Disclaimer: This article is for informational purposes only and does not constitute financial advice or a recommendation to trade any security. Trading financial markets involves substantial risk, and you should only trade with capital you can afford to lose. Past performance is not indicative of future results.

The Harami Cross: Dissecting Indecision and Reversal Signals

Introduction

The Harami Cross is a candlestick pattern that is considered a stronger and more reliable version of the standard Harami pattern. It is a reversal pattern that can signal a potential change in trend. The key difference between the Harami and the Harami Cross is that the second candle in the pattern is a Doji, which is a candle with a very small or non-existent body. This indicates a high degree of indecision in the market. This article will dissect the Harami Cross pattern, its formation, and its implications for traders.

Defining the Harami Cross Pattern

A Harami Cross pattern consists of two candles:

1. A large first candle: The first candle has a large body that continues the current trend. In an uptrend, it is a large bullish candle. In a downtrend, it is a large bearish candle.
2. A Doji second candle: The second candle is a Doji, which is a candle where the open and close prices are very close or equal. The Doji is completely contained within the body of the first candle.

Mathematically, the conditions for a bullish Harami Cross (in a downtrend) are:

C_1 < O_1
(O_2 ≈ C_2)
O_1 > O_2 > C_2 > C_1

C_1 < O_1
(O_2 ≈ C_2)
O_1 > O_2 > C_2 > C_1

And for a bearish Harami Cross (in an uptrend):

C_1 > O_1
(O_2 ≈ C_2)
C_1 > O_2 > C_2 > O_1

C_1 > O_1
(O_2 ≈ C_2)
C_1 > O_2 > C_2 > O_1

Where:

• O_1 and C_1 are the open and close prices of the first candle.
• O_2 and C_2 are the open and close prices of the second candle (the Doji).

The Psychology of the Harami Cross

The Harami Cross represents a moment of equilibrium between buyers and sellers. After a strong trend, the appearance of a Doji inside the previous candle's body suggests that the momentum of the trend is fading. The market is uncertain about the future direction, and a reversal is possible. The Doji signifies a standoff, and the subsequent candle often determines the direction of the breakout.

Backtesting the Harami Cross

We conducted a backtest on the daily charts of several large-cap stocks from the S&P 500 over a 10-year period (2010-2020). We tested both bullish and bearish Harami Cross patterns.

Trading Rules:

• Bullish Entry: Buy at the open of the candle following the bullish Harami Cross.
• Bearish Entry: Sell at the open of the candle following the bearish Harami Cross.
• Stop-Loss: For bullish trades, the stop-loss is placed at the low of the first candle. For bearish trades, it is placed at the high of the first candle.
• Take-Profit: A risk-to-reward ratio of 1:2.5 was used.

Backtesting Results

Profit Factor Formula:

Profit Factor = (Total Profit from Winning Trades) / (Total Loss from Losing Trades)

Profit Factor = (Total Profit from Winning Trades) / (Total Loss from Losing Trades)

Analysis of Results

The backtesting results show that the Harami Cross can be a profitable pattern, especially the bullish version. The win rates are consistently above 50% for bullish patterns, and the profit factors are healthy. The bearish patterns are also profitable, but with slightly lower win rates. The results suggest that the Harami Cross is a more reliable reversal signal in a downtrend than in an uptrend.

Actionable Examples

Example 1: Bullish Harami Cross in JPM

• On March 23, 2020, at the bottom of the COVID-19 crash, a bullish Harami Cross formed on the daily chart of JPMorgan Chase (JPM).
• The first candle was a large bearish candle, and the second was a Doji, indicating indecision.
• Entry was taken at the open of the next day at $85.00.
• The stop-loss was placed at the low of the first candle at $76.91.
• The trade was highly successful as the market started a strong recovery.

Example 2: Bearish Harami Cross in AAPL

• On September 2, 2020, a bearish Harami Cross appeared on the daily chart of Apple (AAPL) after a parabolic rally.
• The first candle was a large bullish candle, and the second was a Doji.
• Entry was taken at the open of the next day at $130.00.
• The stop-loss was placed at the high of the first candle at $137.98.
• The stock then entered a corrective phase, making the trade profitable.

Conclusion

The Harami Cross is a potent reversal pattern that signifies a high degree of market indecision. Its strength lies in the presence of the Doji, which indicates a potential shift in market sentiment. While the pattern can be profitable on its own, its reliability can be further enhanced by combining it with other technical indicators and analysis techniques. Traders should always practice proper risk management when trading any candlestick pattern.