these basic concepts will help identify valid reversals that can yield

substantial moves.

Japanese Candlesticks
Another method to exhibit a price bar is a Japanese Candlestick.
These formations illustrate the nature of a price bar in a very clear manner. I
utilize Candlestick charts extensively in my trading. Also, I present all of
the examples of harmonic patterns throughout this book using Japanese
Candlesticks.
Charting markets with this type of a price bar has been around for
centuries. Originally, Japanese Candlesticks were developed to chart the
price of rice markets. There are several excellent books on candlesticks that
I recommend you read. One of the most comprehensive books that I have
ever read on Japanese Candlesticks is Japanese Candlestick Charting
Techniques, by Steve Nison. (New York: New York Institute of Finance,
1991.) It is a fascinating area of Technical Analysis. However, for these
purposes, I will illustrate only the most basic of candlestick price bars.

Bullish Candlestick

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 A price bar that has an area that is clear or white represents a bullish
Candlestick. As you can see, the enlarged area shows the difference
between the open and the close.
The Candlestick illustrates the price action more clearly than a single,
line price bar. Also, in combination with a harmonic set-up, the Candlestick
can provide greater indication of a potential reversal.

Bearish Candlestick
A filled or black bar depicts the bearish Candlestick. This price bar
also shows the range between the open and close more clearly than a single,
line price bar.

Candlesticks are excellent measures of price action because they

clearly illustrate the range between the open and close. Although the total
range of the price bar is important, the difference between the open and the
close can provide even greater indication of future direction.

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Other Significant Japanese Candlesticks
Other candlestick formations are very significant when they
materialize in a Potential Reversal Zone. These candlesticks provide an
even stronger indication of a potential reversal when they form in a
harmonic area.

Doji
The Doji is an excellent potential reversal signal. It occurs when the
open and the close are the same. Usually, the open and the close are found
in the middle of the price range.

This price bar indicates a market that is uncertain of its future action.
It is important to closely watch the price action following the formation of
this price bar, as this will often provide clear signals regarding the future
trend of a stock.

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Hammer
The hammer is a price bar that has a large total range with a small
difference between the high and the low. This difference should be
approximately 1/3 the total range for a valid hammer. Depending on where
it develops on the chart, there are other terms for this price bar, such as a
Hangman or Shooting Star. However, for these purposes, it is important just
to recognize this as a reversal signal, especially when it forms in a Potential
Reversal Zone.

The next illustration shows a hammer that is inverted. Again, it is

important to recognize this sign as an indication of a potential reversal when
it develops in a harmonic area.

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 Japanese Candlesticks clearly illustrate each bar of price action. I
believe that Candlesticks can indicate a great deal more about a future price
action than a single, line price bar. Also, there are several combinations of
candlesticks that identify critical turning points in stock. I strongly
encourage you to study this area of Technical Analysis. Although these are
very basic illustrations and explanations of candlesticks, it is important to
recognize these price bars as reversal formations in a Potential Reversal
Zone.

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 4

Invalid Harmonic Set-ups

The markets often provide clues to determine future price action.

Although anything can happen in the financial markets, harmonic set-ups
that experience price action that acts completely opposite to what is
anticipated usually will provide signals to indicate the flawed nature. This is
not to say that a harmonic set-up will not go completely against you -
because it can. But, in my experience, the market will provide evidence of
"probable future action."
It is important to read these signs that the market offers to gauge the
next potential move. After you develop the feel for harmonic price action,
you will be able to determine how a price action "should" act within a
Potential Reversal Zone.

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The Warning Signs

Blowouts
Blowouts, as I refer to such price action, occur when the Potential
Reversal Zone is completely violated. Potential Reversal Zone blowouts are
associated with three primary warning signs: price gaps, tail closes and
abnormally large price ranges. It is almost uncanny how frequently these
warning signs occur to warn against a potentially flawed harmonic reversal
zone. But, they are reliable indicators of an invalid set-up.
As I mentioned previously, harmonic areas are excellent opportunities
for defining profitable stocks, but they do not work all of the time. It is
essential to study the price action in the Potential Reversal Zone, especially
if the area contains several harmonic calculations within a close range. As
you examine these situations, let the market provide the clues of its next
move. When warning signs develop, they act as clear signals that the area is
not a good opportunity.
Although warning signs will signal a potentially flawed set-up, it is
also important to examine the following price action. Since blowouts
represent strong price action, the stock should continue to trade in that
direction.
This principle of continuation is extremely important because it will
define the significance of the warning sign. For example, if a stock gaps up
on the open and finishes with a bullish close, this would indicate a strong
stock. Due to the strength of this price action, you might expect the stock to
move higher. However, if a stock does not move higher after such a move,
the stock could be considered potentially weak. Therefore, warning signs
should exhibit some type of follow through to confirm the price action.

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Price Gaps
It is very common for price gaps to occur in a Potential Reversal
Zone. A price gap occurs when the price action opens beyond the previous
close, leaving an open area where no trading has occurred. A price gap in a
Potential Reversal Zone indicates that the set-up is to be treated with
extreme caution. It is important to respect an extreme sign like this because
a price gap indicates a significant change in sentiment.

I believe that a price gap in the Potential Reversal Zone occurs most
frequently and is the strongest of all of the warning signals. A price gap is
an extremely significant indicator of an invalid set-up and has kept me out of
many bad trades.

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Tail Closes
Tail closes are price bars that close at either the high or low. Tail
closes suggest extreme price action that is to be respected. Therefore, when
a tail close occurs after hitting a Potential Reversal Zone, it is prudent to
exercise extreme caution.

When price action closes at the high or the low of the day, it indicates
sentiment that is overwhelmingly strong. If you take a moment to really
contemplate the meaning of this price action, it indicates that the majority of
the participants trading that particular market are extremely biased in one
direction. It is almost common sense to wait for an obvious reversal signal
in this situation because of the strength of the price action. Therefore, a tail
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