 ! SMA2Q0 4,385.1? Volatility Bands(20.2.0)

t>- zz0.0010 i zz0.01 O- zz0.1 i J>- zz 1.0 W- zz 10.0

4.900.1
2.000 % $4,848.2002 (+795.0801 +19.62%)

4.800.1

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4.400.1

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_L.Qct._ J Nov ..L_ Dec l .2016
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*NDX 28-OCT-16 Harmonic Analyzer (TM) v6.05 Copyright @ 2001-2008 HamomcTrader.com, LLC. All Rights Reserved

Harmonic Trading Volume 3: Reaction vs. Reversal

74
Alternate AB=CD Pattern

Originally outlined in my first book The Harmonic Trader; I believe is to review

Alternate AB=CD variations that work well in specific situations, especially when the
formation does not come together. When we consider these alternate variations as a
different form of a sine wave in price action expression, there are different expectations
that must be aligned with the structural types. Although sometimes more
complementary than others, they are as effective specific pattern situations.

Bullish Alternate AB=CD Pattern

The Bullish Alternate AB=CD pattern was derived from my research of structural
differentiation. In patterns such as the Alternate Bat and Crab, this extended formation
was a reliable measure among many possibilities.

75
Bullish Alternate AB=CD Pattern
In all of my software, I have programmed various combinations of alternate
structures. These can include 1.13, 1.27, 1.41, 2.0, etc. These are more
complementary measures in specific situations however I must stress that the 1.618
AB=CD is a unique creature unto itself. The following 15-minute chart of the Australian
Dollar versus the Japanese Yen shows an ideal extended AB=CD formation.

MA13S1.50 HM08150 1 mmtW SMA5031.33 8 SMA20B81.02 Volatility BaidsROZOl

|R 220.01 <>• 220.1 O- 221.0 l

< >- ,2210.0

§2.25
A Australian Dollar/Japanese Yen
82.00
11 *....   **
(AUDJPY_AO-FX): 15-Minute P,81.75

81.50
U |

81.25

ji-iJ 81.00

80.75

80.50

80.25

80.00

79.75

1? Feb IS Feb 19 Feb 21 Feb

R-16_18:08 Hirmonif Analyzer (TM) uS.B? Copyright* 2001-2(108 HinmmttTndfi.cora. LLC. All Rights Ktsttwd

This pattern completed at 80.05. The interesting aspect of this decline was the
price action as it tested the equivalent completion point for the AB=CD which was
projected approximately at 80.75. When the price action tested the equivalent level, it
declined sharply and accelerated to the alternate 1.618 calculated level. This is an
oversimplification of utilizing the alternate measure but exemplifies how the market will
manifest failed signals of demonstrative price action when the particular possibility is
not valid. In this instance, the acceleration beyond the exact equivalent AB=CD was the
immediate warning sign.

Harmonic Trading Volume 3: Reaction vs. Reversal

76
Bearish Alternate AB=CD Pattern

As we outlined the different rules for pattern structures, these alternate types
will become readily apparent as to their most effective application. The simple
awareness as an alternate possibility above and beyond the equivalent formation also
provides price objectives when price action exceeds the minimum completion point.

Harmonic Trading Volume 3: Reaction vs. Reversal

77
Bearish Alternate AB=CD Pattern

The following chart of the British Pound/Japanese Yen exemplifies the extended
structure that these alternates possess. Despite the lack of symmetry, the initial AB leg
does possess relevant measures that can be projected. In this case, the 1.618 AB=CD
structure at the 157.35 level served as short-term resistance on the intraday chart.

m * ' aWMfil »i YS,7> 9HStlS5i| SN VoW«yBands|2C20)

HI umvi i'h sttf (;} 841 z/to 0, nm

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GBPJPV.yre 8-APR-MM Huank/ta}per{IM)<iiB C«fjii»kt# MM Hamimi(Tniltt.ti)«, LLC. .ID Rights Rwnri

B Point Tolerance Classification

One of the earliest breakthroughs that I made in my classification of M and W

formation types was the specification of their alignment. The AB=CD structural variation
was an important price differentiation to distinguish similar possibilities. However, it
was not until the release of my first harmonic scanner software, the Harmonic Analyzer
that I was able to finally research and distinguish each structural pattern

Harmonic Trading Volume 3: Reaction vs. Reversal

78
point. Released in 2001, this is the first harmonic pattern program ever created. The
rules for pattern algorithms were programmed from my first book The Harmonic Trader
and design to find valid opportunities automatically. If you like to access this program,
please go to the website and download the free version at www.HarmonicAnalvzer.com.
The program has enabled me to test pattern alignments with unprecedented precision
and refine the structures immensely. One of the most profound breakthroughs was our
specification of the prescribed ratio alignments at the B point. Although this was one of
my primary tenets to differentiate similar price structures, I was not able to exactly
define acceptable tolerance limits until we had the power of the Harmonic Analyzer
software to reveal the optimal results. Although there are a number of possibilities, I
have been able to categorize precise patterns with B point tolerance limits that possess
to the following constraints.

• +/“ <3%: One of the first structural types that I differentiated was the
Gartley versus the Bat pattern. Essentially, my initial research showed that the
Gartley only worked when it's B point was within a close proximity to the 61.8%
limit. We will look at the specifications later in this chapter but the results were
profound. My research proved that those Gartley structures that had a B point
that was +/-3% of the ideal 61.8% level yielded opportunities with the greatest
potential. This means that any M or W structure with a B point between 58.8 -
64.8% was the valid tolerance for variation beyond the ideal measure. In all
other cases, it would typically default to a Bat pattern if it was less than the 3%
tolerance or become invalid above the upper limit. I must emphasize that this
strict definition also applies to Butterfly patterns. These small distinctions have
been instrumental in eliminating those structures that appear similar but are
flawed from the start.

• +/- <5%: The 5% tolerance is applied to B points of most other structures.

Although the Gartley and the Butterfly are two strict examples, the 5% tolerance
at the B point is effective when analyzing Bat patterns in particular. Again, the
purpose is to generally categorize what type of structure we are dealing with but
the tolerance limit goes a long way to creating finite of defining valid
opportunities.

Harmonic Trading Volume 3: Reaction vs. Reversal

79
Gartley Pattern

Elements:
B Point Ratio: 0.618 (+/-3% Tolerance)
AB=CD-1.27AB=CD
BC: 1.13-1.618
XA = 0.786
Stop Loss >1.0 (Depends upon AB=CD)

Bullish Gartley Bearish Gartley

(Stop Loss Limit)

XXXXXXXXXXXXXXXX 1.0XA

0.786 XA

1.13-1.618BC
AB=CD (Minimum)
1.0XA XXXXXXXXXXXXX '
(Stop Loss Limit)

Notes:

• Wait for entire PRZ test - especially the 0.786 XA Retracement and the AB=CD -
to be tested before executing the trade.
• Initial test of pattern completion SHOULD NOT extend BEYOND PRZ = Valid
Gartley patterns exhibit decisive reversal behavior.
• Utilize area beyond 1.0 XA as make-or-break stop loss limit measure and include
the 88.6% level, especially when AB=CD completes beyond the 78.6% area.
• Price action MUST REVERSE immediately after testing the entire PRZ.
• B Point Alignment @ 61.8%XA +/- 3 max.

Harmonic Trading Volume 3: Reaction vs. Reversal

80
Bullish Gartley Pattern

Harmonic Trading Volume 3: Reaction vs. Reversal

81
Bearish Gartley Pattern

92.400

92.350

92.300

92.250

92.200

92.150

92.100

92.050

92.000

91.950

91.900

91.850

AUDJPYjtf-FX n OCT l)_»J:» Hjn »k AnjIriK (TM)«M5 Copm-klS ?WI Ml HaiTOixTmfcMiK, IXC. AD Ej-kn Rnnw*

Sm   fMJSB'W./t “002992.18 1 1 SMA2W92.20 Vola*il#y Ban<Js«20^.0i

i } HOjflio ill zzO.OI i >• zz0.1 < >. Btl ? >r zzlOJ

92.350*

/J92.2434 92.300
SMS
|6 tnm $ mu 92.250
«& 
i L'%" :

iffl11 - 92.200

92.150

92.100

I 92.050
,i |

I jiff
92.000

91.950

i 'I
91.900
i ' i
91.850

91.800
02 04 06

AmiPVAl FX rOCT-l)J5:JO Huron* AMlvwiftMlrfJf Cojxrizkl$2NI-1NI HuronkTnfcwna. LLC. All Ri»hs Kfjmrf

Harmonic Trading Volume 3: Reaction vs. Reversal

82
SPECIAL SITUATION: Gartley Pattern @ 88.6% XA Retracement

When AB=CD pattern completion extends past 78.6% retracement, other

measures and a larger tolerance must be employed to gauge the real-time action
relative to the parameters of the Gartley. In these cases, the 88.6% XA retracement
must be considered with as a defining price level for the execution of the trade.

Elements:
B Point Ratio= 0.618 (+/-3% Tolerance)
AB=CD
BC: 1.618-2.618
XA: 0.786-0.886
Stop Loss > 1.0-1.13X (Depends upon AB=CD)

Bullish Bearish

(Stop Loss Limit)

XXXXXXXXXXXXXXXXX 1.0XA

1.0XA XXXXXXXXXXXXXXXXX '

(Stop Loss Limit)

Harmonic Trading Volume 3: Reaction vs. Reversal

83
Bullish Gartley Pattern with 88.6% Retracement
ttOnun v H1A13 1.40 1-MA2U 1.41\ M I MAM UO SMASO 1.40 t SMAZOtl 1.39 Volatility 8anrt&<2U.2.0)

z 0.00195 <$ 2> zz 0.0121 <? t> - zz 0.1 <$ zz 0.50&4 <Z zz 25.10705

l||N

''Z?
i.
'' u
•« I I1»;!
II

mi i!
nk
!'
tU-i
k 1.3850

/! I

_ a.-iaos^-4^

6 Mar 10 Mar

EUR AO FX 06 APR-11 04:00 HuTMBkAnalyzer (TM) v*.0S Copyright © 200 1 2008 Harmonic Tnder.rom. LLC. AU Rights Reserved

SMAl^OO 1. :*f» Volatility B*»t»rts(20,2.0>

I §> - 2S.1<570f»

M,
l ! li

.cl

to

BAJR,

i i
lO IVfcx*
1 1.5 JVI**jr
)
 ade r.co»»», IJL.CT. All Rig,Kt» R«*«e rv»*d

Harmonic Trading Volume 3: Reaction vs. Reversal

84
Bearish Gartley Pattern with 88.6% Retracement
B4A131.76 B4A20 1.7$ % .. . EMASG i.?8 .. SMA50 178 1 .. SJ4A200 1,/-? 1 VeiaMify B*nds(2O,Z0)

« >. Zt 0410195 <i >. It 0.0121 <j>- IT*L\ tz 0.5054 <[>- TZ 25.16705

1.7750

[AB«€P # $lJ t.mxA # n,- 1.7700

1.7650

l."600

1.75JO

Euro Dollar/New Zealand Dollar

(EURNZD_AO-FX):
1.7500
15-Minute
Bearish Gartley Pattern
1.7450
With 88.6% Retracement
14 16 18 20 22 00 02 04 06 08 10 12 14 16 18 20 2,2 00 02 04 MS 08 10 12 14 16 1
4 »

ETRNZD AB FX W FEB-1119:45 Harwanir AjuJ\ier (TM)4lS-05 Cepyrifcht^ -8$l 28®8 HimooJurTraii^r com. LLC. All Ri-hw Rr-ien<-d

15rw » W,«!31.« USUOl.Kl 1B1MW SHAM 1.7? 1 SW2SBU? Volatility BamisiZOZOi

i > H0.OO195 i >. n00121 O- zzO.1 4 >. 4705054 <]>- 7725,16705

Euro Dollar/New Zealand Dollar (EURNZD_AO-FX): 15-Minute 1.7740

Bearish Gartley Pattern 1.7730

@88.6°/o Retracement 1.7720

O.S8<S % II."70S (+00131 +0.79%) 1.7710

1.7700
u
1.7690

l.'6S0

1.7670

1.7660

till 1.7650

1.7640

1.7630

1.7620

1.7610
I
\ I
m
ll 1.7600
10 02 04

fTR.NZD_A8 RM FEB 1114:45 Hjmoiik.Sjul;-m(TM)i4.eS C«pvrigki* .m»08 BuauikTnitMM, LIC. .ill Rein Rmhm4

Harmonic Trading Volume 3: Reaction vs. Reversal

85
Bat Pattern
Elements:
B Point Ratio: 0.382-0.50
AB=CD-1.618AB=CD
BC: 1.618-2.618
XA: 0.886
Stop Loss > 1.13X (Depends upon AB=CD)

Bullish Bat Bearish Bat

(Stop Loss Limit)

XXXXXXXXXXXXXXXX 1.13 XA

0.886 XA

1.13-1.618BC
AB=CD (Minimum)
1.13XA XXXXXXXXXXXXXXXX
(Stop Loss Limit)

Notes:

• Expect PRZ test of 0.886 XA Retracement with minimum AB=CD (Typically

1.27AB=CD).
• Initial test of pattern completion can test close to 1.0XA.
• Utilize 1.13 XA as make-or-break stop loss limit measure.
• Price action MUST REVERSE immediately after testing the 0.886 XA Retracement.
• B Point Alignment @ 50%XA +/-5% Max

Harmonic Trading Volume 3: Reaction vs. Reversal

86
Bullish Bat Pattern
60mm » EMA13 1.53 EMA201.53 I EMA501.53 SA1A50 1.53 S . SMA20D1.51 Volaj«yBands220ZO)

4>. 22 0.00195 H 2/0.0121 4 >. 2Z0.1 4 3>. 220.5054 4 p. 2225.16/05

1.34301.
British Pound/Swiss Franc (GBPCHF_AO-FX):
60-Minute r 1.5425
Bullish Bat
1.5400
• 1 |
j,« : .1 . i
1 | i-: 1.53~5

i 1 X
1.5350

!iy i If i ili-, i
iy i 1.5325

i Is at l| 1.5300

!i 1 • „-" V ij i
i' 1 -
1 li V % y *»!  1.5275

'1- ’ ft (1 1.5250
sm
\ 1.5225

-mm mf-mi 1.5200

1.5175
1,<I8AB=€» § $1,520

I 14 Jan ! 16Jan 1 l'Jan L lSJan 1 l?Jan .... JL 20 Jan 21 Jan 5Jan 1.5150-
i

GBPCHF AS-FX ! 1 MAR ! 112:00 Hin»£P.KEiuJ'Tf r (TM} ifcjp Csprci£At& 2B61 2888 HfflMBkTndtnmn. LLC. A0Ri*fetj Rripnf4

