Harmonic Indicator—Behind the Scenes
What does the length setting do?
The length setting determines the minimum wavelength—or swing—from one high / low point to the next. This is important because it establishes the measuring points used in calculating Fibonacci retracements and extensions.
At the most basic level, a high point is a bar that is higher than the two surrounding it. This would be equivalent to a length setting of 2. So, in this example, in order to be considered a high point, the bar must be the highest of the two looking back AND the highest of the two looking forward.
Similarly, a length of 3 would mean that the high point must be the highest of the three bars looking back AND the highest of the three bars looking forward.
Compare the swings for lengths of 2, 3, and 4 below.
A length of 2 would be zoomed in to the micro-level of price movement while a larger length of 25, for example, would zoom out to a more macro-level.
One more example. Take a look at various lengths applied to the daily chart for ADBE.
I chose a default setting of 13 for the length because it seems to provide good, medium-length swings. You should experiment with different length settings to see what works best for the instrument and time period you trade. For instance, if you like to trade on the 1-minute chart, you may find a longer length (say, 20) works better as it will tend to filter out some of the price vibrations, or noise, that occur on that shorter chart.
By the way, the length setting used in the Wolfe Wave indicator works exactly the same as just described.
How are the harmonic patterns identified?
Knowing that the patterns calculate distinct Fibonacci price structures that identify highly probable reversal points, we need to have clearly defined measuring points. That’s what the length setting discussed above does for us.
The daily chart of ADBE shown below is using the default length of 13 and demonstrates a nearly textbook example of a Bearish Crab pattern.
What is a Crab pattern?
The Bearish Crab pattern, as identified by Scott Carney in his book Harmonic Trading: Volume One, looks like this:
Identifying the pattern.
Starting from some point (X), price will first decline to point (A) and will then retrace between 38.2% and 61.8% to point (B).
Price will then decline to point (C) completing a retracement of the (A) to (B) move between 38.2% and 88.6%.
The potential reversal zone (PRZ)
The PRZ is the area where the pattern has a high probability of completing and then reversing direction. Once points (X), (A), (B), and (C) have been identified, the PRZ can be calculated.
Determining the PRZ requires identifying three different levels.
First, the 161.8% retracement of the move from (X) to (A) is calculated.
Second, the 261.8% and 361.8% retracements of the move from (B) to (C) are calculated. In this example, the 361.8% retracement was beyond the maximum (X) to (A) retracement of 161.8% so it is not shown.
Third, the (A), (B), (C) extension of 161.8% is calculated. Note, this value is not shown on the Crab pattern reference image, but is included in Scott Carney’s book.
Finally, once all three of those levels have been identified, the PRZ is highlighted between the highest and lowest of them.
The harmonic indicator is automatic.
The harmonic indicator automatically identifies and labels the Bat, Alternate Bat, Butterfly, Crab, Deep Crab, and Gartley patterns. Once points (X), (A), (B), and (C) have been identified, and before price has completed its move at point (D), the PRZ is calculated. Additionally, the dashed lines show the ideal pattern completion point.