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COPYRIGHT HARMONICTRADER.COM, L.L.C. 2004

The Harmonic Trader

(Excerpt 2)

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.

Copyright Scott M. Carney, 1999

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Ideal Gartley

The ideal Gartley set-up will be defined by specific Fibonacci retracements. One of the most important numbers in the pattern is the completion of point D at the .786 of XA. Although the price action might exceed this number slightly, it should not exceed point X. The pattern is a nice set-up, especially with the convergence of an AB=CD. Another important point in the pattern is the .618 retracement of the XA leg. The AB leg should reverse very close to this retracement. The .618 retracement at point B is critical because it will establish another Fibonacci projection - usually a 1.27 of BC - in the potential reversal zone at point D.

Bullish Gartley

In the bullish Gartley, it is important to note that certain points in the pattern must be located properly to ensure a valid signal.

Point X is below all of the points in the pattern. Point A must be above point C, and point D must complete below point B. The most critical aspect for a valid reversal is that point D must hold above point X. Furthermore, the pattern should possess a clear AB=CD pattern.

Bullish Gartley Stop Loss

The key to any trade execution is determining in advance the amount you are willing to risk. Defining the “uncle point,” or stop loss limit, is crucial in containing losses and preserving equity capital. A stop loss limit in harmonic trade set-ups is really the point at which you believe the potential reversal zone is no longer valid. Harmonic trade set-ups are effective because they define a high probability area for trend reversal. Once that area is defined, the point at which the set up is no longer valid is fairly clear.

The stop loss limit in this pattern is measured relative to the initial point (X) of the defined pattern. In a bullish Gartley, the stop loss should be placed just below the initial point (X).

Although the price action can retest the extreme point at X, the stock must reverse above this key area for the pattern to be valid. So, it is very important to examine the price bars in this area and be wary of any potential warning signs that might invalidate of the pattern.

Ideal Bullish Gartley

The ideal bullish Gartley has specific Fibonacci retracements that are essential to define a valid pattern. In my opinion, the .786 is the most important number in the potential reversal zone. Although there are several other harmonic calculations that define the potential reversal zone, I believe the .786 is the most important number in the pattern because it is a projection off the largest price leg.

Another very important harmonic calculation is the completion point of the AB=CD. I consider this entry point to be a minimum requirement for a trade to be executed. The AB=CD completion point is useful because it should nicely complement the area of the .786 of the XA leg. Let’s look at some examples of ideal bullish Gartley patterns.

Wells Fargo formed this bullish Gartley that was extremely harmonic. There were several numbers converging within less than a point and a half – between 31 15/16 and 33 5/16.

There were three harmonic calculations that clearly defined the potential reversal zone. The stock possessed a nice AB=CD pattern. Although the CD leg was slightly extended, the distance of the two legs were relatively close. The AB leg was 7 1/8 points, while the CD leg was 8 5/16. The completion point of AB=CD was projected at 33 5/16. The .786 retracement of XA was calculated at 32 1/8. The 1.27 projection of BC was located just below 32 at 31 15/16.

The following enlarged chart illustrates the price action in the potential reversal zone very well. As you can see, the stock literally bounced off this area. Although the price action was somewhat strong on the day it hit the potential reversal zone, the stock turned around quickly in the next few days.

When three numbers converge in a specific area like this example, the probability for a reversal is very likely. Wells Fargo reversed exactly off the .786 retracement of the XA leg at 32 1/8. Wells Fargo rallied over 10 points in two months, which is equivalent to over a 30% gain.