60mm » EMA131.54 EEW20154 | EMA50 1.53 SMA501.53 I S11A2001.52 VolSatyBandsOTZO)

4 } 22a00195 <>- 220.0121 4 > 220.1 4 >- 220.5054 4 »- 22 25.16705

British Pound/Swiss Franc (GBPGHF_AO-FX):

60-Minute
Bullish Bat Potential Reversal Zone (PRZ)

1.5150

1 19 Jan i 28 Jan 21 Jan 1 2JJ;

GBPCHFA8-FX 11 -MAR-11 12:18 Kara***Aaalner<TM)»Ct? C^fvrigfel$ Mil 2088 HamaakTr^fr.cca LLC. All Rijktj Rfwivrd

Harmonic Trading Volume 3: Reaction vs. Reversal

87
Bearish Bat Pattern
15mtn   6MA131411 EBA20 14)1 1 EMA50 IjOI SMA501JD11 ' ’ SBA200 1.01 VotaWyeandsfTCUAi)

i y 2204)0195 < >- 22(10121 IS 22 0.1 <[>- 220.5054 <;>. 2225.16705

1.0120*

1.0110
mu%nm
141SEC m il 1.0100

1.0090

1.0080

I
»1.00_0
M
1.0060

1.0050

US Dollar/Canadian Dollar (CAD_AO-FX): 1.0040

Bearish Bat Pattern
1.0030

10 14 16 12 14 16 18 20 22 02 04
.JL 26 Dec

CADAIFX ] 1-UAR-ll 11:49 HamndcAintawi Ccpni»ki * MSI-MW HairosiT rafctt.ra, LLC. All RijlB RtKiwd

15mm   EMA131.01 EMA20 till 1 EHA50 Ull SMASO UJt   smm 1.81 Vdatilfcy 6and$(2CU JJ

4 >  22 000195 4 >- 22 0.0121 < >• . 22 01 <j>- 22 0.5054 4\y 27 25.16705

US Dollar/Canadian Dollar (CAD_AO-FX):

11104 Bearish Bat Pattern 10110
Potential Reversal Zone (PRZ)
1.0105

IjflSBC % $
1.0100

1.0095

1.0090

1.0085

1.0080

1.0075

1.0070

16 1.0065
26 Dec

CADA0FX 11-MAR-11_11:16 HuntoraAjulrter(TM)tlL05 C«pyri«ht $ -8811098 Hinas aif Trader, com. LLC Ail Rights Rwenrd

Harmonic Trading Volume 3: Reaction vs. Reversal

88
Alternate Bat Pattern

Elements:
B Point Ratio: 0.382 Max (-3% Tolerance)
AB=CD-1.618AB=CD
BC: 2.0-3.618
XA: 0.886-1.13
Stop Loss > 1.27X (Depends upon XA Measurement)

Bullish Alternate Bat Bearish Alternate Bat

(Stop Loss Limit)

XXXXXXXXXXXXXXXX 1.27XA

1.13XA

2.0-3.618BC

1.618AB=CD
1.27XA XXXXXXXXXXXXX ' (Minimum)
(Stop Loss Limit)

Notes:
• Expect PRZ test of 0.886 XA Retracement as minimum but these situations must
incude the 1.0XA.
• Utilize 1.27 XA as make-or-break stop loss limit measure espeecially when the
1.13XA level is relevant.
• Price action MUST REVERSE immediately after exceeding 1.0 XA general
retracement area.
• B Point Alignment @ 38.2%XA or LESS with 3% tolerannce max.

Harmonic Trading Volume 3: Reaction vs. Reversal

89
Bullish Alternate Bat Pattern
ISmn » EMA13 133.70 FMA20 133.67 8 EMA50 133.51 SMASO 133.42 i SmiW VAtt Volau&ty B;mds(20,2.0)

4 >- hO.OOIO 4 >• 120.01 4 >- 77 0.1 <1^- ai.o 4 > aio.0

134.10
134.00
(L85(L\B 133.90

I  . j 
133.80
II 133.70

M 133.60
I. I-   133.50
133.40
:
% ; i if;
Iltri 133.30

I V
««7 Dt!^ 133.20
 v*   133.10
ty 133.00
’>
132.90
132.80
132.70
132.60
16 18 20 00 02 04 06 08 10 12 14 16 132.50
26 Sot

EOUPY .U FX r OCT I) 05:W HuwMirAmhKI (TM)v«J5 Ccpm^il * 301 :m HimeBkTr»fer.t«». LLC. AU Ri-fco RttmT0

mm * EMA13133.71 EMA70133.MI EMA50 133.44 SMASO 1 33.34 I SMA/GO 13321 VoWAlyBandaMZOl

i >. n0.M10 4 > 770.01 < >. 77 0.1 <j>. 7710 <J>. nlQ.O

133.80*
| --- 3 "I !
Dl.’O
I 133.60

I I 133.50

I !

I 133.40

.
1133.30

% I 133.20

• . 133.10

133.00

132.90
032.9653
132.50

132.70

04 06 08 10 12 14 132.60,

EURJFYA0FX P OCT D Of :08 HaimonkAftilvier (TM3v6J5 Copvri*k! £ 2101 -2081 HimeBkTndfr.tem. LLC. All Ri»ko

Harmonic Trading Volume 3: Reaction vs. Reversal

90
Bearish Alternate Bat Pattern
1*n*» S CMA50QJM SMA50 0.08 M SMA700 Q.88 VOMtiMy BamtsCMUMI)

i > 77 0.00285 <>- Z7 0.Q1?t 77 0.09 <[>- 72 067268 < n 26.16/05

n S9TH1
1.130 c W.SS9S ( +€.0154 *1.76U
Swiss Franc (CHF_AO-FX): 15-Minute 0.SS90

Alternate Bearish Bat Pattern O-SSSO

ossto

0.SS60

0-SS5O

0-SS40

!i- 0JSS3O

0.8820

0-SS10

| o^soo
OS*90

0.$*S8

8.S778

QJt/68
08“5O

0-8”4IJ

m m n u is m 22 m 02 la 12 it is IS 20 22 no 02 04 Ofi 08 M 12 14 16 02 84 68 OS IS 12
I 20 Mav¬ 22 Mav 23 Mav 24 M:

CHFA8-FX 24-Jt8« HwTmnkAiuJvirf (TM)v4uB5 C*j>vrishi * !W1 !*•» HarmonVTrWrj.m. LLC. AD Rigte RrM-rw4

15fntn *r 1 BSW50 0.88 smsoo-oa i S&A700 0.88 Votof#yBafwte<aZBl

'4 > 77GJ0206 O 770.0121 <j>. 770.00 €!>- 77 0J57268 4> 7726.18705

Swiss Franc (CHF_AO-FX): 15-Minute 0.8900

1.138 c HQ m% ( -0-0154 *1 “6«* )

1 Alternate Bearish Bat Pattern 0.SS90

Potential Reversal Zone (PRZ)
0.8880
i.8864
O.SS’O

22M8BC % mmi
0.8860

0.8850
Ul$AB*CD# S0 SS44

0.8840

0.8830

0.8S20

0,8810

I ii 10.8800
14 16 18 20 22 00 02 « 06 08 10 12 14 16 18 20 22 00 02 04 86 OS 10 12 14 16 18 20
23 Mav
*e— ZA Mav

CHF .« FX SUESHir~«i<V»iJfi»tOai)t«.85 C.pvT«Hs »14«l HanaMkTnfcuMi UC. Al) Rijl« Kn.nH

Harmonic Trading Volume 3: Reaction vs. Reversal

91
Crab Pattern

Elements:
B Point Ratio: 0.382-0.618
AB=CD-1.618AB=CD
BC: 2.618-3.618
XA: 1.618
Stop Loss > 2.0XA (Depends upon AB=CD)

Bullish Crab Bearish Crab

(Stop Loss Limit)

XXXXXXXXXXXXXXXX 2.0 XA

1.618 XA

2.618-3.618BC
1.618AB=CD
2.0XA XXXXXXXXXXXXX ' (Minimum)
(Stop Loss Limit)

Notes:
• Expect PRZ test to exceed 1.618XA with volatile price action.
• Utilize the area beyond the 2.0 XA as make-or-break stop loss limit measure
especially when the reversal at completion point is extreme. In these cases,
price action MUST REVERSE immediately after exceeding 1.618 XA general
retracement area.
• B Point Alignment not less than 38.2% but can be up to 61.8% B point.

Harmonic Trading Volume 3: Reaction vs. Reversal

92
Bullish Crab Pattern
15mm * f«A13U4 EMA20W11 f HAM 04 SHAM 1.34 ( SHAM 07 Vol4M#y&3raJs(20i.0i

O- H0.00195 i >. «0J)121 <i>- 120.1 <j>. 220.5054 <[>. 2225.16705

A ... 11450.'
Euro Dollar (EUR_AO-FX): 1

15-Minute 13425

t IL
Bullish Crab
ill
V#
\
jI 1.3400

K
^ ’< I 13375
fl
.1 13350
k fl /' ^ 'i,-.,

' 1j
r %
13325
L 1'
1330
j.
%v S'§
ll': Ini•<i i.
\
\ !  Mil 13275

t fRUTEFWth 1

ZS21ZZ 13250

02 04 KB U 11 li M 12 14 16 IS 20 22 SO 02 04 W 0$ M 12 14 16 II 28 22 « 82 04 06 OS 18 12 14 M IS 20 72 EB 113225
I 16 Jan 1, l’Jan I 18 Jan J
< 

