Top 7 harmonic patterns every trader should know
Harmonic patterns can be used to spot new trading opportunities and pricing trends – but only if you know exactly what you are looking for. Read on to learn about the top harmonic patterns, and how to use them correctly.
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What are harmonic patterns?
Harmonic patterns are chart patterns that form part of a trading strategy – and they can help traders to spot pricing trends by predicting future market movements. They create geometric price patterns by using Fibonacci numbers to identify potential price changes or trend reversals. Traders can identify these patterns and use them to inform their next trading decision.
There are multiple chart patterns to choose from, each of which can be used to spot a different kind of trend. However, it is important to note that before following any pattern, you should be confident in your ability to perform your own technical analysis, so that you are always able to make the best – and the fastest – trading decisions.
The ABCD pattern
Arguably the easiest pattern of all, the ABCD (or AB=CD) pattern is composed of three movements and four points. First, there is the impulsive movement (AB), then a corrective movement (BC), and then another impulsive movement (DC) that goes in the same direction as AB.
Using the Fibonacci retracement tool on the AB leg, the BC leg should reach precisely 0.618. The CD line will be the same length as the AB line, and the time it takes for the price to go from A to B should be equal to the time it takes to go from C to D.
Traders can choose to either place their entry orders close to the C point, which is defined as Potential Reversal Zone (PRZ); or they can wait until the entire pattern completes before taking a long or short position from the D point.
The BAT pattern
The BAT pattern gets its name from the bat-shaped end product. Identified by Scott Carney in 2001, the BAT pattern is made up of precise elements that identify PRZs.
It has one leg more than the ABCD pattern, and one extra point, which we will call X. The first leg (XA) will lead to a BC retracement movement. If the retracement up to point B stops at 50% of the initial XA movement, then you are probably looking at a BAT pattern.
The CD extension must be at least 1.618 of the BC keg and can reach as high as 2.618. The CD extension must not be less than BC's, otherwise the figure is invalidated. The end point (D) creates the PRZ, which means that traders can open their positions to trade either a bullish price reversal, or a bearish price inversion.
The Gartley pattern
Created by HM Gartley, the Gartley pattern has two key rules:
- The retracement of point B must be 0.618 of XA
- The retracement of point D must be 0.786 of the XA movement
It is similar to the BAT pattern in that the XA leg leads to a BC retracement, except that the retracement of point B must be precisely 0.618 of XA. The stop-loss point is often positioned at point X, while the take-profit is often set at point C.
The butterfly pattern
The butterfly pattern was discovered by Bryce Gilmore who used different combinations of Fibonacci ratios to identify potential retracements. It is a reversal pattern composed of four legs, marked X-A, A-B, B-C and C-D.
The most important ratio to define is the 0.786 retracement of the XA leg. This helps to plot point B, which will help traders to identify the PRZ.
The crab pattern
Another Scott Carney discovery, the Crab follows an X-A, A-B, B-C and C-D pattern, which allows traders to enter the market at extreme highs or lows. The most important feature of the crab pattern is the 1.618 extension of the XA movement that determines the PRZ.
In its bullish version of the Crab, the first leg forms when the price rises sharply from point X to point A. The AB leg retraces between 38.2% and 61.8% of XA. This is then followed by an extreme projection of BC (2.618 - 3.14 - 3.618), which identifies a valid area for the completion of the pattern and the potential reversal of the current trend.
A bearish crab will track a dip from point X to point A, followed by a modest price rise, a slight fall, and a sharp rise to point D.
The deep crab pattern
This is a slightly different version of the Crab pattern outlined above. Its only differential is that the retracement of point B, which must be 0.886 of the XA movement without exceeding point X.
The BC projection can range from 2.24 to 3.618.
Why are harmonic patterns so popular in forex trading?
Forex traders love harmonic patterns, as they are particularly well suited to the real-time dynamics of the foreign exchange markets. When they are correctly used, they can warn a trader when underlying conditions are likely to result in a price drop, based on historical data.
How do you identify and draw harmonic patterns?
How you identify and draw harmonic patterns depends on the type of market movement (bearish vs bullish). So, while there are many different harmonic patterns, they can be split into two categories: bearish patterns, and bullish patterns.
Bearish vs bullish harmonic patterns: what is the difference?
Bullish traders believe that their market is about to experience an upward price movement, while bearish traders operate under the belief that the market is on a downward trajectory. When it comes to understanding bearish vs bullish harmonic patterns, the same rule applies.
If a series of harmonic patterns indicate that the market is on an upswing, bullish traders might use this insight to take a long position on their chosen market, in order to profit from any upturn.
If a trader notices a bearish harmonic pattern, they may want to start shorting their market, by trading stock or commodities under the assumption that the price will fall.
How to start trading with harmonic patterns
To start trading with harmonic patterns, follow these steps:
- Take some time to learn the theory behind harmonic patterns
- Decide whether you are going to follow a bearish strategy, or a bullish strategy
- Open a trading account with us and start looking for harmonic patterns in your market of choice
Harmonic patterns summed up
- Harmonic patterns are used by traders to help predict future market movements
- Traders can take a bearish or a bullish approach
- Bearish harmonic patterns indicate a possible downturn in the market
- Bullish harmonic patterns indicate a possible upturn in the market
- You can trade using harmonic patterns by opening a trading account with us
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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