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TMs

The Origin of Harmonic Patterns

Harmonic Patterns have emerged in recent years as a popular analytical approach among traders. Names such as Bat^TM, Shark^TM, Crab^TM – mostly animals – have become the language of Harmonic Pattern^TM traders. Although I named these structures and introduced the rules two decades ago, a great deal of misinformation of what it means to truly be a harmonic pattern has distorted the essence of these strategies in recent years. The origins and tenets of Harmonic Pattern^TM strategies require clarification and proper citation, as many have rushed to promote many technical concepts as HARMONIC. Relating to what is prevalent today, the definition of what makes a price structure harmonic must reference the essential principles that preceded these discoveries to unlock the “natural cycles” in the markets.

Past “harmonic” references within the scope of Technical Analysis – especially from the likes of Elliott, Gann, J.M. Hurst and others, featured specific metrics that attempted define price pattern wave “cycles” based upon various types of geometric and numeric frameworks with respect to price and time. For harmonic pattern purposes, the focus is mostly on price structures that adhere to structural wave types (M&W formations) which possess prescribed (harmonic) ratio alignments. This is one clear difference of harmonic patterns because the time calculations are implicit within the symmetry of the structures. In fact, the clearest pattern situations – no matter what market or timeframe, must satisfy the measurement and symmetry requirements in all situations to be considered as valid possibilities.

For our purposes, the gamut of trading strategies that are employed within this approach are focused upon harmonic price pattern measures only. Although harmonic patterns can be integrated as an accurate tool to any existing trading plan, I must emphasize that we do not include Elliott Wave or related Gann strategies. Harmonic patterns are an entire start-to-finish methodology that provides step-by-step rules to identify, execute and manage these opportunities. I must stress that these concepts are an essential aspect to understand the entire harmonic pattern framework. In this article, it is my intention is to present historically accurate references while emphasizing the essential principles that make patterns harmonic. Let’s start at the beginning.

Although its origin is founded in primary concepts of Technical Analysis – mainly Wave Theory and Ratio measurements, the advent of the current Harmonic Pattern Theory commenced with my first book, The Harmonic Trader (1998 Harmonic Trader Press), and subsequent Volumes I, II released in 2004 and 2007, respectively and Volume III In 2016. These books outlined the exact rules based upon years of research as well as the integration of a variety of measurement strategies to optimize Harmonic Pattern identification requirements. Furthermore, harmonic pattern measurements for execution and management proprietary rules presented in these books facilitate the trading process to provide an entire framework to guide decisions. Although these aspects of the process are often overlooked, they are as important than the simple identification of the structure.

I must stress that the harmonic pattern concepts that are accepted as common knowledge today actually EVOLVED OVER THE COURSE OF MANY YEARS before I solidified the basic harmonic pattern identification, execution and management framework. For years, I experimented, integrating proprietary ideas with standard concepts of Technical Analysis. This process led to my definitions of harmonic patterns that evolved into a sequential rule-based methodology to identify, execute and manage any opportunity. After releasing my Harmonic Trading: Volume One in 2003, the process was defined exactly with remarkable precision for specific-pattern strategies. Furthermore, the Harmonic Pattern measures possessed unique and unprecedented key differences from other Wave theories are these exact rules that define harmonic zones (Potential Reversal Zone) – as valid and relevant levels of support and resistance. We will look at a few examples momentarily, however it is important to note that this degree of measured analysis provides an ability to isolate situations that satisfy prescribed requirements and define pattern-specific strategies to optimize decisions in an integrative manner.