Settings VoKM* 17.5)2 ffiWOO-6) 0.78 RSM14) 44.11 Stochf 14-3) 33.0 MACDC12 26S) OOOHist; 4L00 ADX|14! 27.22 19.62 -24.5? Off(21MU)45 Accumttss(20j
~~~ ...-.1_r.
EVR .48-FX 18 MAR II 17:84 H»ra«k.4jnli-ttr (TMtriJj Ceprri^Ki % 28810841 Hirms&kTridf r.com. LLC. Ail Ri;l>B Rmhw4

15mm * I MAI J 1.14 I.UW201.34   4HA501.34 . . SHtt01.34 I StMUi VoM*ty8«lds<20£S)

<> ntmm <:5>. 22041121 <;>- u«.i <>- 2Z 0.5054 '<(>. 22 25.16705

I Euro Dollar (EUR_AO-FX): 15-Minute

1.3350
1 *i .Bullish Crab Potential Reversal Zone
'4 <u W - , (PRZ)
1.3325

it *i *11
ifo 1.3300
•j
1 p 1  " . 1 •,
® to* 1 l | 1.3275
1
r I I

l£mA%%l3U 1.3250

1.3225

JHOO % S1370S (-0JJ2O8 13584)

1.3200

18 20 22 00 02 04 06 08 10 12 14 16 18 20 22 00 02 04 #6 08
1 17 Jan I

Settings V0K6O) 5,116 HVW08-6) 0.71 RS((U) 32.51 StocM14 3) 17.9 M*CD(12-26.91 -0D0»st: -04» ADX(14) 26.12 10.56 30.90 08421104)41 Accumttss(20)

HE A4-FX l? MAR I l l.' SS HanMnk.taalrzrr (TMlvOS »: 780i HimeiurTn4r[.c«ni. LLC. All Ri^ta Efwnrl

Harmonic Trading Volume 3: Reaction vs. Reversal

93
Bearish Crab Pattern

Sm« t EHA13532.76 B4A20 533.01 f E6SA5053350 S6IA50 534.39 R 3SHA200M4 Vola1«ityBands(20.23l)

22 03)0195 O- a03)121 230.1 i>- 220.5054 < >- 22 25.16705

___ $47.50 *
j3
23)00 f$S45.7SM <+19JM8

Google (GOOG): 5453*1

5-Minute
Bearish Crab 54250

$3750
.aSEE
$35330

53150

530.00

52750

10 12
11 Oct
«

Settings V0K6O) 12,124 HVR) 100-61 0.01 RSt(14) 41^8 St0d*14 33372 MACD<12-26'9) 4351 Htet: -0.03 ADX{14> 30.51 18331 29.61 0*121)0.049 Accut»ttss{2»)

GOOG 2s NOV IS 0955 HvmsiutAlulnei (TM)\t Q5 Cnj>vri.1il t 2001 2008 HirmenjtfTrjOfr.tera. LLC. Ail Ri*6a RfteneO

5ntat ' EMA13535J38 EMA20 534.92 I EP4A50 5343)5 S4.1A50 534.04 i SMA2W 532.62 Volatility Barctsi20Z0)

<>. 2203)0195 <,>. 2203)121 2 >. 220.1 <j>. 22 0.5054 tj>- 2225.16705

550.00
Google (GOOG): 5-Minute
Bearish Crab Potential Reversal Zone (PRZ)
547.50
23)00 (6 $544.7300 (+W4600 +3539,)

545.00

542.50

537.50

535.00

12 532.50

Settings Vol(60) 26,182 HVR»; 100-6) 0.60 RSK.14) 49.31 Stoch* 14-3) 64.9 MACCH1226-9) 0.35 Mist -0.66 A0X(14) 21.45 2121 20.83 CttFgf) 0.156 AccunvD«^20)

GOOG 16-NOV-18W55 Hira»*kAialmr Capm^i $ m>M* HirmtutTnitTsom. LLC. All Ri-fctt Restnri

Harmonic Trading Volume 3: Reaction vs. Reversal

94
Deep Crab Pattern

Elements:
B Point Ratio: 0.886 (+5% Tolerance)
AB=CD-1.618AB=CD
BC: 2.0-3.618
XA: 1.618
Stop Loss > 2.0X (Depends upon AB=CD)

Bullish Deep Crab Bearish Deep Crab

Notes:

• B point @ 0.886 XA Retracement is a minimum that must be t estedd to trigger

the structure and possesses +5% tolerance.
• Utilize 2.0 XA as make-or-break stop loss limit measure.
• Price action MUST REVERSE immediately after exceeding general 1.618 XA area.
• B Point Alignment @ 38.2%XA or LESS up to 5% max above 61.8% level.

Harmonic Trading Volume 3: Reaction vs. Reversal

95
 Bearish Deep Crab Pattern
tSOrnm » att1308S EMA20 0.95 1 EHA58&9S SHAM) 0.961 SMA200D.95 Vc«#tsr8and$(20Z0)

Settings VolitiO) 13,414 HVR(1006i 0-71 RSt*14) 6193 Stochi143}77.9 MACW12-26-9) 0.00t*st: 090 ADXtll) 25.49 1796 9.73 CMf(21)0.205 Accumftssi20)

AUDCHF_Afl FX ll-MAR-ll U:0fl HjnmnitAMlmrtTMMtflf C«pvri»ltt» Mi-Mi HurntnurTnlcuom. LLC. ADKijkB Rnrrvtl

mnm * fMAl.30.96 f:MA?I)0.«l Et.MsOO.96 SIM50 0.W I SMA2000.95 Vt*ttil»y8ands(20.2.0)

4 >- u0.00195 i >- 7/0.0121 i }- 7/0.1 §g. 2706054 4}- 7/2516705

Australian Dollar/Swiss Franc (AUDCHF_AO-FX): 09 50

2000 rg {0.9735 {+OJ3376 -43t2*«) 60-Minute
0.9725

0.9700

0.9675

0.9650

0.9625
• I
0.9600

0.9575

0.9550
Potential Reversal Zone (PRZ)
25 Ocl 20 Oct 2'Oct 2S Oct

Settings Voli60) 44.262 WR(100 6t 0.61 RSNM) 60.12 Stoch( 113)64.S MACOt12 269) OJOHts): 0.00 ADXI14) 12.76 18.11 1512 C«<21)0937 AcctanOtss(20)

AtDCHF .Efl FX ls \!AR II I.'Of H&nn&iuc Iruiyifi (TM)t69? CoprrifhlS 2601)888 HaimonicTraAf uaia. 11C .41]Ri^tib Rfienri

Harmonic Trading Volume 3: Reaction vs. Reversal

96
SPECIAL SITUATION: Crab/Deep [email protected]

The 1.902 is an additionnal measurement that I encountered in Bryce Gilmore's

Geometry of Markets (Traders Press 1989). I found it worked extremely well in
extension patterns like the Crab that experienced strong price action at completion
point. It is a complementary tolerance measure effective in specific situations.

Elements:
AB=CD-1.618AB=CD
BC: 2.0-3.618
XA: 1.618-1.902
Stop Loss:> 2.0 (Depends upon 1.618-1.902XA)

Bullish [email protected]

Due to the extremity of this structure type, it is common to observe extreme

price action as the pattern completes. The key is to observe the price behavior as all
the numbers at the harmonic support are tested and include the 1.902 measure as an
additional tolerance limit beyond the 1.618.

Bullish Crab Pattern

Potential Reversal Zone (PRZ)@1.902XA

xxxxxxxxxxxxxxx
Copyright HamwM«cTra<J«r I..1X.

Harmonic Trading Volume 3: Reaction vs. Reversal

97
 6011*1   EMA131.10 EMA201.10   EMA501.10 SMA501.10I SMA200 1.09 Volatility Baiuls|20.2.0)

i $ 77 0.0010 i t>- 110.01 i 2>- 17 0.1 i $ zzl.O O- ZZ10.0

J, 1.1200

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#v'tfjvs
I
if1 Tl
1.1150

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Hul 1100
j| > - J3.786AB 1.1050

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r =: S?.

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20W8C § $1.085^iO18AB=CD # $10851
1.0850
1.902 % $10828 (-0.0230 -208%)

1.0800

J.7 Mar 8 Mai 9Mar 10 Mar JL_11 Mar.113 Mar.J.„ 14 Mar

<

EUR AO-FX 22-APR-1610:00 Harmoak Analyzer(TNT)v6.05 Copyright© 2001-2008 HamumkTrader.com, LLC. All Rights Reserved

60min T EMA131.10 EMA201.10 1 EMA501.10 SMA501.10 I [ SMA200 1.09 Volatility Bands{20,2.0)

1.1U30*
H
1.1025

1.1000

1.0975

1.0950

1.0925

1.0900

1.0875

1.0850

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JMar.____ I . 10 Mar. .11 Mar. I

EUR AB-FX22-AFR16_10K(0 Hamaik Aialyzor (IM) o6.D5 Copyright© 2001-20118 HirawiufTradtr.com. LLC. All Rights Rritiwd

Harmonic Trading Volume 3: Reaction vs. Reversal

98
Bearish [email protected]

The 1.902 measure increases the acceptable tolerance of extreme price action,
especially when reversals test the 2.0 stop loss limit. It is important to remember that
stop losses are placed beyond these levels. Therefore, it is essential to assess price
action as the pattern completes to gauge the validity of this additional tolerance beyond
the ideal completion point.

Bearish Crab Pattern

Potential Reversal Zone (PRZ) @1.902

xxxxxxxxxxxxxxxxxxxx
2.0XA (Stop Loss Limit)
1.902 XA

1.618 XA
2.618-3.618 BC

1.27-1.618AB=CD(Minimum)

Harmonic Trading Volume 3: Reaction vs. Reversal

99
Bearish [email protected]
60nim w FMA13 79.29 /, BJA20 70.21 1 jBAASO 79.11 . J SMASH 7&M   S«A200 79.30 Volatility BatHis<20,2.0)

«!'». 720.0010 <|>: 220.01 .<!>. 22 0.1 « ». 221.0 <i». J 2Z 10.0

80.75

80.50

80.25

80.00

I
79.75

79.50

79.25

79.00

78.75

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AUDJFYAfl-FX 22-SEP-16_16:fll H>moMtAita]yzer(TM)v{.05 Copyright© 20012008 HaxmonicTTader.com, LLC. All Righti Reieircd

Harmonic Trading Volume 3: Reaction vs. Reversal

100
Butterfly Pattern

Elements:
B Point Ratio: 0.786 (+/-3% Tolerance)
AB=CD-1.27AB=CD
BC: 1.618-2.24
XA: 1.27
Stop Loss > 1.414XA (Depends upon AB=CD)

Bullish Butterfly Bearish Butterfly

Notes:

• B point must be a precise 0.786 XA Retracement and requires a 3% tolerance to

distinguish these structures.
• Utilize 1.414 XA as make-or-break stop loss limit measure.
• Favor the 1.414 level especially when the AB=CD exceeds 1.27 XA level.
• Due to the nature of the pattern price action MUST REVERSE immediately after
exceeding 1.27 XA general area.
• B Point Alignment must be within the 3% parameters of the 78.6% retracement
otherwise these structures will typically form a Crab at the 1.618.

Harmonic Trading Volume 3: Reaction vs. Reversal

101
Bullish Butterfly Pattern
ISntto   .<EMA131 M , EMA20 l.M B 6M*S0 UB SMASH \M. • SI«C8»t4ie Volatility Bamhs<20.2.0)

O- 0.00195 « 2>- zz 0i)121 «!». 2*0.1 4 >- IZ 0.5054 <:>. H25.16705

1D0S0
British Round (GBR_AO-FX):
1XWT0
1.0060

1-0050

k'•I M l i J 1.0040

'1.0010

k: 1.0020

1.0010
\ *' 1.0000

0.9990

0.99S0

0.9920

0.9960

0.9950

0.9940

0.9958
16 IS a 22 00 82 84 as i» 12 u 16 is m n m 02 m 10 11 14 16 IS 28 m 02 04 06 0$ 10 12 14 10 18 20
,.....J.„„,._. 14 Feb I 15 Feb i 16 Feb

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Bullish Butterfly
1.0010

1.0000
•I
I ili v* 0.9990

0.9980
I^SJ,
0.99'0

T 0.9960

22m 0.9950

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CPRZ)
0.9930
00 02 06 08 10 12 , 14 16 18 20 22 02 04 06 08 10 12 , 14
15 Feb 16 Feb

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Harmonic Trading Volume 3: Reaction vs. Reversal

102
Bearish Butterfly Pattern
15min -- EMA13 1.280.85 EMA20 1.281.05   EF.1A50 1.280.41 SMASO 1.280.88 U SMA2Q0 1,277.64 Volatility Bamls(20,2.0)

4 >- zz 0.00185 4 t>- zz o.oi?i 4 S>- zz o.i 4 y ZZ 8.5054 4 » ZZ 25.16705

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1.29QJ
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1.2S7J

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1,2$24

1.2801

1,277j

Standard and Poor's 500 March 2011 Mini-Contract

i, 1 (ES_H1) Bearish Butterfly: 15-Minute
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4l> 220JW195 4\>- 0.0121 <j>. »a.i • *]>- noses* <$> zzts.isros

Standard and Poor's 5001,292.1

Harmonic Trading Volume 3: Reaction vs. Reversal

103
Shark Pattern

The Shark Pattern is a new harmonic pattern that I initially released in 2011 in
my Patterns into Profits course. Although I was aware of the price structure for quite
some time, I needed to refine the identification parameters to discover the best
opportunities. Essentially, the pattern is the primary structure that precedes a 5-0
formation. This structure is outside the typical M and W framework. It possesses a
unique formation called an Extreme Harmonic Impulse Wave that retests defined
support/resistance while converging in the area of the 0.886 retracement - 1.13
extension. In all cases, the completion point must include the powerful 88.6%
support/retracement as a minimum requirement. In addition, the unique extreme
Harmonic Impulse Wave employs a minimum 1.618 extension.
This combination with the 88.6% retracement defines a unique structure that
possesses two profound harmonic measures to define the minimum level. In many
cases, the price action will retest the initial starting point of the pattern and define
excellent opportunities to take advantage of a market that has moved to far too fast
within a limited period of time. These structures typically possess over-extended
price action that utilizes the "natural" state of the Extreme Harmonic Impulse Wave
which is typically categorized with reactionary trading behavior. This pattern
frequently defines excellent opportunities but these reversals are often sharp and
require specific management strategies to capitalize on the phenomenon. In many
situations, the price action will retest the prior support/resistance level and typically
result in a limited counter trend move. This structure should be handled differently
than the standard M and W patterns. In fact, the overall expectations in price action
should be short-lived and seek to capture the clearest opportunities. The Shark
pattern yields many accurate and aggressive reactions that can be successfully
traded as long as a more active management is applied.

Trading The Shark Pattern

The Shark Pattern is represents a temporary extreme structure that seeks to

capitalize on the extended nature of the Extreme Harmonic Impulse Wave.
Since it precedes the 5-0, the eventual 50% level acts as the optimal profit target.
Once executed, the position requires an active trade management strategy.
Confirmation at the pattern's completion point demands a demonstrative change in
price action character immediately following minimum test of 88.6% retracement
and the 1.618 Extreme Harmonic Impulse Wave. After these have been tested, the
price action typically will exhibit a change in direction that can be quite volatile. As
long as the minimum measures have been tested, the reversal must be anticipated
quickly thereafter. It is common for price action to exceed the minimum levels but
the overall determination of the pattern's validity depends upon the price action at
the completion point.

Harmonic Trading Volume 3: Reaction vs. Reversal

104
1.13 Extension - The Failed Wave

The 1.13 extension usually represents a failed breakout (shake-in) or breakdown

of an established prior resistance or support point (shake-out). The 1.13 harmonic
ratio is the inverse of the 0.886 and it is as important in specific situations. The
1.13 ratio represents a critical structure outside the M and W types.

Bullish Bearish

This is an divergent reversal in nature where the secondary test does not have
the strength to continue in the directio of the primary trend. The 1.13 extension
represents a make-or-break level in many retests of clear support and resistance. In
fact, price action that exceeds a critical 1.13 extension level frequently will continue
farther to the 1.27 or 1.618 areas.

Harmonic Trading Volume 3: Reaction vs. Reversal

Harmonic Impulse Waves

Harmonic Impulse waves are defined price movements that adhere to specific
ratios. These structures should be treated in the same manner as complex patterns.
These are unique structures outside the realm of M and W structures but even more
accurate in certain situations.

Bullish Bearish

Shark Pattern Management

Because the Shark pattern is a reactive trading opportunity, it requires an active

- if not automatic - management strategy. The optimal profit objectives must
anticipate a reaction to the 50-61.8 % to test the 5-0 Pattern Potential Reversal Zone
(PRZ). Specifically, the initial profit objective for the Shark Pattern should be the
LESSER OF the 50% level or the Reciprocal AB=CD Pattern - whichever comes first.
Typically, the initial profit objective will be the first price measurement in the 5-0
Potential Reversal Zone (PRZ). Although other discretionary strategies can be employed
to determine if a larger reversal as possible, in most cases the management of the
Shark pattern seeks to capture the highest probabilty price segment automatically.
Although it can be difficult to automatically secure profit targets, in this pattern it is

Harmonic Trading Volume 3: Reaction vs. Reversal

106
essential to maximize these opportunities. We will examine the important differences
that optimize these decisions.

Bullish Shark Pattern

It is important to note that I have added an additional measure at the OX

retracement of a 38.2 - 61.8% at the A point. Since this is outside of the normal M and
W measures, it does differentiate Shark structures as valid opportunities.

The Shark is an excellent structural formation but does require some

specification to avoid invalid possibilities. The key technical event is the retest of the
initial pattern point at 0. Depending upon the impulsive leg, the OB measurement will
occur after the 88.6% retracement has been tested. There can be some variation where
price action exceeds the 1.0 level and reaches for the 1.13 but this depends upon the
impulsive structure. We will look at some combinations throughout this material the
primary price event that is unfolding in the structure is a sharp retest of the initial point
that possesses some powerful reactive harmonic phenomenon.

Harmonic Trading Volume 3: Reaction vs. Reversal

107
Bullish Shark Pattern Potential Reversal Zone (PRZ)
The Shark pattern defines a unique conglomeration of impulsive and reactionary
harmonic structures that provide definitive entries. The bullish Potential Reversal Zone
defines the harmonic support at same area as the retest of the initial point pattern.
Essentially, this alignment of structures identifies an opportunity to buy at established
support. Although the 88.6% retracement is an important minimal consideration, the
larger focus should analyze price action in the area of the 1.0 XA level as well.

Bullish Shark Pattern

Potential Reversal Zone (PRZ)

0.886 OB

1.618-2.24AB

_1.13 OB
XXXXXXXXXXXXXXX (Stop Loss Limit)

