What Are Harmonic Patterns
While in the realm of different trading strategies and indicators, it is important to talk about even the most uncommon of strategies that are still being used by several traders today. Now, you should know that these strategies are only uncommon because they’re quite harder to interpret than our regular strategies. However, they are probably just as good at identifying and interpreting market trends and directions. Today we’re going to be discussing one such strategy that has divided traders worldwide. Some are quite skeptical about the accuracy of this strategy while others are welcoming it with open arms.
Just as the name suggests, harmonic patterns are a certain group of chart patterns that come together to form a pretty unique trading strategy. They can assist traders in identifying trends in price. They achieve this goal by forecasting the movements of the market in the future. In addition to this, they generate geometric pricing patterns. They achieve this by identifying probable price shifts or trend reversals using the numbers derived from the Fibonacci sequence. Traders are able to recognize these patterns and incorporate them into their upcoming trading strategy using them as a guide.
How to Read Harmonic Patterns
I think most traders back out from even testing out this strategy after they look at some geographic harmonic patterns. This makes them panic as they see very technical diagrams and it makes them think harmonic patterns are actually pretty complicated. In reality, every trading strategy is pretty complicated until you understand the technique and methodology behind it. Obviously, anyone can think something is complicated if they don’t understand it or even try to understand them. Let’s dissect harmonic patterns and look at some of its most basic components and find out how to identify these components:
Point X
Point X is probably going to be the most easiest point for you to identify in a harmonic pattern. This is a distinct starting point and we base the entire harmonic pattern around this one point. Point X is going to be a clearly high or clearly low point when you take a step back and look at the chart from a historical point of view. It is either going to be the highest or lowest point when looking at historical price movements.
Point A
Point A is also a super important point in a harmonic pattern. This is the point where the market will first pivot or retract after the high or low created by Point X. This point is usually identified by just simply looking at the chart. It does not need to be identified by using any other methods like Fibonacci retracements. This point is pretty significant as it will be used later on to determine where both Point B and Point D will fall in the harmonic pattern.
Point B
Point B is where we will actually find out what sort of harmonic pattern we’re facing in the chart. There is a pretty specific way we have to use in order to find out where Point B lies. We do this by using the Fibonacci retracement method. In order to do so, we have to take the Fibonacci retracement from Point X to Point A. This will give us a pretty specific value. We will use this value to determine what harmonic pattern we are looking at. If the Fibonacci value comes back as a 50% retracement, we’re most probably going to be looking at a BAT pattern, which we’ll get into more detail later.
Point C
Point C is found in a pretty similar way to Point B. We will again be using the Fibonacci retracement method in order to find this point in the harmonic pattern. We do this by measuring the Fibonacci retracement from Point A to Point B. The value we get will help us determine where Point C lies in the harmonic pattern.
Point D
Point D is going to be the most complicated point to find. This is mainly because it is the last point in a harmonic pattern and usually closes out the pattern. In order to find Point D in a harmonic pattern, we have to once again use Fibonacci retracement. However, this time we’re going to have to combine several Fibonacci retracement levels in order to determine the exact value of Point D. We will have to combine all the values starting from Point X, joining Point A, including Point B, and finally, Point C as well. All these Fibonacci levels together combine to form Point D.
Types of Harmonic Patterns
Now that we’ve understood how exactly we can identify a harmonic pattern, let’s go a step further and find out some of the most common harmonic patterns and how they are formed. You should know that there are countless harmonic patterns in the market but not all of them are useful for trading. We recommend only sticking to the most basic of harmonic patterns in order to have a better chance of becoming a successful trader. Here are some of the most common harmonic patterns in the trading industry:
The ABCD Pattern
The ABCD pattern, often known as the AB=CD pattern, is commonly considered to be the easiest of all patterns. It may be broken down into three distinct motions and four distinct points. To begin, there is the impulsive action that is taken (AB). After it, you will get a corrective movement, sometimes known as a BC. The final movement is an aggressive one (DC), which follows in the footsteps of the previous one (AB). When applied to the AB leg of the Fibonacci sequence, the retracement tool indicates that the BC leg should reach exactly 0.618.
The length of the CD line will be equivalent to that of the AB line. The amount of time it takes for the price to go from point A to point B should be comparable to the amount of time it takes to move from point C to point D. Traders have the option of positioning their buy orders in a location that is near the C point, also known as the Potential Reversal Zone (PRZ). If this is not possible for them, another option is for them to wait until the full pattern has been completed before moving into a long or short position beginning at the D point.