The Foundation of Harmonic Pattern Concepts

Harmonic patterns integrate two schools of thought within the realm of Technical Analysis. Employing prescribed metrics of (harmonic) ratios with structural wave analysis to categorize multi-segmented price movements, harmonic patterns are primarily 5-point M&W-type wave formations. Although other harmonic patterns such as the Shark and 5-0 fall outside of this scope, the primary arsenal of these structures are comprised by specific M (bullish) and W (bearish) price formations. Much like 5-wave Elliott counts, wedges, triangles and other types of structural pattern analysis, these methods analyze the market trading history to identify repeating price movements that can be defined, illustrated and outlined. It is important to note that many of the harmonic pattern discoveries were inspired by pioneers of Technical Analysis – past and present – and their determination to unlock opportunities through an unbiased MATHEMATICAL perspective. Much of the credit for the harmonic ideas is due to the work of Hurst, Gann, Elliott and many others but the specifics of these strategies resulted from a great deal of my own research to devise consistently effective measures within a natural framework as defined by the pattern requirements.

Wave Theory-Market Structure (R.N. Elliott/Merrill&Levy/Gartley)

The writings of R.N. Elliott were some of the most comprehensive structural analysis ever presented at this time. His classifications of three-wave and five-wave price phenomena were among the first prescribed structural analysis that identified the importance of multiple waves in the markets. Furthermore, the defined wave counts related to his Fibonacci-inspired time projections provided a framework to categorize market movements, and even put forth the notion that the market can follow similar cycles that are prevalent throughout nature. Subsequent “Elliotticians” integrated new metrics with wave counts to enhance this framework (Prechter&Frost). These ideas evolved over the decades from general wave theory to a more standardized wave pattern recognition. With its roots in Elliott Wave Theory, the crux of what makes a structure harmonic depends upon a specific formation. Instead of 3&5 Waves, harmonic patterns are mostly M & W-Type structures with specific alignments of measurements.

Although his work is not as popular as Elliott, Arthur Merrill’s book, Filtered Waves (Analysis Press, 1977) presented illustrations of a few dozen different Zig-Zag types in which he labeled as M&W-type 5-point structures. The M and W formations – much like triangles, wedges – are classic wave patterns that have been refined by the likes of Merrill and Robert Levy who categorized dozens of Zig-Zag classifications. The work of Levy and Merrill can be attributed as the modern-day advancement of Zig-Zag waves to validating M and W-type formations as 5-point XABCD structures.

(p. 46, Filtered Waves (Merrill, Arthur Analysis Press, 1977)

Most popular of all harmonic patterns, the origins of the Gartley have been mired in a haze of misinformation and misrepresentation. I have the utmost respect for H.M. Gartey’s book, Profits in the Stock Market (1935). His wave studies and in-depth analysis of confirmation strategies are often overlooked, as this masterpiece was ahead of its time. However, the notion that Mr. Gartley defined harmonic patterns in this book is completely false. The infamous Gartley Pattern was not even named until 50 years after the release of his book, and he did not reference Fibonacci in any regard. So, what is in the book that everyone cites? In his book, “Gartley’s pattern” presented two types of price action retesting a support/resistance point after an extended price move. His detailed work is some of the earliest and most comprehensive trend and wave analysis of its time. The following illustration recreates his structural interpretation from Profits in the Stock Market (1935).

(Recreation of Illustration from pg 222, H.M., Profits in the Stock Market, Pomeroy, WA: Lambert-Gann Publishing, 1935.)

Released a few years before R.N. Elliott introduced “The Wave Principle,” Gartley’s “Profits” advanced Technical Analysis in a number of areas but he focused more on what he termed “breadth-of-the-market” studies – a range of ideas regarding trend channels, market conditions and general structural analysis. His work reflected the primary technical ideas of the time but lacks any mention of harmonic concepts, specifically Fibonacci. This illustration was among the earliest to build upon wave concepts but this is the extent of pattern recognition in the book. Although the bullish and bearish illustrations are different, the larger concepts of structural recognition at the retracement of an important price extreme was an initial attempt to isolate situations based upon repeating price 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. Although Gartley’s work was a breakthrough in Technical Analysis, this is an immensely important and personal clarification for the source of harmonic patterns. In subsequent years, others have applied ratios (Fibonacci, Static) and Zig-Zag formation strategies to wave structures. However, the harmonic pattern breakthrough of a rule-based approach for M and W-type formations was first introduced in my first book, The Harmonic Trader in 1998. These early ideas integrated existing and new harmonic measurements to isolate EXACT REQUIREMENTS that validated these structures as trading opportunities. The combination of ratios and other wave rules advanced the general XABCD^TM knowledge to convert M&W-type structural analysis into predictive trading capabilities.