Copyright HarmonicTrader L.L.C.

The key in determining whether to execute at the 88.6% retracement or the

113% extension is to analyze the impulsive minimum 1.618 extension. Depending upon
where this completes, it will dictate whether the Shark pattern will complete at the prior
initial low or there will be a situation of extended price action to the 1.13 level. If the
minimum 1.618 impulsive wave completes before the 88.6% retracement, then 2.0 or
2.24 would be use to best compliment the harmonic support. Regardless of how far the
price action trades beyond the minimum levels, the key in all reversals is to see
demonstrative price action that continues in the countertrend direction following
completion of the pattern. The following example of the Euro/Dollar possesses all of the
ideal elements of structure. The AB impulsive leg was a 2.24 extension that completed

Harmonic Trading Volume 3: Reaction vs. Reversal

108
before the OB 88.6% retracement. Since the minimum 1.618 impulsive leg was
satisfied, the completion of pattern was focused on the 88.6% level.
i5mm ^ f voi^«y8«Hjs(?o.?.o)

^> ZZ0.0G185 ZZ 0.0121 <>- zz 0.1 4\>- ZT 0.5054 «>. ZZ 25.16705

EuroDollar (EUR_AO-FX): 15-Minute 1.4225

Bullish Shark Pattern

1.4200

1.4175

1.4150

1.4125

1.4100

0.S%6 % $1.4081 ( 0.0125 Q£S*/o )

1.4075
2.240 <«> $1.4069 ( -0H138 0.97 *«, )

1.4050

22
26 Mav

S«rn««js Vo«60) 2.872 HVFtylOO 6) 0.32 RS1<14) 45.78 Stoch<14 3) 34.2 MACD(12 20 9) 0.80 H»St: 0.00 ADX(14)8J?1 12.53 16.63 Cf«1f{21) 0.071 Aec»4mtMSS<20>

Et.fR A® . FX 26-MAY-H_21:15 Haurooru*AnaJvxrr(TM)v6.65 (®pvri»h« « 2801 2808 HirmonirTndfr.com. UX'. All Rwrvrd

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3-08195 zz 0.0121 4j>' zz 0.1 <]>• zz 0.505-1 zz 25.16705

1.4160

1.4150

1.4140

I  i
1.4130

1.4120

1.4110

1.4100

1.4090
0.886 B.SS6 (ft S1.40S1 ( -0.0125 -O SS'?. )
1.4080

2.240 ># SI.4065 ( MDS -O OT0. ) 1.4070

EuroDollar 1.4060

(EUR_AO-FX): 1.4050

15-Minute 1.4040

06
Bullish Shark
OS
Pattern
10
Potential
12
Reversal
14
Zone
16
(PRZ)1; 1.4030

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EUR^Afl-FX 26-M.4V-ll_:);l5 Hirwor.ji An.i.T.r (TM) v6.B5 Cop-Tight^ 288) 2088 Harroonit rraXrr.tom. IXC. All Rights R.t.n.d

Harmonic Trading Volume 3: Reaction vs. Reversal

109
 Bullish Shark-> Bearish 5-0

As I have mentioned previously, the Shark pattern is a structure that typically

precedes a 5-0 formation. We will outline the 5-0 pattern later in this chapter but it is
significant confirmation in the handling of Shark pattern opportunities. In fact, the 50%
retracement is utilized as the initial target for the Shark. This underscores the
importance of recognizing the Shark as a reactive structure first and foremost. In this
example of the Euro on a 15-minute chart, the initial reversal from the Shark pattern at
1.4070 served as sharp intraday support while the 50% ratio of the pattern defined an
important minimum target. Although it is possible for 5-0 patterns to fail, they most
commonly experience consolidation that requires immediate trade management at the
predetermined profit target under most conditions. After gaining experience with these
trades, it will become clear that the best decision is to capture partial profits at a
minimum at these price objectives.

15min   MAI 3 1.4? mm 1.42 1 (MAM 1.1? SHAM 1.42 I SMA7U01.il VoWdty

’4 ]} 740.00195 i\h ?? 0.0121 <[>- 0.1 4\$. 11 0.6054 '<{?- « 25.16705

^ m ** mTW"W**w
1.4200
1 EuroDollar(EUR_AO-FX): 15-Minute
1 1 Bullish Shark Pattern + Bearish 5-0 i j -
1.4175
Potential Reversal Zones (PRZ)

1.4150

*.*
OiOO <§ $1.4136 (+0.0071  0J0%)
1 X 1.4125

1.4100

0.886 O.SS6f 11.4051 (-0D125 -tm%)

1.4075
2.240 <ft $1.4060 (-0JJ13S 0.97% )

1.4050

1.4025
12 14 16 18 22 00
: 4 >

Sellings V0K6O) 24.397 HVW00 6) 0.82 RSI( 14) 57.38 S»OChj14-3) 65.4 MAC.D(12-28.9) 0.00 lost -0.00 ADX(14) 18.21 19.82 -12.95 CMf'21) 0.073 AccunvDiss!20)

Harmonic Trading Volume 3: Reaction vs. Reversal

110
Bearish Shark Pattern

The key in defining the bearish Shark is to distinguish the minimum impulsive leg
relative to the OB retest. Depending upon where the 1.618 minimum impulsive leg
completes, the extent of the price action exceeding the initial point of the pattern can
be clearly determined.

Copyright Harmonic Trader t.i.C.

Harmonic Trading Volume 3: Reaction vs. Reversal

111
Bearish Shark Pattern Potential Reversal Zone (PRZ)

Generally, the price action in the Potential Reversal Zone will require
confirmation at the pattern completion point but the overall bias of whether the reversal
will be a retracement at the 88.6% level or an extension at the 1.13 XA measure will be
dictated by the impulsive leg. In most cases, I expect the Shark to retest the initial
point of the pattern (1.0 OB). Therefore, price action that exceeds the 88.6% level is
common for structural types.

Bearish Shark Pattern

Potential Reversal Zone (PRZ)
XXXXXXXXXXXXXXX 1.13XB (Stop Loss Limit)

The following example of the Canadian Dollar on the daily chart possesses
perfect structure and exemplifies the reactive nature of the pattern. Although the 1.618
impulsive leg preceded the 88.6% retracement, the alignment of these measures define
the area close to the initial point of the pattern as the preferred area for completion. It
is important to note that the price action exceeded these minimum measures but
reversed on the exact day it tested the entire zone.

Harmonic Trading Volume 3: Reaction vs. Reversal

112
Bearish Shark Pattern
Dady «• 4MA13 1.0S M4A20 1,05 S tUAW 106 SMA50 UK R SMAMO 1.08 Volatility BatKtsOO.2.0)

t4>- ZZ0.00195 <J>. zz 0.0121 <j>. zz0.1 <> ZZO.SOS4 ZZ2S.1670S

Canadian Dollar (CAD_AO-FX): Daily 1.0900

Bearish Shark Pattern l.OSOO

1-130 A $107:6

c 1.0700
2.000 A $111671

0.8S6# 110594 (1.0600

1.0500

1.M00
1.0300
1.0200

1.0100

1.0000
0.9900

1 8 15 11 19 5 12 19 16 3 10 10.9800
Mar Aur JV
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CAD4FXCMA0TX 11 MAR-11 Han««nk.VA*]yier (TM)»6.55 Copyright*? 2801-2S98 HirmonxTradrr fom. LLC. All Right* Rrsmed

Ddtfy ~ CMA131.02 tMA20 1.03 S HM50104 SMASH 1.04 P SMA2CO 1.07 Bdnds(213_?.0)

ZZ 0.00105 <>- Tl 0-0121 <;>. zz 8.1 <]>  zz 0.5054 <j>r . zz 25.16/05

Canadian Dollar (CAD_AO-FX): Daily

Bearish Shark Pattern 1-130 % S1.0"?6 (^0.
1.0800

Potential Reversal Zone (PRZ)

/ 2.000 % $1.0671 ( *0.
1.0700

c
7 0J8S6 (§! $1.0594 ( +0J> 1.0600

1.0500

1.0400

1.0300

1.0200

u Aor
19 10

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CADgfXCMjM FX 11MAR U KvMMifAMlyMT<TM)»<.8S Copyright $ J88I 2083 4airTn.fcr.com. LLC. All Right* R**em4

Harmonic Trading Volume 3: Reaction vs. Reversal

113
Bearish Shark > Bullish 5-0

Regardless of the timeframe, the Shark pattern always incorporates the

minimum 50% level as its profit target. In this instance, the pattern will morph into a
Bullish Shark into a Bearish 5-0 structure. Again, these situations are best captured with
automatic profit targets on a portion of the position at a minimum. On this daily chart,
the reversal was severe and exceeded the minimum 50% level. This is typical but
automatic profit objectives secure these reactive moves most efficiently.

mi f MSA131.02 00201.021 HUH 1.02 SMAS01021 SMW001.B Volatility eands(?(UJJ)

CAMFXCMA6FX )l MAK 11 HimoiuiAjuJiw (TMltiK C«tfri(kl«.WUM HimawtTrsif r.toin. LLC. All Rj»fcu Rfontd

Harmonic Trading Volume 3: Reaction vs. Reversal

114
Shark Pattern Conclusion

This is a distinct structure but different than the M&W harmonic pattern types.
This structure serves as the precursor to the 5-0 Pattern that also helps define its
optimal profit target. The pattern works extremely well retesting prior
support/resistance points (0.886/1.13) as a strong counter-trend reaction. Remember,
the extended AB Extreme Harmonic Impulse Wave must be at least a 1.618 (can be as
much as 2.24) but it serves as the definitive price segment as long as the minimum
88.6% OB retracement is tested. The 1.13 OB Extension can not be exceeded and
defines the area for the stop loss limit. In most cases, it is essential to automatically
capture the profit objective at the first measurement in 5-0 within the Potential Reversal
Zone (PRZ). Finally, this is Harmonic Trading history since it is the first book where I
have released the advanced specifications of the the pattern.

5-0 Pattern

The 5-0 pattern was originally presented on HarmonicTrader.com in 2003 and

released to the public in an article on TradingMarkets.com in March 2005.
fhttp: / /tradinqmarkets.com/recent/are you a fibonacci fan voull like this patt
ern-655968.htmn The 5-0 requires an exact alignment and ideal symmetry. Harmonic
Trading Volume Two (2007) defined the exact alignment of ratios and all aspects of the
structure. This nature of this pattern is a relatively new discovery in the field of
Technical Analysis. Although other interpretations of extended structures have been
presented in previously, the exact rules for the 5-0 pattern are unprecedented and
exemplify why Harmonic Trading is different from the rest.

5-0 Pattern Basics

The 5-0 structure is different from the M-type and W-type alignments in the
other patterns but the same Harmonic Trading principles apply. The measurements
employed with the 5-0 place greater emphasis on different price segments than the
other patterns. For example, the 0B point AND the BC projection determine the validity
of the structure. The initial XA leg of the structure typically possesses a 1.13, 1.27,
1.41 or 1.618 extension. The Reciprocal AB=CD pattern - a variation of the regular
structure - is utilized to define the Potential Reversal Zone (PRZ). The 50% XA
retracement is the defining limit at the pattern's completion point but the 61.8% XA
retracement is included in the determination of the setup, especially in the Stop Loss
determination.

Harmonic Trading Volume 3: Reaction vs. Reversal

115
Reciprocal AB=CD

The Reciprocal AB=CD measured by first counter-trend move within an

established trend. It typically resembles a lazy "Z" or "S." The Reciprocal AB=CD is
more of an estimation that must be complemented by other harmonic measurements
and it is applied to non-M &W-type structures. Also, it is effective in distinct price
channels to gauge the predominant reactive counter moves that can define important
continuation zones within a primary trend. Remember, these are approximation
measures that are employed in specific situations. Other distinct measures must be
included with this pattern type but it is effective in structures such as the Shark and the
5-0.

Bullish Bearish

C B

Harmonic Trading Volume 3: Reaction vs. Reversal

116
Bullish 5-0

The Bullish 5-0 pattern is an extremely effective formation but it must be

identified properly. There are a number of situations that can closely resemble this
structure but if any individual point of the formation fails to satisfy the pattern ratio
requirements, it must be dismissed. However, when clear formations develop with the
correct measurements, these harmonic zones are extremely accurate. In particular, the
incorporation of the 61.8% retracement provides a dynamic means of identifying
important continuation levels.

If the 61.8% retracement is the most powerful ratio of all Harmonic Trading
measures, its implementation in the 5-0 pattern is the most effective of all price
structures. Depending upon where the Reciprocal AB=CD completes, the exact

Harmonic Trading Volume 3: Reaction vs. Reversal

117
termination point for the execution of the structure will vary. In the bullish pattern, if
the Reciprocal AB=CD completes before the 50% retracement, the execution will be
immediately at this level. However, a Reciprocal AB=CD that completes lower than the
50% level will always include the 61.8% retracement as the optimal entry price for the
trade. Although the stop loss in both situations is beyond the 61.8% level, each total
determination depends upon the Reciprocal AB=CD.

Bullish 5-0 Pattern

Potential Reversal Zone (PRZ)

50%AB

Reciprocal AB=CD

_0.618 AB (Stop Loss Limit)

xxxxxxxxxxxxxxx

Copyright HartnonicTraderL.L.C.

Harmonic Trading Volume 3: Reaction vs. Reversal

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Harmonic Trading Volume 3: Reaction vs. Reversal

119
Bearish 5-0

The Bearish 5-0 structure is an excellent continuation pattern within established

trends. Although the execution of the opportunity is determined by the Reciprocal
AB=CD, the 61.8% bearish retracement will always be the most important measure in
the set up. At a minimum, it serves as the defining area for the stop loss level and is
vital in the determination of the validity of the trade, especially on the initial test of the
Potential Reversal Zone.

Harmonic Trading Volume 3: Reaction vs. Reversal

120
 In the Bearish 5-0 Potential Reversal Zone, the 61.8% limit will be the top end of
the resistance in every situation. The only difference will be whether or not the
Reciprocal AB=CD defines the execution closer to the 50% or higher. In most cases,
the Reciprocal AB=CD will converge closely to the 50% ratio but if it is above that the
execution will default to the 61.8% price level.

Bearish 5-0 Pattern

Potential Reversal Zone (PRZ)
XXXXXXXXXXXXXXX 0.618XA (Stop Loss Limit)

The following 15-minute chart of the GLD exemplifies the continuation nature of
the structure. After an extended decline, the price action formed a distinct bearish 5-0
at the 134 level where the formation pinpointed the acceleration of the downtrend. The
Reciprocal AB=CD was slightly below the 50% level which defined the Potential
Reversal Zone for the harmonic resistance. The most important aspect of this example
is to note the immediate effect that the resistance had on the price action. The inability
of the GLD to trade above these levels was the first sign that the pattern was proving to
weigh heavily on the short-term rally. After several hours of sideways consolidation in
the zone, the price collapsed and accelerated lower.
This type of price action is common in most harmonic patterns when the initial
reaction seemingly stalls at the exact zone. Although these are early signals, the
distinctive change in the character of the uptrend at the Potential Reversal Zone was
quite clear. These situations are comprehended readily with experience but this type of
price action should be closely monitored as an early sign of pattern validation.

Harmonic Trading Volume 3: Reaction vs. Reversal

121
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Harmonic Trading Volume 3: Reaction vs. Reversal

122
Harmonic Head and Shoulders Pattern

In this book, I have gone to greater lengths to provide other classifications for
states of price action during the trade execution and trade management phases. I
strongly encourage Harmonic Traders to consider the importance of this degree of
categorization. My emphasis with this detailed analysis is to ascertain the precise signals
and termination points that provide information throughout the trading process.
I have held this belief for a long time that any technical reading geared to
provide an actionable signal must possess a definable limit as to when it is immediately
validated. In terms of classic price formations, I have tinkered with various alignments
over the years to create a definable means to validate these structures. In fact, I
believe that the breakthroughs in harmonic patterns were similar to the work that
Arthur Merrill presented in his material nearly 50 years ago. He was attempting to
define M and W price formation phenomenon but ended up presenting more Zig-Zag
type classifications.
The most famous classic price pattern is the Head and Shoulders formation.
Technicians have studied this structure for decades. However, all presentations of this
formation have presented various Zig-Zag definitions without any ratio measurements.
For me, I have experimented with various ratio applications in relation to the basic
premise that was initially presented regarding the structure. Although I will not get into
classic rules that were originally presented, my interpretation employs reciprocal
harmonic ratio relationships of the formation to more precisely identify when these
