Harmonic Price Patterns

Harmonic trading is based on geometry and fractals. The core of this trading practice incorporates the primary ratio and its derivatives (1.618, 0.618, etc.). Harmonic price patterns work as a sign of potential trend retracements. These patterns can be combined and confirm trade ideas deriving from other technical analysis tools.

The best book for understanding harmonic patterns is “Harmonic Trading” by Scott M Carney.

 

Introduction to Harmonic Patterns

The harmonic patterns generate signals of upcoming sharp reversals in the currency rates, stocks, indices, etc. In general, these reversals cover a price zone between two Fibonacci ratios, and this is commonly called a Price Reversal Zone (PRZ). Harmonic trading can be seen as high-probability trading. Harmonic patterns are more reliable in M30 and higher timeframes. The general win/loss ratio of harmonic trading strategies is above 70%.

There are a lot of different harmonic price patterns and include:

1. ABCD Pattern
2. Three-Drive Pattern
3. Gartley 222 Pattern
4. Harmonic Bat Pattern
5. Harmonic Crab Pattern
6. Harmonic Butterfly Pattern

Critical Issues for trading with Harmonic Patterns

Here are some critical issues:

1. Traders should open their Long or their Short Positions by the time a harmonic pattern is near to completion
2. It is more reliable to identify harmonic patterns in longer timeframes (above M30)
3. Harmonic Patterns in higher time frames should not conflict with each other
4. In general, the Risk/Reward ratio must be above 1:3
5. Each harmonic pattern shows different behavior according to the market movement

 

(1) The ABCD Pattern

ABCD is the simplest harmonic pattern. Trading with this pattern requires the Fibonacci retracement tool.

No matter if the ABCD pattern is identified on a rising or a falling market.

1. AB and CD are the legs
2. BC is the retracement

Steps for Identifying the Perfect ABCD Pattern

(1) By using the Fibonacci retracement tool on AB, the BC retracement must reach the 0.618 level

(2) Afterward, by using the Fibonacci retracement tool on BC, the CD should ideally reach 1.618

Variations of ABCD

Alternatively, BC can reach .786 of AB and CD could reach 1.272 of BC.

Extra Conditions when using the ABCD pattern:

■ AB should have exactly the same length as CD

■ The time needed for the price to form the AB line should be exactly the same as the time needed for the price to form the CD Line

 

(2) Three-Drive Pattern

The three-drive pattern is a pattern similar to the popular Elliott Waves pattern. The three-drive pattern is also similar to the ABCD pattern except for the fact that it has three legs and not two legs. Moreover, it has two retracements, and not one.

Steps for Identifying the Three-Drive Pattern

1. Point A must be the 0.618 of Drive 1.
2. Point B must be the 0.618 retracement of Drive 2.
3. Drive 2 must be the 1.272 extension of correction A
4. Drive 3 must be the 1.272 extension of correction B.

Extra Conditions when using the Three-Drive pattern:

■ The time needed for the price to form Drive-2 should be equal to the time the price needs to form Drive-3

■ The time needed for the price to complete retracement A must be equal to the time needed to form the retracement B

 

 

(3) Gartley 222 Pattern

Harold McKinley Gartley was a stock-market analyst and one of the first investors who applied scientific methods in order to explain the stock market behavior. Gartley published the book “Profits in the Stock Market” back in 1935. The page of that book numbered 222 named Gartley’s pattern. The Gartley pattern is in close relation to the Fibonacci numbers. Gartley patterns are considered high-profitability patterns with a success rate of over 70%.

Gartley 222 Pattern

Gartley’s patterns incorporate the classic ABCD pattern but they are a little bit more complicated. The Gartley 222 pattern is constructed by 5 pivot or swing points. The Gartley Patterns can be visualized as ‘W’ or ‘M’.

1. ‘M’ for bullish Gartley pattern
2. ‘W’ for bearish Gartley pattern

Steps for Identifying the Gartley Pattern

1. AB line must be the .618 retracement of XA
2. BC must be either the .382 or the .886 retracement of AB.
3. If BC is .382 of AB, then CD should be 1.272 of BC. On the other hand, if BC is .886 of AB, then CD should be 1.618 of BC.
4. CD should be the .786 retracement of the initial XA line

Gartley 222 and Target Price Levels

■ Firs-target is the price move to 0.618 of CD

■ Second-target is the price to move accordingly to XA length

 

 

(4) The Crab Pattern

According to Scott Carney, the Crab Pattern is the most accurate harmonic pattern. The Crab Pattern is characterized by a high reward-to-risk ratio and a very tight stop-loss order placement.

Steps for Identifying the Crab Pattern

1. AB must be the .382 or .618 retracement of the XA line.
2. BC must be a .382 or .886 retracement of the AB line.
3. If BC is .382 of AB, then CD should be 2.618 of BC. On the other hand, if the move BC is .886 of AB, then CD should be 3.618 of BC.
4. CD must be the 1.618 extension of the initial XA line.

 

(5) The Bat Pattern

The Bat Pattern is another pattern found by Scott Carney. The bat pattern is similar to Gartley 222 pattern and differs only in terms of the Fibonacci ratios between swings and pivot.

Steps for Identifying the Bat Pattern

1. AB must be the .382 or .50 retracement of XA.
2. BC can be either the .386 or .886 retracement of AB.
3. If BC is .386 of AB, then CD must be the 1.618 extensions of BC. On the other hand, if BC is .886 of AB, then CD must be the 2.618 extensions of BC.
4. CD must be the .886 retracement of the initial XA line.

Differences between the Bat and the Gartley 222 Patterns

Bat Pattern	Gartley 222 Pattern
AB can retrace between 38.2 – 0.50 of XA	AB must retrace 0.618 of XA
CD can retrace up to 0.886 of the initial XA	CD can retrace up to 0.786 of XA
CD can retrace up to 1.618 – 2.618 extension of AB	CD can retrace between the 1.13 and 1.618 extension of AB

 

(6) The Butterfly Pattern

The Harmonic Butterfly is a pattern discovered by Bryce Gilmore.

Steps for Identifying the Butterfly Pattern

1. AB must be the .786 retracement of XA.
2. BC must be either the .382 or the .886 retracement of AB.
3. If BC is .382 of AB, then CD must be the 1.618 extension of BC. On the other hand, if move BC is .886 of AB, then CD must be the 2.618 of BC.
4. CD must be the 1.27 or 1.618 extension of the initial XA line.

 

Trading Setup for Trading Harmonic Patterns

Harmonic patterns are very profitable patterns with a success ratio of over 70%. The problem is that these patterns are rare and difficult to be identified, especially by non-professionals. There are many available plug-ins for MT4 and MT5 which promise to do that job automatically. For those traders wishing to spot and to trade harmonic patterns, these are some basic questions that all valid setups must take into consideration.

1. Does price action indicate the existence of a potential pattern?

2. What is this pattern?

3. Is it a basic ABCD pattern or another harmonic pattern?

4. Are there any other harmonic patterns in other timeframes that can confirm or can cancel this pattern?

5. Do time cycles confirm the existence of this pattern? (Time symmetry)

6. At what point this pattern will come to completion?

7. At what price the pattern will no be longer valid? (Close to this price you may place your Stop-Loss order)

8. What is the optimal price for taking my profits (Take-Profit order)

9. What is the Risk/Reward of that trade? (Risk/Reward must be above 1:2 or even better 1:3)

10. How much of my capital should I risk in this trade? (Choosing Capital Leverage)

 

■ Harmonic Patterns

George Protonotarios for Trading Center (c)