Ratio Measurements (W.D. Gann/Dow/Hurst)

W.D. Gann presented numerous measures that have become its own discipline within Technical Analysis. Tools such as Gann angles, Square of 9, Hexagon, and Circle of 360 were his primary market forecasting methods. Although I agree with many of his Geometric principles, Harmonic Patterns have nothing to do with his other areas of study, particularly Astrology. Gann exposed the unique relationships of cyclical phenomena in nature that was manifested in the markets. Despite his Astrological leanings, W.D. Gann can be considered as the forefather of Sacred Geometric ratio integration. Although his measures were unique, the application of his squaring techniques for example, initiated a new paradigm in price analysis, as he effectively refined concepts from Ancient Geometry into a predicative analytical framework. In this regard, harmonic patterns and their measurements respect the natural phenomenon of cyclical movements of growth and decline in the same manner. Gann’s work ascribed to define and follow a natural order of price parameters based upon his measurement strategies. In fact, he provided the earliest reference of “harmonic analysis” as it relates to the markets in his 1927 book, The Tunnel Thru the Air, stating:

“But mathematical science, which is the only real science that the entire civilized world has agreed upon, furnishes unmistakable proof of history repeating itself and shows that the cycle theory, or harmonic analysis, is the only thing that we can rely upon to ascertain the future.”

(“The Tunnel Thru the Air”; Lambert-Gann Publishing; Pomeroy Washington; 1927; pg. 77.)

In these regards, immense respect is due to Mr. Gann for integrating geometric measures to define predicative (harmonic) order. However, long before Gann, Charles Dow was among the earliest technicians who categorized market movements, proposed general percentage retracements (1/3, ½, 2/3) and defined many of the basic principles of Technical Analysis throughout his career contributing articles to The Wall Street Journal – and this was over 100 years ago.

“The market has three movements (1) The “main movement”, primary movement or major trend may last from less than a year to several years. It can be bullish or bearish. (2) The “medium swing”, secondary reaction or intermediate reaction may last from ten days to three months and generally retraces from 33% to 66% of the primary price change since the previous medium swing or start of the main movement.” https://en.wikipedia.org/wiki/Dow_theory

Finally, J.M. Hurst was another technician around the time of Merrill AND Levy who released “Profit Magic of Stock Transaction Timing” (Hurst, J.M. Prentice-Hall 1970) that focused on wave structure. Hurst’s application for market forecasting was ahead of its time, and among a generation of Wave technicians of the day (Prechter, Frost, Merrill, Levy, many others) who were advancing Elliott’s original work. In particular, he featured one-to-one structures where each price segment was equal in length AND time. He emphasized predicative Wave Theory strategies that forecasted price movements based upon the market’s own trading history. Furthermore, he was a personal inspiration of the “target zone” concept to measure possible outcomes in advance. He even described this price relationship in his “Principle of Harmonicity” stating:

“The periods of neighboring waves in price action tend to be related by a small whole number.”

(J.M. Hurst Cycles Course, Greenville, S.C.: Traders Press, 1973.)

He defined distinct wave structures and projected “measured moves” where he defined targets of an anticipated move utilizing 100% price projections. In effect, Hurst work exposed the predicative Wave properties that trends can possess, and he integrated a unique application of projected price and time measures. It is important to note that these ideas led to the understanding of the AB=CD structure as a vital component of harmonic patterns.