patterns are actionable trading opportunities.
In my opinion, the original rules for the structure lack the precision of exactly
measuring where the pattern completes. Harmonic Trading measurements can close
the gap to precisely measure price levels to define exact completion of the opportunity.
In doing so, I feel that I have brought more clarity to the structure. I am refining more
advancements in the years to come for many classic pattern formations.

Bullish Harmonic Head and Shoulders Pattern

The bullish pattern is also referred as an inverse Head and Shoulders. In the
reciprocal application of Harmonic ratios, the two most important characteristics of the
structure are that it should possess related ratios and ideal symmetry to distinguish
these patterns. It is quite common to see a bullish pattern form in the right shoulder
that would signal a more complex harmonic scenario than a singular ratio. These are
interesting situations that do unfold regularly but the most important aspect of the
Harmonic application to the head and shoulders pattern is to recognize only the clearest
of structures.

Harmonic Trading Volume 3: Reaction vs. Reversal

123
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Harmonic Trading Volume 3: Reaction vs. Reversal

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Bearish Harmonic Head and Shoulders Pattern

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Harmonic Trading Volume 3: Reaction vs. Reversal

125
 It is important to note that in both examples the symmetry was quite ideal. Not
to mention, the right shoulder of the structure in each example possessed the reciprocal
of the ratio exhibited left shoulder. The previous 60-minute chart of the Australian
Dollar/Swiss Franc formed an ideal Head and Shoulders pattern. This was validated in
particular due to the ratio relationships. Although these are simple advancements, I
believe that any structural signal must be entirely quantifiable to be of actionable value.
Hopefully, this interpretation might move the needle a little bit to help traders employ
this formation more effectively.
The historic dilemma with the Head and Shoulders pattern underscores the
frustration within Technical Analysis. For years, people have attempted to quantify
exactly what the Head and Shoulders pattern really means. In my research, I found
many individuals trying to outline Head and Shoulders patterns that simply did not
possess the ideal elements as prescribed in the original interpretation. I believe that the
pattern was presented in attempts to define a specific market environment. Although
there is more to the structure than the simple formation, its classification based upon
precise ratio measurements is a leap forward.

Standardized Harmonic Trading Identification Measurements

Conclusion

Although I have discussed pattern identification rules in each of my books, I felt

it necessary to present a quick review of all parameters that define these structures as
Harmonic Trading opportunities. I thought it was necessary to be precise to emphasize
the limitations of each structure. Of course, there will be some allowance for real-world
trading beyond measured objectives. However, these structures represent standardized
harmonic models. I believe that structures such as the Shark and the 5-0 go a long way
in analyzing those pattern possibilities outside of the M and W formations. Although the
Harmonic Head and Shoulders pattern is more of an observation than a preferred
trading opportunity, it exemplifies how simple measured relationships can provide
greater technical information regarding the overall state of price action.
For decades, many were aware of the phi (0.618/1.618) ratios as potential
support/resistance. However, the application of this ratio never advanced beyond the
simple measurement until they were incorporated into harmonic patterns. Therefore,
the complex rules that categorize price structures as unique technical entities are
designed to convert recognizable phenomenon into actionable strategies. I will continue
to refine structural measurements like these in all my work. As I have done so, my
realization has shifted my focus from purely structural considerations to the principle of
defining the larger context within which harmonic patterns complete. In doing so, the
basic foundation that harmonic patterns have provided is now a larger analytical
perspective that incorporates other critical measures with equal importance at the
execution and management phases of every opportunity.

Harmonic Trading Volume 3: Reaction vs. Reversal

126
 Chapter 3
Advanced Harmonic Trading Execution Strategies

Every trader must have a sound reason to enter a position. No matter what type
of methodology is employed, all successful traders define those variables that signal
opportunities consistently and reliably. Within the Harmonic Trading approach, we
establish a variety of measured variables and readings that define states of potential
price behavior. Harmonic patterns are one example that measures unique cyclical
formations with prescribed ratios to consistently identify accurate price ranges for
anticipated moves. This predictive ability is derived from a comprehensive measurement
and overall assessment of multiple conditions of the market. Applying proven strategies
that can be statistically quantified, it is possible to identify market conditions when they
manifest characteristics of complex models that have been historically substantiated.
In this book, I discuss a variety of standardized measures and general statistical
expectations that help to establish the proper framework of expectations for any market
environment. Most of the strategies presented herein are the result of refining multiple
variables to uncover those situations that have yielded the most significant results
consistently over time. In fact, it is one of the reasons why I have waited so long to
present much of these concepts. In my own research, I tinkered with the initial
foundation of many of these ideas for quite some time before optimizing all parameters
of the opportunity. This is an area that I plan to expand upon and present detailed
research on exact situations within particular markets in future material. For this
discussion, I am only outlining broader statistical biases consider with each individual
strategy. Furthermore, my focus on all of this material is to tie it into the
comprehensive process to understand complex environments more readily.
The Harmonic Trading execution strategies encompass a variety of
considerations much the same manner that pattern identification rules define possible
entry levels for trading opportunities. I consider the execution phase the most difficult
skill set to master, as decisions are compressed within a relatively small time period.
Although this challenge can be overcome through thorough preparation, the execution
process typically experiences the greatest degree of human error. Therefore, successful
navigation of the execution phase requires defined skill sets and confirmation signals
that validate what the structural pattern measures are suggesting.
The execution phase starts with the confirmation of an anticipated price reaction.
There are numerous confirmation strategies that can be employed but the best
measures with harmonic patterns typically reflect a similar environmental reading to

Harmonic Trading Volume 3: Reaction vs. Reversal

127
that of the price structure. One way to think about it is that an execution seeks to
capitalize on the reaction to a particular technical stimulus. A harmonic pattern that
defines the natural limits of any price move and/or technical reading such as Relative
Strength or the Harmonic Strength Index can gauge intensity of a particular price move.
I discuss throughout this book, the primary objective of establishing those parameters
that define larger reversals versus minor reactions is most essential in the execution
phase. In fact, all Harmonic Trading executions must include some combination of price
structure with a coordinated technical measure to further refine and categorize the
situations with the greatest potential in advanced.
The integration of price and environmental measures creates a clearer
framework of expectations to guide trading decisions. Both harmonic patterns and
indicator strategies are effective analytical approaches in their own right. However, in
concert they are vastly more precise and help define a larger comprehension of market
direction. I have always emphasized importance of measuring the market to define
expectations. It is the only way to consistently guide trading decisions and have
confidence in signals your analysis is generating. Furthermore, it is essential to
consistently "get in the right ballpark" on most trades - that is, your analysis does not
put you in situations where you get blown to pieces instantaneously. Although
mistakes may be made, the overall facilitation of one's analysis demonstratively
identifies opportunities with defined price parameters. Although anything can happen
in the market, a reliable trading skill set must include a clear understanding of various
trading situations that must be handled properly. In most cases, the strategies fall into
only a few different categories to develop general rules that shape trading decisions
regarding probable future price action.

Expectations within the Harmonic Trading Process

Trading is a defined process and it must be treated as such. It is a matter of

discipline. The trader must be prepared with a defined skill set of accurate expectations
to guide decisions. A simple understanding of required tasks and points of concern in
each step of the process will facilitate decisions effectively. There are mandatory actions
that must be realized at each stage to successfully identify, execute and manage
harmonic opportunities. Regardless of the phase in the process, each step possesses
defined measures that distill infinite possibilities down to one or two clear causes for
action. In fact, all harmonic measurements are designed to eliminate the impossible and
focus on those finite possibilities within any situation. The simple understanding that all
trading situations possess finite possibilities instills a degree of confidence by simply
quantifying the unknown to a greater degree. Later in this chapter, we will examine the
various strategies that help explain these finite possibilities and clarify how this larger
understanding of expectations can signal those flawed situations well in advance. This
comprehension helps to limit losses by identifying those scenarios that are not
exhibiting anticipated response. Simply stated, if in doubt, get out! Those situations that
do not provide confirmation immediately at the completion of a harmonic pattern

Harmonic Trading Volume 3: Reaction vs. Reversal

128
opportunity typically signals a price structure that will not yield any measurable profit.
Although it is common for price action to nominally pause at these levels, the possibility
to capture any degree of profit is muted. When those situations become obvious, the
trader must exit the position at breakeven or with a small loss and be happy that they
were smart enough to make the assessment of a flawed scenario rather than hoping it
would work out. Again, we will address these strategies in detail but the general
expectations of each step of the process are essential in optimizing trading decisions,
especially when market conditions can easily create confusion.

1. Trade Identification Expectations: The most important aspect of this initial step
is to properly measure pattern structures with harmonic ratios to define the
execution price range. For new traders, this may require a period of study to fully
understand the individual measures of each pattern structure and how other
confirmation methods can validate those with the greatest potential.

2. Trade Execution Expectations: As the shortest phase in the trading process, the
execution of a harmonic opportunity must assess multiple factors simultaneously.
The most important initial step is to identify exact pattern completion point - known
as the Terminal Price Bar(T-Bar). Immediately following the completion of this price
bar, the anticipated reversal must be demonstrative within a limited period of time.
We will review this concept in detail momentarily but it is an essential singular price
point upon which secondary calculations can facilitate the analysis of price action
and ultimately the execution of trade. Furthermore, confirmation factors must be
coordinated with price action to gauge the real-world trading behavior results
against the model of harmonic measurements. We will discuss numerous scenarios
that provide enormous insight to determine best opportunities.

3. Trade Management Expectations: After properly identifying distinct harmonic

pattern opportunity and coordinating execution confirmation strategies, the trade
management parameters facilitate a defined understanding of what is possible. We
still need to employ exact rules to instill the proper expectations during the trade
management process to maximize profit and minimize loss. It is important to note
that there are clear strategic assessments that must be considered in advance
before even executing the opportunity. Respective timeframes as well as specific
price action must be assessed to gauge the probable future price action. Although
these strategies are not complex, they must be clearly understood to thoroughly
understand the possibilities of the Harmonic pattern opportunity.

Harmonic Trading Volume 3: Reaction vs. Reversal

129
Potential Reversal Zone (PRZ) Review

The Potential Reversal Zone (PRZ) is the founding principle of Harmonic Trading.
The ultimate objective of any approach that attempts to identify opportunities in the
markets is to define clear price levels that consistently pinpoint when to enter the trade.
Harmonic Trading is absolute in the nature of its classification of what constitutes a
potential trade opportunity. In my opinion, 80% of all trading mistakes are made in the
identification of a particular opportunity. I believe these are avoidable mistakes, as
well. One of the most common mistakes is not identifying patterns correctly and
executing trades at the proper levels of support resistance. Harmonic Trading employs
specific ratios and measurement strategies that eliminate many possible opportunities
based upon a discrete combination of structures to validate the execution. This concept
was one of the initial discoveries within the Harmonic Trading approach. Once
identified, the potential opportunity is monitored until the price action tests all of the
numbers in the Potential Reversal Zone (PRZ) to mark the official completion of the
structure. These harmonic measurements create a price range to focus on and observe
other affirming phenomenon in the same precise area as the completion of the pattern.
Although one singular price bar does not define a trading opportunity, significance of
Potential Reversal Zone highlights the critical area where this phenomenon is possible.
As I mentioned previously, this is known as the Terminal Price Bar (T-Bar).

Terminal Price Bar (T-Bar)

The Terminal Price Bar represents a definitive interval of price action that marks the
projected reversal area within the context of the relevant pattern that is completing. I
outlined this concept in Harmonic Trading Volume 1. As most people already know, the
Terminal Price Bar represents the exact completion of the pattern. Simply stated, the
structure is only an actual trading opportunity at the completion of this data point. If we
consider all patterns as a collection of data points - which they are, we must be able to
identify the precise set of trading data that is meaningful and material in the
identification of a pattern's exact completion point. In particular, it represents an
important advancement within the Harmonic Trading approach, as it is a
complementary measure beyond the simple identification of patterns that confirms the
