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Harmonic Trading: Terminal Bars and PRZ Failures

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Harmonic Trading: Terminal Bars and PRZ Failures


When we look at most of the commonly employed techniques in technical analysis, one of the most striking things that comes to mind is the fact that there have not been many recent developments in the way day traders view price activity. Looking at the past research and market innovations in these areas, names like Gann, Wilder, Elliott, and Gartley quickly come to mind. But it is hard to ignore the fact that these names are relatively old and we have not seen many recent innovations in the underlying philosophies that mark modern technical analysis. This is most surprising because we have high-powered online trading stations that make this type of analysis much easier that it was 100 years ago (when technicians were literally plotting out their strategies with a pencil and a piece of graph paper).


Harmonic Strategies


One of the few exceptions to these troublesome trends (a large lack of innovation in TA strategies) is the work that has been done in Harmonic Trading. To less experienced traders, the Harmonic patterns might seem overly complicated and too much work in determining a regular trading strategy. But these patterns are really nothing more than a simple combination of Fibonacci retracements and extensions. So if you are familiar with these techniques (and most traders are), then harmonic trading should not be impossibly difficult to master. It can become difficult to remember all of the specific calculations for each pattern, and we have outline the parameters for all of the major patterns in previous articles. Specifically, details outlining the Bat, Crab, Butterfly and Gartley patterns can be found here.


All of these patterns started with the Gartley pattern, which did not even use Fibonacci calculations as part of the structure. So, it is clear that traders have been looking for new ways to define these patterns since their inception. This is highly encouraging for technical analysis traders, as these types of strategies have several advantages that include high-probability directional indicators and tight reversal zones that allow traders to place stop losses very close to their initial trade entries. This can help immensely with risk-to-reward ratios, and give you a much bigger edge when trading in volatile markets. But modern traders can get lazy when using these patterns, as there are basically software indicators that do most of the work.


These are very good indicators to use in active trading (for Metatrader, the plugin can be downloaded here). But it is very important to understand how the indicator works, and here we will look at two critical elements of the structures that must be understood in order to make Harmonic patterns work in your favor. These elements are the Potential Reversal Zone (PRZ) and the Terminal Bar (or T-Bar).


Spotting Reversals with T-Bars


The main purpose of using the Harmonic pattern is to spot trend reversals. If you are looking to trade in the main direction of the market -- and to capitalize on the majority price momentum -- then Harmonic patterns are NOT for you. Harmonic patterns are used as the basis for contrarian positions and are usually seen during periods of high market price volatility. If these types of conditions and strategies do not appeal to you, it is time to look elsewhere (perhaps at breakouts or range trading scenarios). But if you are a contrarian trader that looks for opportunities to ‘buy low, and sell high’ then harmonic patterns can be a fantastic addition to your trading arsenal.




(Chart Source: CornerTrader)


Visually, some of the earliest opportunities can be seen when a Terminal Bar (or T-Bar) forms on your chart. For example, an ideal bearish harmonic reversal should start with both the upper and lower levels in PRZ (explained below) have been tested. In the graphic example above, we can see that strong bullish momentum was violently rejected, resulting in a long upper wick and a quick break of short term support. If this occurs in an area where the previous price moves match the requirements for one of the Harmonic patterns (see the articles referenced above), then you have the criteria you need to make a trade entry.


Bearish Bat Example




Next, we look at a real-time example where the Harmonic leg requirements for the Bearish Bat pattern are met, and the ZUP trading plugin sends an alert (as it does for all Harmonic patterns). In this case, the Terminal Bar would only become invalidated if prices exceeded the 1.27 Fib extension of the move XA. Ideally, prices would drop after the Terminal Bar is formed, but there is also the possibility that prices could trade sideways without violating the pattern (as long as prices do not move beyond the 1.27 Fib retracement).




Looking more closely at the Terminal Bar area, we can see the PRZ parameters being defined. This marks the entry point for a Harmonic Trade. The dashed line is the top of the Terminal Price Bar, and since this is a bearish pattern the area should be viewed as a level of critical resistance (if the pattern was bullish, the area would mark the key support zone). In cases where the T-Bar support/resistance level is broken, traders could actually flip the bias and trade in the direction of the original trend (as this would suggest that the original trend is still in place). Further work in some of these areas can be seen in the forex technical analysis section at ForexAbode.


Failed Harmonic Reversals


One of the benefits of the Harmonic pattern is its high level of success and accuracy. Most Harmonic patterns accurately depict the point of reversal in a strong trend, and this information can be very valuable for traders. But no price pattern -- no matter how well-defined -- is foolproof. And traders need to have strategies in place to decide what to do next when price patterns fail.




(Chart Source: CornerTrader)


In the graphic example above, we can see that prices have violated the PRZ and risen above the area market by the T-Bar. This means that the Harmonic pattern was never valid in the first place, and that the original trend is likely to continue. Aggressive traders could actually take the bullish position in a case like this. But for traders that are looking to employ Harmonic patterns exclusively, it is better to just wait on the sidelines. The philosophical tug-of-war in a situation like this would depend on whether you are looking to side with the market’s momentum or with the possibility of trend reversal. This is also a reason why many investors opt instead for options trading strategies when dealing with the financial markets. Those that side with the Harmonic argument would be in agreement that trades should be taken when prices have reached extremes (lows for longs, highs for shorts).




In the chart graphic above, we can see prices reaching the 1.27 Fib extension of the price move XA. Given the strength of the move, it would not be ridiculous to start betting against the market in anticipation of a downside correction, if not a complete reversal in trend. But if traders had taken a bearish position, major warning signals should be received if prices continue higher. All short positions would need to be closed (as there is not real argument for high-probability short trades).


Conclusion: Watch Your T-Bars To Decide When Harmonic Trades Should Be Closed


Some traders refer to the T-Bar failure shown above as a Harmonic Breakout, as the forces that combine to structure the harmonic patterns have been overcome by the underlying momentum that is seen in the market. In traditional breakout trades, this is an argument to establish positions in the position of the break. In Harmonic situations, the probabilities for success are even higher, as there are more factors at work (not just simple support and resistance levels).


In any case, the Terminal Bar can give traders a good deal of information in determining the validity of a Harmonic pattern that has shown on your price chart. For these reasons, it can be argued that the PRZ and T-Bar area is perhaps the most important area in the entire pattern. This applies in all cases, so the rules will still be the same no matter which Harmonic pattern you are watching on your chart.

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I scan forums from time to time to see what people are saying about harmonic patterns.  It is amazing that you posted this information which comes from my books INCLUDING ILLUSTRATIONS/IMAGES from my Harmonic Trading Volume One yet you fail to cite me as the source.  Why?  I created harmonic patterns, concepts like PRZ, TBar and the explanations of this approach which you describe but the omission is puzzling.   Maybe you will not approve this response but you can respond directly to me.


Scott Carney

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