Trading a sideways market: When opposing chart patterns converge

By: Kathy Garber

Originally published on September 4, 2013

When the price of a market is indecisive, moving sideways, it is often between opposing emerging harmonic patterns. The e-mini S&P (ESU13) is showing just such a a combination of patterns.

A great thing about opposing harmonic patterns is that you have targets whether price goes sideways, breaks up, or breaks down through important levels. Even better, the harmonic patterns themselves show you those levels.

Let’s look at the ES hourly chart and decipher the story these patterns are giving us.

At first glance it may seem unclear or even useless information, but if you break down each pattern, you see specific completion targets, and specific levels that determine whether that pattern is valid.

Another great thing about harmonic patterns (I can offer so many reasons, but I’ll keep it to a minimum) is that they are derived from Fibonacci ratios and extensions, which are derived from geometrical values. Math is an abstraction of absolutes; it is dependable and doesn’t change because we want it to. 1 + 1 always equals 2.

Two patterns, identical upside targets

The green triangle represents the first three points of an emerging Bearish Bat. Just by knowing these three points, I understand that when price holds above 1650, the probability of completing the Bat at 1662.75 increases. If price cannot hold above 1650, the probability of completing the Bearish Bat goes down and the probability of retesting the other point of the triangle at 1624.75 goes up.

Latorilla / Foter / CC BY-SA

The Bearish Bat is the largest emerging pattern. The second largest, in brown, is the emerging Bearish Butterfly. It always creates a sense of awe when I see such a tight confluence of two totally separate harmonic moves that have completion targets at the same spot. The ideal completion target for the green Bearish Bat is 1662.75, and for the brown Bearish Butterfly it is 1663, one tick apart.

The downside and the invalidation of both patterns

If instead, price continues to the downside and pushes below 1624.75, both the green and brown patterns are invalidated. This is true even if the price breaches 1624.75 by one tick. A hold below 1624.75 leads to an emerging Bullish Butterfly (in blue), with a completion target of 1619.

melolou / Foter / CC BY-NC-ND

In another confluence further down, if price cannot bounce from that Butterfly PRZ (Potential Reversal Zone – aka harmonic pattern completion target), then we already have an extended target at 1610.50. This comes from the correlation of a different harmonic pattern, AB=CD, which has a completion target at 1608.75.

So  if price goes below 1624.75, it invalidates the two emerging patterns, Bearish Bat and Bearish Butterfly, that have upside completion targets. If price goes above 1650, it invalidates the blue emerging Bullish Butterfly / Crab.

What to do with this information and how to trade it? Well, price is currently at an important region, that I call a GRZ (Golden Ratio Zone), and this becomes the initial resistance test. If the price holds below 1638, the bias is to return to the point of the blue triangle at 1630.75 for a support test. This implies that a required leg (there are four legs total) has been established and the ideal target for a short position will be the double bullish PRZ at the 1609 area.

I have scaling points at 1624.75 and 1619. Scaling points are areas of potential bounce, so I view them as an area to take some profit when trading multiple units or contracts, to exit a position, or to protect a profitable position.

What if price holds above the GRZ level of 1638? If the bottom of a GRZ is an important level, so is the top, so it offers a long opportunity with a hold above 1638, but 1642.75 is a definite place to take some profit or protect a position. Only if price can hold above 1642.75 does the 1650 retest target come into play.

Once again, above 1650 the ideal target is that double bearish PRZ at 1662.75, with scaling points at 1654.75 (brown triangle point) and 1658.50 (another confluence region derived from two different rotations having a merged level of interest.

Where does the sideways trading come into all this? Until 1650 or 1624.75 is taken out (price goes beyond these levels), price will remain in a sideways range and offer a long opportunity at a bounce off 1624.75 and a short opportunity at the rejection of 1650, with the other extreme as the major target. 1650 and 1624.75 are the upper and lower boundaries of the sideways channel.