precise entry point for a trade. Other strategies such as indicator confirmation
techniques, trendline analysis and time projections have facilitated harmonic pattern
identification signals. The biggest step that must be mastered starts with the realization
that the identification of patterns is only a starting point.
The concept of ratio alignments and strict measurement classifications has advanced
the general pattern concepts of the past, as Harmonic Trading has become known for
yielding precise technical information as measured by the market's own movements.
There are not many methodologies that even attempt to identify market moves in such

Harmonic Trading Volume 3: Reaction vs. Reversal

130
an exact manner. As anyone who is really trading, the translation of ideas into profits
involves some real-world challenges that requires reliable information and clear
direction for any position in the market. Every trader must know when to get in, have
an idea how long to stay in the position, optimize the entry as to minimize loss and
maximize profit with proper management.

"An ideal reversal usually tests all of the numbers in a

Potential Reversal Zone (PRZ) 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 BarfT-BarJ."

Harmonic Trading Volume 1 pg. 185

Scott M. Carney Copyright 2004
Financial Times Press 2nd Ed. 2010

The concept of Potential Reversal Zone (PRZ) is the most important price range
that is measured in Harmonic Trading and serves as the basis for most trading
decisions. Although this price range is relatively small within the total price history that
comprises most patterns, the precision of focusing precisely within this "window of
opportunity" is another reason that Harmonic Trading is so effective, as it outlines the
most important price levels within any trend.
For some, the Potential Reversal Zone (PRZ) takes time to integrate within one's
trading plan discipline requires. Once mastered, other important relationships typically
materialize within these ranges that provide substantial confirmation of the larger
timeframe. For example, it is common for a Potential Reversal Zone (PRZ) to comprise
only 3-5% of the total range of the pattern. Also, this finite range is frequently about
the same amount with respect to time. It is in the commonality of these situations
facilitates analysis of price action during these phases and defines consistent
characteristics that provide early signals of validation.

Terminal Price Bar in the Potential Reversal Zone (PRZ)

I first discussed the concept of the Terminal Price Bar in my book Harmonic
Trading Volume 1. The principle of what the Terminal Price Bar represents has been a
major step forward in the refinement of Harmonic Trading strategies to pinpoint exact
price levels that represent significant change. Remember, the Terminal Price Bar is the
price for that tests the extreme range of Potential Reversal Zone (PRZ) - that is, the

Harmonic Trading Volume 3: Reaction vs. Reversal

131
price bar that ultimately tests the final number been established price range. It is very
common for harmonic patterns to experience a degree of consolidation as the pattern
completes. In these cases, it is common for the price action not to immediately test the
entire Potential Reversal Zone (PRZ) and require some consolidation before reversing.
In fact, the price action can linger for some time and then test the final number that
defines the zone at the pattern completion point. In some cases, the price action will
test all of the numbers in a single bar. These are the most ideal cases while more
complex reversals benefit from such standardization by categorizing price action
behavior at the completion of these opportunities.

Terminal Price Bar Tips

• The price bar that tests the last measured number of the entire Potential
Reversal Zone (PRZ) is the official Terminal Price Bar.
• The T-Bar marks the price level where the pattern can be considered officially
complete and look to execute immediately thereafter (T-Bar+1).
• The T-Bar can test the entire PRZ at one time or require some consolidation
before testing all of the harmonic measurements.
• Acceleration in the anticipated reversal is typically realized in the price action
after the entire range is tested.
• Assess the Potential Reversal Zone (PRZ) measurements closely in relation to the
price action, particularly the relative AB=CD structure in comparison to the XA
and BC calculation.
• Assess Confirmation Factors simultaneously with reversal progress in the PRZ.
• Price action must exhibit a change in "character" by expressing individual price
action shortly after completing the Terminal Price Bar of the pattern that
confirms the anticipated direction. For example, a bearish pattern must exhibit
individual bearish price bars immediately following the Terminal Price Bar as
early occasion of some type of countertrend reaction.

Terminal Price Bar Psychology

The Terminal Price Bar strategies fit into a framework where a valid opportunity
must exhibit the required price action triggers to confirm structural price level. Although
it be a challenge at first to maintain the discipline to find situations and wait for them to
complete, the ability to apply a predetermined plan and wait for the market to provide
the necessary signals to dictate opportunities is when the beginner graduates to a
professional skill set. The triggers that validate Potential Reversal Zones must exist to
generate an execution and they serve as evidence for what the pattern is dictating.
Therefore, the associated psychology and expectations involved with the Terminal Price
Bar create definitive limits, especially when a situation is not working out.

Harmonic Trading Volume 3: Reaction vs. Reversal

132
 When the price action cannot confirm the anticipated reversal, traders must ask
themselves whether or not they are correctly reading the signals the market is
providing. Sometimes, traders fail to make the correct assessment and/or admit what is
clearly happening immediately following the Terminal Price Bar as they lose sight of the
individual importance of this price analysis in real world conditions. Of course, confusion
can happen to everyone. However, the key is to continually improve your understanding
of the significance of the Terminal Price Bar within the execution phase. As experience
bolsters trading comprehension, the ability to capitalize on such information becomes
easier and overall results prove.
For me, trading psychology must focus on what is possible at all times. The mind
must be in a constant state of possibility that seeks to optimize all decisions based upon
the relevant signals that the market provides in general. The challenge can be if the
trader ignores information that is presented in front of them. It is a common human
error within the trading process but one that continually motivates the integration of
acting upon the information presented by harmonic expectations to turn analysis into
profits.
When it comes to the Terminal Price Bar, we must think of this singular data
point as the "Execution Light Switch" that turns the trade opportunity ON! Simply
stated, the trade opportunity becomes valid immediately AFTER the completion of the
T-Bar. In doing so, the expectations of the harmonic pattern and the relative
confirmation strategies create a definable price range of predictable behavior. It is only
within this price range that these assumptions are valid. Beyond these price limits, the
anticipated behavior must be considered incorrect and money management strategies
must kick in to minimize losses. It is in this transition of measuring identifiable
phenomenon and converting it into executable opportunities is where the greatest
challenge exists for traders. However, awareness is always the first step in any solution.
If we are able to precisely measure all aspects of this point in the process, it is possible
to isolate those consistent factors that dictate success and limit failure. These measures
can be compiled to create a Defined Trading Realm.

Defined Trading Realm

Any methodology that seeks to measure the market and find opportunities based
upon specific measures is attempting to establish parameters that help quantify
particular market movements as unique environments. Volume, Moving Averages,
MACD and Elliott Wave are all examples of technical strategies that are attempting to
measure unique situations to define trade opportunities. Most of these measures are of
no value on their own. However, they do possess some merit in combination with other
considerations.
From a Harmonic Trading perspective, the most important focus is the price
range of support or resistance as defined by the pattern. Beyond this, Relative Strength
is the primary means of confirming the pattern at hand. The structural information
provided by the measurements of the pattern define the entry for the trade and help

Harmonic Trading Volume 3: Reaction vs. Reversal

133
ascertain the stop loss for the entire set up. All of these measurement strategies
eliminate the impossible first and then define the remaining possibilities that can be
considered. The Defined Trading Realm of harmonic measures provides this insight by
establishing proper expectations and defining price objectives for each step within the
process. Furthermore, this understanding eliminates confusion and clarifies the tea jig
options in advance.
Ultimately, this "Defined Trading Realm" is the window of opportunity where all
price parameters of entry, exit and stop loss targets are known in advance. There must
be a degree of clarity before any trade can be executed. That is, the position
considered possesses overwhelming technical measures that clearly outline the critical
price levels of the opportunity before its completion. Within the Harmonic Trading
approach, we employ patterns to define price levels for identification, price action and
indicator analysis for execution, and predetermined targets and trendline considerations
to dictate management. Each step possesses specific price levels that are measured in
advance that help to guide decision-making process.
The Defined Trading Realm is important because it advances the concept of
precise measurement strategies to be as exact as possible categorizing the analysis of
price action. The Defined Trading Realm starts immediately after the pattern has
completed. As soon as the Potential Reversal Zone (PRZ) has been established, the
Terminal Price Bar marks where the pattern completes and the point where specific
confirmation strategies must confirm what the structural signals are suggesting. Finally,
the Defined Trading Realm also instills a degree of discipline, as it requires multiple
conditions to be satisfied before entering the trade. Furthermore, the confirmation of
multiple signals reduces the noise of the market to define only those situations with the
greatest potential for profit - focusing more on reversals and less on reactions.

Defined Trading Realm Expectations

Throughout the evolution of my trading experience, I've come to realize that

consistent success comes from a superior methodology that has been tested thoroughly
and applied uniformly. Many people argue that certain individuals are naturally more
gifted to be traders and others. I completely disagree with this and tend to argue that
the application of one's methodology is what defines success. Although some people
may be more adept at implementing a system of strategies, the general litmus test of
success depends upon if the actions taken are inherently effective. Specifically, the
Harmonic Trading approach can consistently pinpoint the ballpark areas on pattern
measurements alone where even the beginner trader can take advantage of these
strategies. Although they may not understand everything that is unfolding before them,
the simple fact that these measurements create price limits that can facilitate the
proper handling of potentially catastrophic trades by signaling failure well-before it is
realized.
Most important, the Defined Trading Realm establishes a framework for
expecting success. A well-defined trading plan that consistently proves itself instills a

Harmonic Trading Volume 3: Reaction vs. Reversal

134
great deal of confidence and engenders an attitude of clarity. Many traders do struggle
throughout their career as they try to find those strategies that can define opportunities
for them. During this trial and tribulation, traders must focus only on those methods
that can lead to the realization of consistent success. Quite simply, a trader who is not
achieving success does not possess the proper measurement strategies to analyze the
markets. It is imperative for those individuals to stop trading and take a hard look at
what they're doing. If their methodology is not providing them the signals necessary to
accurately decipher price action and define opportunities, the trading analysis is simply
expressing a random and erratic state. And, random analytical strategies always yield
random results.
Effective trading strategies must able to consistently define clear opportunities
that can dictate the relevant expectations to predict probable future price action. Any
measurement of price behavior can be rationalized to possess certain strategic value.
However, all strategic trading measurements must possess an ability to be applied
uniformly across all timeframes and markets in order to avoid making assessments
based upon random price action. This is why the Harmonic measures are so critical
within the Defined Trading Realm. If a particular strategy is accurate, the anticipated
trading opportunity should be easily definable and possess elements of a well-defined
environment that are particular to that situation. The ability to recognize complex
variables and understand these various types will clearly define what type of market
environment must be considered relative to the pattern.
The proper expectation based upon accurate measurements creates a
perspective of anticipation that is a required element of trading success. Although
anything can happen in the financial markets, price action can adhere to cyclical and
structural patterns that provide likely outcomes of projected circumstances. Moreover,
complementary technical readings and other critical price measurements can enhance a
specific scenario and confirm the prevailing expectations of what is happened. Again, I
must stress that these are valid points to consider but are only helpful to the trader if
they are employed according to the prescribed expectation framework. For example, a
trader may understand that a pattern will likely fail when the situation fails to provide
confirmation or immediately triggers a stop loss but not react to take the action
necessary to appropriately respond situation. This is a case when human error simply
overrules the overwhelming evidence of the Defined Trading Realm. We'll talk about
this later in the material but it is a primary conflict that all traders must overcome. The
Defined Trading Realm provides the parameters to assess the opportunity but it is still
up to that person to execute strategies and expectations the market is presenting to
them.
I want to take a note to emphasize the importance of the correct expectation at
each harmonic price level. In this book, I have outlined a variety of situations that detail
likely scenarios based upon complex measurements. I want to take that step further
and stress the direct interpretation of each measure within the gamut of harmonic ratio
measurements. The simple price measures unto themselves provide standardized
assessments of what to expect. This was a new concept when I initially introduced it in

Harmonic Trading Volume 3: Reaction vs. Reversal

135
The Harmonic Trader. However, I would like to further emphasize this concept and
apply it across all harmonic measurement strategies.
Harmonic Trading is a great deal more than just simple measurements. These
measurements constitute the elements of analysis that is derived from the structural
signals the market forms. As I mentioned previously, these labels or categorizations
may seem obvious but no other market approach has attempted to describe price
