Amongst traders of financial markets, there are two specific trades which seem to capture more universal attention than any others: These are entries at major turning points and in the early stages of dominant trends. Successful trades based on either of these entry points can yield powerful results but come with the caveat of increased risk if the trader does not possess a solid method for identification and entry based along these two lines of analysis.
Harmonic pattern trading is often an effective way to enter the market, and of the various patterns involved, there is one particular pattern which seeks to combine these two elements in providing a high probability entry with clear, well-defined trade criteria and parameters. The method, which utilizes market harmonics, Fibonacci ratios, price action and trend lines, is discussed below
In the above chart of the GBPJPY H4, we can see that price formed a double top with a small overshoot and has since broken the bullish trendline formed from the bottom of the double top structure, thus signaling the potential for a move lower. It is possible to enter on a bar-close back below the double top level, but the obvious risk here is that price pushes higher. It is possible to enter on a break of the bullish trendline, but the risk is that the move is simply a “fake-out” and will reverse higher. The setup comes slightly later in the move but with more technical confirmation in place.
Focusing on the price action from the double top formation through to the break and retest of the bullish trendline we can see that price forms a harmonic equality move back into the 61.8% Fibonacci retracement from highs to lows coinciding with the retest of the violated bullish trendline. This is the technical structure to look for and price action a can be used as a trigger for entry.
Price runs through the 61.8% fib and equality-swing level, touches the broken bullish trendline then reverses and closes back under the fib level. This signals entry for me ( you could set an order to sell a few pips below the bullish bar that formed through the fib level if you wanted further confirmation).
A variance on this entry concerns price action at the entry level where you use any sign of rejection as an entry trigger. Any candlestick which touches the level and closes back under is a signal. Any of the above candlesticks signal rejection including the “two-bar reversal.”
The stop is placed using ADR20 in this case 83 pips. The initial target is the bottom of the structure, in this case, 293 pips giving a RoR of 3.5:1. As price action unfolds, we move the stop to breakeven as the trendline formed from highs to lows is retested. IF a trendline from highs to lows is not present, we will move the stop on the retest of the 38.2% Fibonacci level.
We take half the position off at the initial target realising an actual RoR of 1.75:1 and then retain the rest in an attempt to catch a possible continuation of the move under the assumption of a medium-term trend forming. Targets in this instance can be the Fibonacci extensions of the swing made from the double top high to the low of the bullish trend line break. As each successive target is met, we trail the stop down to the former target and will keep doing this until the market takes us out of my trade.
Dependant on your trader personality, time horizon and risk profile you may wish to manage this trade differently. Taking the full position off at the initial target realises the full RoR of 3.5:1 and usually happens fairly quickly (within a week of entry). This initial phase has the strongest chance of success and reduces the likelihood of having to sit through retracements which some traders find difficult. This initial phase also benefits from reduced macro and event risk when compared with the longer time frame needed to realise profits from a more protracted move which exposes the trade to a potential reversal on any information catalyst.
This is a strong technical setup which repeats regularly and can be found at many major turning points and the beginning of many sustained directional moves.