What is Harmonic Trading?
Harmonic Trading is a methodology that utilizes the recognition of specific price patterns and the alignment of exact Fibonacci ratios to determine highly probable reversal points in the financial markets.
This methodology assumes that trading patterns or cycles, like many patterns and cycles in life, repeat themselves. The key is to identify these patterns, and to enter or to exit a position based upon a high degree of probability that the same historic price action will occur. Although these patterns are not 100% accurate, these situations have been historically proven. If these set-ups are identified correctly, it is possible to identify significant opportunities with a very limited risk.
One of the most comprehensive references to Harmonic Trading was outlined by J.M. Hurst in his cycles course from the early 1970s. His Principle of Harmonicity states:
“The periods of neighboring waves in price action tend to be related by a small whole number.”
(Hurst, J.M., J.M. Hurst Cycles Course, Greenville, S.C.: Traders Press, 1973.)
The important concept to grasp is that price waves or distinct price moves are related to each other. Futhermore, price patterns that are quantified by the alignment of precise ratios manifest these relationships, and provide a means to determine where the turning points will occur.
When these turning points are identified correctly, trades are executed at a price level where the cycle is changing. Essentially, this type of trading is respecting the natural ebb and flow of buying and selling. In doing so, these trades are executed “in harmony” with the market. For example, when a stock is bought at this turning point, the majority of the selling that has driven the price down is very close to ending. Quite often, the harmonic techniques identify trades at or very close to the exact reversal point.
It is important to note that Harmonic Trading works on any time frame – intra-day, daily, weekly or monthly charts. I believe the clearest trade opportunities, or “set-ups,” appear on daily charts for position or swing trades. However, hourly charts provide excellent set-ups for shorter-term or day trades. It is also amazing that these methods work on longer-term charts, as well. Weekly or monthly charts are excellent measures of historically critical areas in the financial markets.
The most important principle inherent within the Harmonic Trading approach is the ability to differentiate various types of cyclical price action that adheres to specific structural and ratio conditions. Price fluctuations represent cycles of growth (rally) and decline (sell-off). Similar to many of life’s cyclical growth processes, these movements can be quantified by their relative Fibonacci ratio relationships and analyzed to define unique technical situations.
In doing so, trades are executed at those areas where the natural rhythm of the market is changing.