measurement integration. In fact, each measurement serves as a building block of
evidence to describe situation at hand. If multiple measures signal the same conclusion,
these of the situations have greater probability of being realized than other less clear
examples.

Defined Trading Segments

When all parameters of the trade are defined in advance, the known outcome
defines what I call a "Defined Trading Segment." These Defined Trading Segments are
areas on a price chart where the anticipated outcome is quite clear. It could be the next
obvious harmonic target or the Potential Reversal Zone (PRZ) of a pattern as the price
action is completing the CD leg. All traders are trying to analyze charts to identify
specific conditions that form over time and anticipate their fruition. Within the Harmonic
Trading approach, measured situations frequently materialize where the targeted
objectives are quite clear even when the possibility may seem remote. These defined
segments help to create a bias, especially when the parameters of particular market
identify situations where only one possibility seems relevant based upon the structural
and technical condition at hand.
The defined price segment is even clearer when the obvious price target
possesses multiple technical readings converge in the same direction. These variables
are effective especially as the determining factor signaling reversals that determine
which patterns are profitable which are not. Essentially, these overwhelmingly clear
situations are the result of a deeper comprehensive understanding that comes with
experience. Most traders are able to understand various aspects of trading processes
but when the advanced strategies are integrated to basic price measurements, these
price segments present incredible opportunity to capitalize on clear technical signals.

Bullish Terminal Price Bar

The price bar that tests the lowest measured number of the entire bullish
Potential Reversal Zone (PRZ) marks the price level where the pattern can be
considered officially complete. The price action can test the entire PRZ at one time or
require some consolidation before testing all of the harmonic measurements. The most
important aspect is the pattern is considered complete when the final number in the
entire range has been tested.

Harmonic Trading Volume 3: Reaction vs. Reversal

136
 Bullish Terminal Price Bar
• Bullish price action is
1,134
realized immediately
after the entire range is 1.132
tested.
• Focus on the critical
harmonic measurements
in the Potential Reversal
Zone (PRZ) - particularly
the AB=CD and the XA
calculations.
• Assess Confirmation
Factors simultaneously
with reversal progress in
the PRZ.
• Price action should
exhibit a change in
"character" closing
ABOVE the PRZ shortly
after completing the
Terminal Price Bar of the
12 02 04 06 08 10 12 14 16 18 20 22 00 02 04 08 10
pattern.
Copyright Harmonic Trader l.L.C.

The following 5-minute chart of Apple shows ideal reversal behavior at the
completion of a short-term pattern. The price action formed a distinct pattern that
defined the intraday completion point in the 306.50-307 range. The price action
stabilized after a sharp drop as it entered the range of harmonic support. The Terminal
Price Bar was established after testing the pattern completion point. The reversal rallied
higher within three price bars after the pattern was complete.

Harmonic Trading Volume 3: Reaction vs. Reversal

137
inun   F.MA13 308.22 EMA20 308.39 II F.MAW) 308,09 SMAS0 3W.M M SMA200 308.17 VoUsMUty B«m1s<20.2.0)

!>- zz 0.00195 4 > zz 0.0121 4 !>• zzO.1 O- zz 0.5051 <!>- ZZ25.1S70S

Apple (AAPL)
Bullish Butterfly
Potential Reversal Zone (PRZ):
5-Minute
V-t-m-vK r
I
ii5 Vy I
ft 1is
1s
; j

~ -  J-2~XAM.SM6.835S

14 10

AAPL 2) FEB-11 15:55 Harmonic Analyzer (TM) 1-6.05 Cooviisht V 2001 2808 Harmo iucTradfr.com. LLC. All Rights Re*erved

308.09 SMAS0 309.51 B SMA200 308.17 Volatility Bands(20.2.0)

4l>- 22 0.5054 <£i2>- 22 25.16705

juy.50*

Apple (AAPL): 5-Minute 309.25

rh
Bullish Butterfly 309.00
Potential Reversal Zone (PRZ) 308.75

308.50

I
I 308.25

I
I i 3 08.00

307.75
I !r
307.50

307.25
1.270AB“CD m $307,115

307.00
1.27XA @ $306
306.75

Terminal Price Bar 306.50

14 10 B

Harmonic Trading Volume 3: Reaction vs. Reversal

138
Bearish Terminal Price Bar

The Bearish Terminal Price Bar will signify the important resistance to focus on
within the overall zone. One important consideration as the pattern completes is the
action immediately after completion of this individual bar. This requires close monitoring
of the price action as it tests the Potential Reversal Zone. However, the reaction after
this completes should be immediate. At a minimum, individual bearish price bars
should begin to signal an early validation of the pattern at hand.

Bearish Terminal Price Bar

Terminal 1.134
• Bearish price action is
Price Bar 1.132
realized after the entire
range is tested. (TBar) 1.130
• Assess the Potential 1.128
Reversal Zone (PRZ)
1.126
particularly the relative
AB=CD structure in 1.124
comparison to the XA 1.122
calculation. 1.120
• Assess Confirmation JL 1.118
Factors simultaneously
with reversal progress in 1.116
the PRZ. 1.114
• Price action must exhibit 1.112
a change in "character"
1.110
closing BELOW the PRZ
shortly after completing 1.108
the Terminal Price Bar of 1.106
the pattern.
12 02 04 06 08 10 12 14 16 18 20 22 00 02 04 08 10

The following chart shows a distinct Bearish Butterfly pattern that completed on
the 15-minute timeframe. This is an excellent example, as it shows a rather volatile
reversal despite the distinct structure. The pattern completed in the 0.9285 area and
stalled immediately after the Terminal Price Bar was well-established.

Harmonic Trading Volume 3: Reaction vs. Reversal

139
 ISmin — EMA13 0.92 EMA20 0.92   LMA50 0.92 SMA50 0.92 R SMA2U0 0.92 Volatility Bands<20.2.0)

4\>- zz 0.00195 <$;$> zz 0.0121 <3 $> zz 0.1 4\t> zz 0.5054 <£ zz 25.16705
uyiiu*
TERMINAL n F I
PRICE 0.9300

0.9290

0.9280

0.9270

0.9260

0.9250

0.9240

0.9230

0.9220

0.9210

0.9200

0.9190(

0.9180

0.9170

0.9160


CHF_ AO FX 06 APR 11 04:15 Harmonic Analyzer (TM) v6.05 Copyright © 2001- 2008 HarmonicTrader.com, 1-1.C. All Rights Reserved

15rnin   EMA13 0.93 EMA20 0.92 M EMA50 0.92 SMA50 0.92 1 j. SMA200 0.92 Volatility Bands(20.2.0)

<S $> ZZ 0.00195 zz 0.0121 <3 ZZ 0.1 <t > ZZ 0.5054 2>- zz 25.16705

n
TERMINAL 0.9300

0.9290

...mmsmmm
0.9280

!ES2TS

0.9270

II_ T
0.9260

0.9250

0.9240

16 18 20 22 00 02 04
. i
 

CHFA0FX 06-APR-11 04:15 Harm©nic Analyzer (TM) v6.05 Copyright © 2001-2008 HarmonicTrader.com, LLC. AH Rights Reserved
.. ....

Harmonic Trading Volume 3: Reaction i/s. Reversal

140
Terminal Price Bar (T-Bar) Overspill

I want to make a comment about the importance of assessing price action

following Terminal Price Bar. It is quite common for the Terminal Price Bar to exceed
the extreme of the Potential Reversal Zone (PRZ). Such price action can create some
doubt regarding the ability of the pattern to mark an important reversal in the overall
price trend of the market. The Terminal Price Bar is immensely significant in validating
the entire price range where a reversal may unfold. The Terminal Price Bar typically
sets the limit for any price action beyond the measured zone.
It is common for by section to exceed the Potential Reversal Zone (PRZ),
especially on the initial test. Although there is some degree of what I refer to as
technical "overspill" - the amount price has exceeded the ideal harmonic measured
levels, this assessment is one of the most important considerations to master. Although
harmonic patterns are quite precise, there will always be some degree of live trading
that exceeds the measured levels. The difference between the pattern's ideal entry
point versus the extent of live trading that exceeded these levels requires skilled
interpretation and experienced management abilities. It can be tricky to differentiate
between price action that is clearly violating the projected completion point of a pattern
versus a similar set up that requires a more consolidation beyond the Potential Reversal
Zone (PRZ) before the entire scenario can unfold. However, the individual price action
immediately following the Terminal Price Bar provides material information regarding
how much room is permitted beyond the ideal calculations to determine the validity of
any trade.
As I have discussed previously, I do believe the sum total of the second
calculations and trading cycles that converge into unique areas create kind of an
electrified atmosphere where by price action uncannily reacts at the projected
measurements and defined harmonic zones of support/resistance. After the Potential
Reversal Zone has been established, the extent of the price action at the completion
point will validate the overall structure. It is important to recognize the importance of
the price action immediately following the completion of the Terminal Bar. The Terminal
Bar extreme creates an ideal integration of the PRZ measures to define a permissible
price range to optimally execute the opportunity.

Permissible Execution Zone (PEZ)

After defining the official completion point of the pattern, the realization of the
trading opportunity begins. The assessment of the execution must occur quickly and in
accordance with other clear confirmation signals. In fact, there are other important
considerations beyond the price action of the pattern that must be assessed between
the time the Terminal Price Bar has been established and the undeniable trigger of price
action that confirms the structural reality. Immediately following the completion of the
pattern, the Terminal Price Bar serves is the defining technical level to validate the

Harmonic Trading Volume 3: Reaction vs. Reversal

141
structure. As long as the price action changes course shortly after the Terminal Price
Bar as established, the validity of the pattern is greatly assured. These small but
significant signals happen frequently within the Potential Reversal Zone (PRZ) and help
to define what I call the Permissible Execution Zone.
The area that comprises the Permissible Execution Zone is extremely small
relative to the total size of the pattern. Despite the required preparation, such discipline
is one of the advantages that separates the best traders. I believe that a thorough
understanding of the price history of a particular market is required to have an idea of
important support and resistance levels. In relation to patterns, the Potential Reversal
Zone (PRZ) serves as the mechanism to define these areas. Added with the
confirmation of a few other important measurements, the execution within the trading
process becomes simple. If the proper elements provide the evidence to suggest an
opportunity, these are the best situations where a trader can stack of probabilities in
their favor.

Permissible Execution Zone (PEZ) Tips

• PRZ+T-BAR Extreme = Permissible Execution Zone (PEZ)

• Potential Reversal Zone (PRZ) AND the extreme of the Terminal Price Bar
identifies the ideal measurement area that accounts for the real-trading behavior
within an acceptable tolerance beyond the ideal Potential Reversal Zone (PRZ).
• Improves Risk/Reward ratios by optimizing trading decision relative to current
price action.
• Advances Harmonic Trading Execution Strategies from POTENTIAL REVERSAL
ZONE (PRZ) to PERMISSILE EXECUTION ZONE (PEZ)
• Execute trades in this area STARTING ON THE NEXT PRICE BAR = T-Bar+1

The concept of the Permissible Execution Zone is the next level within the
Harmonic Trading approach. Over the years, I have distilled a gamut of measurement
strategies to pinpoint the most important measure cyclical areas that seek to minimize
loss and maximize the. The Permissible Execution Zone reduces the entire trading
process down to a precise window. The various readings at this point are tantamount
for the entire future scenario. The price history manifested here represents the
definitive action for the larger trend. There is a degree of discipline required to be able
to distill situations down to such a small window of opportunity. Regardless, these
conditions serve as a reliable limit that defines probable future market action.

Harmonic Trading Volume 3: Reaction vs. Reversal

142
 In theory, the Permissible Execution Zone is based upon the notion that can
measure the markets movements to garner the most important signals that define
where it's headed. The ability of price action to react to these areas provides further
evidence of their validity. Although most situations will require some degree of
consolidation, the signals within the zones are quite clear and have greater significance
within their defined ranges.

Terminal Price Bar (T-Bar) +1

The most difficult aspect of any trade is the assessment and recognition of stop
loss limit. Within the Permissible Execution Zone, stop loss limit could be comprised of
two or three measures. Although most people know the standard stop loss limit as base
upon the pattern measurement, there are other smaller factors that can be calculated
that complement the Permissible Execution Zone relative to the stop loss limit. Again,
the Terminal Price Bar serves as the initiating event in the Permissible Execution Zone.
Sometimes, reversal can occur quickly while other situations may require greater
consolidation. This is where the skills of the trader are required to be patient and wait
for clear signs to confirm the scenario.

Permissible Execution Zone (PEZ) Psychology

The Permissible Execution Zone is the ultimate realization of the Defined Trading
Realm. The ability to define and measure every stage of trading process provides price
levels to guide trading decisions. All of these parameters must be determined before
the trade is even executed. The research required to learn which strategies work best
does require some time but no money. Therefore, I strongly encourage everyone to
understand these concepts and various combinations that can occur before jumping in.
Realizing that the market can be measured in this regard should instill a degree of
confidence. Our focus should be on discovering what we are not measuring properly
rather than believing that our mistakes are not measurable.
Again, there are many steps involved in the trading process. The identification
principles within the Harmonic Trading approach are powerful enough to make any
person feel as if they understand the market's movements. The problem develops
over time when variations of price action do not unfold consistently and a certain
degree of doubt is instilled due to the inability to decipher price action.
Everyone has overcome periods of confusion throughout their career, especially
when things go awry. Stock market crashes, a particular market moving event or even
the reduced capacity of price action can skew one's normal expectation of trading
history. Regardless, the proper perspective realizes that opportunities are defined within
a box of important conditions to validate the evidence of the trading decision. If
opportunities are not measured and quantified, trading executions are random and not
based on any consistent set of conditions.

Harmonic Trading Volume 3: Reaction vs. Reversal

143
 The Permissible Execution Zone is determined by the T-Bar extreme and can be
confirmed by several factors but the key is that executions occur within this area. As
soon as we have an active entry, the stop loss and profit targets are monitored.
Essentially, we have to define all trading possibilities in advance. These parameters
outline the tolerance limits permitted in harmonic levels of support and resistance to
allow for real world trading action beyond the projected measures.

Execution Triggers in the Permissible Execution Zone (PEZ)

There are specific technical events to follow that determine the ultimate execution
entry within the Potential Reversal Zone (PRZ). Ultimately, the action of execution must
be triggered and the trade deemed to be live. This is where the classification of
technical character helps to define those phases of the price action where the expected