Zig-Zag XABCD -> Harmonic Patterns

In my work, the jump from Zig-Zag XABCD structures and the complexities of Hurst’s work to harmonic patterns was inspired by two modern-day technicians. Robert Miner and Bryce Gilmore moved the needle in Technical Analysis with thought-provoking wave ideas and ratio measures. Although deeply-rooted in wave counts and cycle theory, these books inspired me to apply geometric ratio measures to define unique but repeating patterns. This categorization of strategic measures was the most responsible breakthrough for me to advance general M and W XABCD measures to define structural harmonic zones to define trading opportunities.

Robert Miner in his work with “Dynamic Trading” that applied new measures to wave counts in price and time. I actually met Bob once in 1997 in Tucson, AZ and thanked him for these ideas. Although I was never big on Elliott Wave, his projections attempted to define natural cyclical points in new ways.

https://www.amazon.com/Dynamic-Trading-Practical-Strategies-Investors/dp/093438083X

Bryce Gilmore in his “Geometry of Markets” brought a new level and sophistication to this area of geometric projections within Wave Theory. Although Gilmore focused more on Gann and Astrology, their cyclical measurement strategies of geometric ratios exemplified their attempt to define the expected “natural” limits of any market move. Mr. Gilmore’s Wave Trader software and related materials were among the first resources and program to isolate M&W-type wave formations with ratio measures as chart patterns.

https://www.amazon.com/Geometry-Markets-Bryce-Gilmore/dp/0934380554

M&W-Type Harmonic Patterns

The categorization of M&W-type structures as harmonic patterns was a significant step forward in the structural analysis of general 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:

Does this m look like this M ?

Does this w look like this W ?

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.

Harmonic Ratios

Harmonic patterns rely upon Fibonacci-derived ratios to validate price movements as harmonic. That is, price segments that are proportional to prior moves by one or more ratio related directly or indirectly to the 61.8% and 161.8% “Golden Ratios” derived from the Fibonacci sequence. The Fibonacci Sequence is a summation series with unique mathematical properties and it is manifested through many of life’s natural growth processes. The series begins with 0, adds 1 and calculates the sum. The series of calculations follows by adding the sum to the preceding two numbers. After the 8^th calculation, the summation’s proportions are ever-increasingly equivalent to the golden ratio (61.8% and 1.61.8%) as the equation continues infinitely.

0+1 =1

1+ 1=2

1 + 2=3

2 +3=5

0,1,1,2,3,5,8,13,21,34,55,89,144,233…

There are a multitude of natural examples regarding natural cycles that follow this growth pattern as well as exhibit the proportional properties of the sequence. Fibonacci Phyllotaxis is one area of research that has substantiated these proportional numbers’ existence in nature, displaying patterns in plant growth spirals that adhere to this series. In addition, the proportional phenomenon of various body parts in humans (particularly denoted by DaVinci) and animals (Nautilus Shell are other frequently cited examples). The primary 61.8% & 161.8% derived from the Fibonacci sequence repeats in nature and price action in the markets. Although measurement derivations are a result of various square-roots and/or related formula, the set of Harmonic Ratios as depicted below has been another breakthrough as a complete framework in the application of natural measures related to Wave Theory. The following is the comprehensive list of harmonic ratios.

Primary Harmonic Ratios: 61.8% and 1.61.8%
Secondary Harmonic Ratios: 78.6%, 88.6%, 113%, 127%
Complementary Harmonic Ratios: 38.2%, 50%, 70.7%, 100%, 141%, 200%, 224%
Extreme Harmonic Ratios: 261.8% 314%, 361.8%