outcome is closest to its realization as long as the relative stop loss that is risked is still
in the trader's favor. After establishing the Permissible Execution Zone, the penultimate
signal before the actual trade will typically be some type of technical event that unfolds
on the shorter timeframe. For example, a pattern that completes on a 60-minute chart
will typically possess some type of set up on the 15-minute and provide an early
reading of the larger reversal at hand. We will address these situations later in this
material.

Bullish Permissible Execution Zone (PEZ)

The Bullish Permissible Execution Zone is extremely effective when harmonic

support is exceeded by the Terminal Price Bar beyond the ideal measures. The price
action at the pattern completion point can gauge how far to allow any further
consolidation beyond the Potential Reversal Zone and the Terminal Bar extreme. This
limit allows for those situations where the immediate test possesses strong price
behavior but the harmonic pattern opportunity remains valid. Other confirmation signals
can facilitate the analysis at this price level but the extra tolerance is extremely effective
in optimizing executions.

Harmonic Trading Volume 3: Reaction vs. Reversal

144
 Bullish Permissible Execution Zone (PEZ)
1.134
• Assess Permissible
1.132
Execution Zone (PEZ)
established by the Terminal 1.130
Price Bar extreme to define 1.128
the beginning of the
execution process. 1.126
1.124
• Anticipated reversal
1.122
behavior must be exhibited
immediately after the 1.120
Tbar+1 unfolds. 1.118
1.116
• Analyze confirmation
factors with respect to the 1.114
defined trade parameters — 1.112
Stop Loss, Profit Target
1.110
and the measurements
that define PEZ.
Terminal Price Bar^ 1.108
(TBar) 1.106

12 02 04 06 08 10 12 14 16 18 20 22 00 02 04 08 10

The following chart examples of GBP/JPY possess a PRZ that defined support
between the 155.70-155.15 level while the terminal Price bar exceeded this area on its
initial test. This established an extreme low at the 155 level. The nature of this price
action beyond the ideal measure indicated a wider Permissible Execution Zone that
optimize the entry below the PRZ. In fact, the price action was quite severe as it
entered the zone of harmonic support. However, after testing the final number, the
price action stabilized immediately thereafter. It is also important to notice that the
initial test nominally hit the stop loss limit but did not exceed this level. Remember, stop
loss limits are assessed by standard measures but must analyze the immediate action
much like the Terminal Price Bar. We will look at how to handle these situations a little
later in the material but this exemplifies the integration of real-world trading with
harmonic measurements.

Harmonic Trading Volume 3: Reaction vs. Reversal

145
60mm * EMA13 158.16 6MA20 158.22 I EMA50158.33 SMA50 158.41 § SMA20& 15154 Volal^y 8ands(20.2.0)

GBPJPY AI-FX r OCT-U_§5:80 Harmonic Analyzer(TM)\<i.85 Copyright * 2001 21308 HinaomrTradfi.com. LLC. All Right* Reserved

Harmonic Trading Volume 3: Reaction vs. Reversal

146
Bearish Permissible Execution Zone (PEZ)

Any assessment of the bearish Permissible Execution Zone must focus on the
individual price bars immediately after the pattern has completed. An easy execution
confirmation method is to simply wait for an individual bar to confirm the anticipated
direction. If a pattern has completed but requires some consolidation at the harmonic
resistance, it can be helpful to simply wait for the first bearish price bar as a means of
confirmation of a larger move at hand. As experience develops, Harmonic Traders
typically are able to readily execute based upon these confirmation strategies and
clearly navigate any market environment based upon the markets own signals. As we
review numerous examples throughout this material, the immediate reversal types do
possess individual price bar confirmation signals that effectively trigger optimal trade
entries.

Bearish Permissible Execution Zone (PEZ)

• Assess Permissible 1.134

Execution Zone (PEZ) 1.132
established by the
1.130
Terminal Price Bar
extreme to define the 1.128
beginning of the 1.126
execution process.
1.124

• Anticipated reversal 1.122

behavior must be 1.120
exhibited immediately
1.118
after the Tbar+1 unfolds.
1.116
• Analyze confirmation 1.114
factors with respect to
1.112
the defined trade
parameters — Stop Loss, 1.110
Profit Target and the
1.108
measurements that
define PEZ. 1.106

12 02 04 06 08 10 12 14 16 18 20 22 00 02 04 08 10

The following chart of the Australian Dollar/Swiss Franc shows a distinct Bearish
Butterfly pattern that manifested demonstrative reversal behavior at the harmonic
resistance. Furthermore, the Terminal Price Bar slightly exceeded the Potential
Reversal Zone on the initial test. The extreme of this price bar help to indicate that the
immediate resistance should not experience much consolidation beyond the limits of the
Permissible Execution Zone. The extreme of the Terminal Price Bar defined an extra 5
to 10 pips tolerance beyond the minimum limits of the Potential Reversal Zone.

Harmonic Trading Volume 3: Reaction vs. Reversal

147
Therefore, the Permissible Execution Zone defined the acceptable tolerance of the real
trading action to optimize the entry to favor an entry slightly above the measured levels.
This trade defined the 0.9790 area as the ideal entry for the trade.

60imn EMA70 0.9/   EMA50 0.97   SMA200 0.95 Volatility Bands<70.2.0)

4 S>- zz 0.00195 € >- zz 0,0121 4 >- zt at i y zz 0.505) ZZ 25.15705

on %AustraIian Dollar/Swiss Franc (AUDCHF_AO-FX) 0 9S50

Bearish Butterfly
60-Mlnute 0.9825

0.9800

0.9775

0.9750

0.9725

0.9700

0.9675

0.9650

0.9625

AUDCHF_AO-FX 09-MAR-11_10:00 HarmonkAAoinrr (TM)v6.05 2601 2008 Harmonic-Trade r.eom. LLC. Ail Rights Reserved

60mtn   EMA20 0.9? 8 Ef.1A50 0.97 B SMA200 0.95 Volatility Bands(20.2.0)

4 zz0.00195 4i>- zz0.Q121 770.1 zz 0.5054 41 >- 77 25.16705
0.9810
Australian Dollar/Swiss Franc (AUDCHF_AO-FX)
Bearish Butterfly Permissible Execution (PEZ)
0.9S00
60-Minute
0.9790
SST
jEBMiii 0.9780

0.9770

0.9760
*—
og>£ •*"
I 0.9750
I
0.9740

I 0.9730

0.9720

A, 0.9710
22 00
l
02 04 06 08 10 12
S Feb
14 16 18 20 22 00
I
02 04 06 08 10 12
9 Feb
14 16 18 20 22 0<

AUDCHF A0 FX 09-MAR-11 10:00 Harmonic Analyzer <TM)v6.05 Copyright « 2001-2008 HaxmonirTrader.rom. LLC. All Rights Resene4

Harmonic Trading Volume 3: Reaction vs. Reversal

148
Advanced Stop Loss Considerations

I think it's important to review the exact ratios used at the completion point of all
harmonic patterns and the relevant stop loss limits. For example, the Bullish Butterfly
employs a 1.2 7X a as its primary projection to define the completion point of the
pattern. If price action was to exceed this area beyond a 1.414, the ideal stop loss limit
would be triggered and the pattern will be considered invalid. Each pattern has its own
stop loss limit. Stop loss limits are more of the general guidelines as they relate to
patterns and may be integrated into trade management of the position differently
depending upon the price action in the PRZ.

Standard Stop Loss Pattern Limits

Pattern XA Ratio Stop Loss Ratio

Butterfly 1.27 >1.414

Crab 1.618 >2.0
Deep Crab 1.618 >2.0
5-0 0.618 >0.618
Shark 1.13 >1.27
Gartley 0.786 >1.0
Bat 0.886 >1.13
Alternate Bat 1.13 >1.27

Establishing Measured Stop Loss Limits

The ideal stop loss ratio levels are dependent upon the Terminal Price Bar. The
Potential Reversal Zone defines the price range for the completion of the pattern.
Implicit with these measurements, the associated stop loss ratios that I have previously
outlined serve as a guideline in advance. However, the assessment of the real-world
trading action beyond the ideal measures is an essential skill that must also incorporate
the coordination of confirmation strategies to effectively optimize trading decisions. As
with the identification rules for patterns, it is possible to define limits within Permissible
Execution Zone that include the Terminal Price Bar to validate the reversal at hand. This
is an important trading skill because there will be situations that require an active
management approach to effectively handle volatile situations. There is no such thing
as a perfect execution. Harmonic Traders must be realistic understand that sometimes

Harmonic Trading Volume 3: Reaction vs. Reversal

149
active market environments require dynamic measurements to assess how price action
is responding to the harmonic levels.
It is easy to experience success early on and attempt to become more active
trader, take on greater risk and begin to reach outside of your level of ability. This can
lead to mistakes that can impact trading psychology and overall confidence. It is
always better to pass on any trades and only execute those that are obviously clear.
Regardless of any difficulties encountered, the proper expectations will always guide the
correct trading decisions. If losses are encountered, Harmonic Traders must go back
and take a look at the rationale of their opportunities and effectiveness of their
execution. In fact, take long to realize that mistakes are being made and consistency
evaded. Harmonic Traders must be honest with themselves and focus on improving
mistakes and reinforcing good habits. This is particularly important with trade
management. When price action does not unfold as expected, there will typically be
very clear evidence at hand of a failure. One of the most important considerations early
in the reversal process is to assess how price action is unfolding beyond the Terminal
Price Bar completion point.

Terminal Price Bar Advanced Considerations

Over the years as I have refined the strategies, my focus has shifted from mostly
an identification dominated trading strategy where I spent most of my time looking for
valid harmonic patterns to now mostly concentrating on the price action immediately
following the establishment of Terminal Price Bar. The initial few price bars have
enormous significance and the character of this action provides immediate insight into
the nature of the pattern itself. The key is being able to know when to allow certain
price action to consolidate in the general area of a completed pattern versus precise
executions that immediately enter trades at the completion of the structure. In either
situation, there will be a brief period shortly after executing the position where constant
assessments of stop loss considerations and initial profit targets define decision-making
process.

Terminal Price Bar Stop Loss Considerations

Some of the earliest technical research that focused on structural patterns in the
market identified basic breakout formations that identified the concept of continuation.
All markets fluctuate from support to resistance and exhibit price behavior that changes
in character based upon the relative position of the trend. The problem for many new
Harmonic Traders is that they do not differentiate price action. However, there are
definitive conditions where price action signals a failed harmonic level early into the
reversal. This depends upon the Terminal Price Bar as it tests the Potential Reversal
Zone (PRZ) to establish the tolerance beyond the ideal measured level. In valid
reversals, the price action typically exhibits decisive continuation that does not require a

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great deal of time to confirm minimum reaction. However, there are clear situations
when the Terminal Price Bar temporarily validates the Potential Reversal Zone (PRZ) on
the initial test without exceeding the stop loss limit. In fact, most properly measured
harmonic opportunities provide this type of natural reaction must actively assess the
general momentum that the initial test possesses as it trades into the PRZ. At a
minimum, the price action following the Terminal Price Bar should begin to exhibit
individual behavior that is in the direction of the anticipated pattern. Sometimes, it is
prudent to wait for these individual signals before even considering an execution.
However, the most dramatic failures can be avoided easily. These situations unfold
once the Terminal Price Bar exceeds the Potential Reversal Zone and fails to yield any
considerable constructive price action in the anticipated direction of the new trend. The
signals must be respected and are effective trade management tools.

Bullish Terminal Price Bar Stop Loss Considerations

Once price action establishes the Terminal Price Bar, the immediate continuation
frequently signals an immediate failure. In the bullish case, any price action that
continues in the direction of the downtrend should signal a potential failure at hand.

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151
The immediate bearish continuation should at least delay the execution until further
confirmation can be established. The following example of the Australian
Dollar/Canadian Dollar shows a distinct Bullish Butterfly that declined through the
Potential Reversal Zone and continued lower immediately thereafter.

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<|>. r/ 0.M235 t\y EM121 i) nO.1 <;>- «0.5054 (> «25.16705

Australian Dollar vs. Canadian Dollar 1.0440

I.
(AUDCAD_AO-FX): 5-Minute 1.0430

^ Failed Bearish Butterfly 1.0420

..i ii 1.0410
i
',i „l 1
1.0400
m

h
1,0390

j;S6XA
1.0380
%v
1.0370
.d*2XAJf.S].035? AB»CD i tl m

1.0360
Terminal Price Bar Expansion \4 M
1.0330
THROUGH a
Potential Reversal Zone (PRZ) 1.0340

with Continuation I I
1.0330

1.0320

I
1.0310
16 14 20 0®

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At a minimum, the stop loss should be adjusted to protect against dramatic

drawdown or break even if possible. The goal at this point in the trade should be to
limit risk, especially when the individual price action violates the Terminal Price Bar and
continues in the direction of the predominant trend. The following chart of the price
action in the potential reversal zone clearly shows how the harmonic support was
violated, provided a brief consolidation and ultimately failed shortly thereafter. We will
look at how to handle these situations precisely with confirmation strategies to facilitate

Harmonic Trading Volume 3: Reaction vs. Reversal

152
this analysis. However, the simple price action character exhibited overall weakness as
the predominant trend continued lower following a nominal reaction beyond the
Terminal Price Bar. The ideal support zone was measured between 1.0365 - 1.0355 on
the following 5-minute chart. The terminal bar extreme defined the permissible
execution zone below this area at 1.0350. The execution of the opportunity favored the
price range below the harmonic support. Even with this extra tolerance, it was clear
that the price action was not responding and violated the Terminal Price Bar shortly
after testing all the numbers in the PRZ.

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<!> KM«2* <;>. «0.0121 <>. 220.1 <j>. 220.5051 <J>. 2225.16705

0355
.03*0

ab»cd o mm

1.0360

1 l.:*XA 8 J1JU5T
I.240BC :i JU355

,.0350

Terminal Price Bar .0310

1.0330

Australian Dollar vs. Canadian Dollar

(AUDCAD_AO-FX): 5-Minute 1.0320

Failed Bearish Butterfly

Terminal Price Bar Expansion THROUGH a 1.0310

Potential Reversal Zone (PRZ) with Continuation

#

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Harmonic Trading Volume 3: Reaction vs. Reversal

153
Bearish Terminal Price Bar Stop Loss Considerations

One of the primary challenges all Harmonic Traders face is to gauge the extent
of the real-world price action beyond the ideal Potential Reversal Zone. The structural
signal does possess a definitive completion point where the character of the price action
must change. However, an immediate continuation beyond the Terminal Bar signals a
flawed opportunity at hand.

EXTREME TERMINAL PRICE

BAR CLOSE THROUGH THE
POTENTIAL REVERSAL ZONE
(PRZ) WITH BULLISH
CONTINUATION

The following chart shows the price action at the completion point of the pattern.
Potential Reversal Zone (PRZ) defined the 80.25 area as critical short-term harmonic

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154