The 61.8% and 1.61.8% serve as “Primary Harmonic Ratios” that represent the basis for an entire gamut of derived natural metrics. Related directly or indirectly to the Fibonacci sequence, the set of ratios provides that denote the natural levels to examine and apply to wave structures. Although M&W formations are principally measured by these ratios, the other requirement to validate harmonic patterns employs specific “Sine Wave” principles inspired by Hurst and others to create unique measurements that establish standards to categorize each variation precisely. Furthermore, the minimum structural requirements within M&W formations define important basic wave types that possess natural cyclical limits that are more effective than simple ratio alignments. Simply stated, the precision structural metrics of M&W harmonic patterns filter many invalid possibilities and avoids comparing “apples to oranges” through the categorization of similar price structures. For example, Hurst’s “1-to-1” pattern served as the predecessor to the AB=CD Pattern. However, its application of the equivalent structure within M&W-Type harmonic patterns expanded to include Alternate AB=CD variations that have become essential in the identification process of valid opportunities. Revered for its simplicity and effectiveness, the ability to refine AB=CD structures is another example of situational-strategies to optimize decisions and improve risk/reward parameters.

Harmonic M&W Pattern Measurements

The primary harmonic patterns must adhere to the basic tenets of M&W formations within each X, A, B, C, D point. That is, each point must respect an exact alignment within the structure. The Bat and the Gartley exemplify the important differences that distinguish each with precise measures. Each require prescribed ratio combinations and pattern-specific strategies to be validated as a trade opportunity. Most of the proprietary harmonic pattern strategies arose from these measured combinations and strategic integrations. As mentioned previously, harmonic patterns consider wave structures and harmonic ratio measurements within M&W-Type formations that define a target zone for the management of the opportunity. Most importantly, the harmonic pattern traders must properly identify, execute and mange within this framework.

Potential Reversal Zone and Terminal Bar

Beyond the prescribed identification rules, other important strategies have been introduced to define various aspects within the harmonic pattern framework. The Potential Reversal Zone (PRZ) was initially presented in “The Harmonic Trader” (1998), as a means to standardize the various pattern types and create a precise range to anticipate reversals. The harmonic PRZ concept was advanced in “Harmonic Trading: Volume One” (2004) to identify the exact price bar – the Terminal Bar – that tests the final measured level. Serving to effectively gauge the actual price action as it tests the zone, the “T-Bar” or the Terminal Bar concept was a significant breakthrough in the optimization of harmonic pattern executions and management since the strategy can reduce risk and improve overall projected return.

Harmonic Pattern Execution and Management

Although most traders are aware of harmonic pattern identification rules, I must stress that this is only one part of the process. Harmonic pattern execution and management require price parameters to quantify risk/reward and optimize the ENTIRE trading process. It is important to note that harmonic patterns should be actively managed, as most situations will experience a REACTION to a measured level on the first test (Type-I) followed by a secondary retest that typically yields a larger expected REVERSAL (Type-II). The most important aspect of proper execution and management is to maintain a realistic attitude with each pattern. The prevailing notion that a harmonic pattern results in a “home-run” trade in every situation is incorrect. Most harmonic patterns will provide two opportunities – one reaction, one reversal. It is important to be patient and develop some experience before integrating the harmonic pattern price levels into your trading plan.

Example: Gartley vs. Bat Pattern ^TM

The following comparisons of a Gartley vs. a Bat Pattern outline the similarities and differences of each structure. Although they possess similar M & W formations, the handling for each is unique.

Gartley Pattern

The following illustration outlines the M and W formation rules that require exact measurements to define each Potential Reversal Zone. Most important, the mid-point at B must be at the 61.8% retracement within a +/-3% tolerance to validate the other measures within the structure.

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)

These M and W patterns define precise formations that include an AB=CD wave structure at the 78.6% retracement. Together, these measurements quantify a unique M/W structure that is executed and managed differently from other patterns.

Dow Jones Industrial Average Emini (YM): Daily

Bearish Gartley Pattern

The following chart shows an ideal Bearish Gartley with a perfect alignment. The B point was within the +/-3% tolerance at the 61.8% retracement, establishing the other measures to define the Potential Reversal Zone. The price action stalled immediately after the Terminal Bar marked the completion of the pattern at the 78.6% XA retracement and the equivalent AB=CD. A few days later, the reversal was confirmed and the initial reaction resulted in a larger reversal.

Bat Pattern^TM

Although similar to the Gartley, the distinct structural differences that result in a Bat lead to a deeper retest of the starting point of the pattern. The AB=CD structure is frequently extended as the more substantial 88.6% retracement tends to possess more volatile reversals than Gartley patterns.

Expect PRZ test of 0.886 XA Retracement
Minimum AB=CD (Typically Alternate 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

Google (GOOG): Daily Bearish Bat Pattern^TM

The following daily chart of Google shows an ideal Bat structure that reversed from the initial test of the PRZ. The 88.6% retracement defined the top-end of the harmonic resistance. The other measurements of an extended BC structure and an Alternate AB=CD defined the area closer to the starting point of the pattern as the optimal entry for the opportunity. Despite the strong rally into the harmonic resistance, the clear inability to breakout above this area was confirmed within a few days as the reaction turned into a full-blown reversal after completing the pattern.

Harmonic Patterns > Harmonics^TM

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, 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 analysis of structural wave behavior of price action in the financial markets that possesses unique technical conditions as measured by harmonic ratio formulae. Advanced strategies such as RSI BAMM, Harmonic Strength Indx and many others have refined pattern situations and optimize the trading process with confirming factors within the prescribed structural framework. These pattern rules and larger technical measures have become collectively known as the study of Harmonics in the financial markets. Again, these strategies are distinct from past harmonic references that featured Astrological cycles and/or Elliott Wave considerations. Related directly to M and W price patterns, the study of harmonic price action is serious business in the 21st century.

What is the Big Harmonic Deal?

The Harmonic topic has become popular in recent years, especially since it has been promoted as some “secret pattern” by many internet marketers. This has caused doubt into what it means to be harmonic and led to a great deal of misinformation how to trade these opportunities. As creator of the pattern rules and owner of Trademarks, Copyrights of this original work, I must defend the integrity of the metrics that define the harmonic advantages. Most overlook the importance in getting the identification of patterns correct as tantamount to capitalizing on the phenomenon that is harmonic! Proprietary concepts such as the AB=CD^TM conditions, PRZ, Terminal Bar and many others are advancements of the work beyond M&W patterns is critical to understanding this framework.

Conclusion – Harmonic Hype?

I encourage all traders to dig deep into the reference material mentioned in this article. I have always made it a point to recognize individuals such as Merrill, Gann, Elliott and modern contemporaries like Gilmore, Miner and Welles Wilder. However, harmonic price patterns have emerged as a separate but vague technical discipline since their introduction in 1998. Specifically, harmonic patterns such as the Crab, Butterfly, Bat, were introduced within the past 20 years. Regardless, the body of harmonic pattern work is a result of my passion for trading and a respect for those whom preceded me. Their interpretations shaped my understanding of these natural relationships and shaped my market perspective. I have shared most of these ideas in these articles, books and related software projects to empower traders to realize there is order within the chaos of the markets. I have also stressed that harmonic patterns require patience, disciple and a strategic approach that this is more than a black-box methodology – more like a Grey Box! Regardless, I recommend utilizing harmonic patterns as a measured analytical framework first and foremost.

I am the biggest supporter and largest critic of harmonic patterns. The most important takeaway from all of this harmonic pattern hoopla is that it PROVIDES A FRAMEWORK OF NATURAL CYCLICAL METRICS TO MEASURE THE MARKET. However, the identification is merely the first step and I believe traders must understand the required execution and management skills to get the most from the entire harmonic pattern framework. I utilize them as my principal technical means to identify trading opportunities. However, other advancements have led me to refine pattern confirmation strategies such as Wilder’s RSI or my Harmonic Strength Index. Again, these harmonic metrics integrated with harmonic price structures further refine the best opportunities. Harmonic Patterns will continue to be explored by traders in the years to come. My hope is that the measures that make patterns truly harmonic opportunities adhere to the standardized definitions that made them so effective and easy for traders to use.

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