The BAT Pattern
The BAT pattern results in a product that is shaped like a bat, hence the name of the design. In 2001, Scott Carney was the one to make the breakthrough. The BAT pattern consists of very specific components that can be used to locate PRZs. In comparison to the ABCD pattern, it has one more leg. In addition to that, it carries an additional point that we shall refer to as X. The initial leg (XA) will result in a retracement movement along the BC line. It’s likely that you’re looking at a BAT pattern if the retracement up to point B stops at fifty percent of the original XA movement. It is required that the CD extension be at least 1.618 times the length of the BC leg.
In addition to that, it may be as high as 2.618. It is not allowed for the CD extension to be shorter than the BC extension. In the event that it is shorter than the BC extension, the figure in question cannot be used. The PRZ is established at the terminal point (D). This indicates that investors can open their positions to trade either a bullish price reversal or a negative price inversion, depending on which scenario they anticipate will play out.
The Gartley Pattern
HM Gartley was the one who came up with the Gartley pattern. It has two primary requirements. The first requirement is that the retracement of point B must be 0.618 of XA. This is the only acceptable value. The second requirement states that the retracement of point D must be equal to 0.786 of the movement made by XA. It resembles the BAT pattern in certain ways. This is due to the fact that the XA leg leads to a retracement of the BC. The only thing that’s different is that you have to make sure the retracement at point B is exactly 0.618 of XA. In many cases, point X serves as the location of the stop-loss point. In a similar fashion, the take-profit target is typically determined to be point C.
The Butterfly Pattern
Bryce Gilmore is credited with the discovery of the butterfly design. In order to locate probable retracements, he utilized a variety of different combinations of Fibonacci ratios. There are four distinct legs that make up this reversal pattern. These legs are labeled with the letters X-A, A-B, B-C, and C-D respectively. The retracement of the XA leg at the 0.786 level is the most crucial ratio that has to be defined. This contributes to the development of point B. Because of this, traders will have an easier time locating the PRZ.
The Crab Pattern
Another pattern that was found by Scott Carney all by himself is the Crab pattern. An X-A, A-B, B-C, and C-D pattern is followed by the Crab in this particular pattern. Traders are able to take advantage of this by entering the market at extremely high or cheap prices. The 1.618 expansion of the XA movement is the aspect of the crab pattern that stands out as the most significant. This is due to the fact that it establishes the PRZ.
The first leg of the Crab pattern that appears in a bullish market occurs when there is a significant price increase from point X to point A. The retracing done by the AB leg takes place between 38.2 and 61.8 percent of the XA leg. The next part is an extreme extension of BC, which comes after this (2.618 – 3.14 – 3.618). This, in turn, pinpoints a legitimate region for the rest of the pattern to be completed in. In addition to this, it highlights the possibility that the present trend will change direction. A bearish crab will follow a dip from point X to point A in the direction of movement. After then, there will be a minor increase in cost, then a decline, and then a significant increase to point D.
The Deep Crab Pattern
The Deep Crab pattern is the next harmonic pattern that we are going to learn about and examine. The Crab pattern, which we have just discussed in the previous sentence, is shown here in a slightly modified form. The retracement of point B is the sole difference that it has. This retracement has to be equal to 0.886 of the XA movement, but it can’t go beyond point X. The BC projection has a possible range of values ranging from 2.24 to 3.618.
The Shark Pattern
The Shark pattern is yet another one of Scott Carney’s discoveries. There are a few parallels can be seen between this design and the crab patterns. This reversal pattern consists of five separate legs. The points on this pattern are labeled as O, X, A, B, and X respectively. The following three rules of the Fibonacci sequence must be satisfied by a shark pattern.
The first condition states that the AB leg should display a retracement of the XA leg that falls somewhere in the range of 1.13 and 1.618. The second rule is that the BC leg must be equal to 113% of the OX leg. The objective of the CD leg is to reach a Fibonacci retracement level that is 50 percent of the BC leg. Every single transaction with a shark pattern is executed based on point C. A pre-defined profit objective is employed in this design, and it is represented by the D point.
Benefits and Drawbacks of Harmonic Patterns
There are countless harmonic patterns in the forex industry and we’ve just talked about some of the most basic ones above. Traders have mixed feelings about this strategy of forex trading. This is because even though it has quite a bit of benefit, it has a bit of risk involved as well. Let’s take a look at some of its top benefits and drawbacks in order to properly understand if this pattern is worth our investment or if it’s just another one of those patterns that are fake.
Benefits
Harmonic patterns are pretty useful in predicting any future market price movements way before they actually occur. Since these patterns are repeatable, they prove to be pretty reliable and accurate most of the time. What is also great about harmonic patterns is that they can also be used with other trading indicators like the RSI, MACD, or whatever you are most comfortable with. It can also work with any timeframes and any instruments, unlike some other strategies.
Drawbacks
Just like it has a couple of benefits, harmonic patterns also have a couple of drawbacks which you need to keep in mind as well. As you can probably tell by now, these patterns are pretty technical and can be really difficult for the ordinary trader to understand. It requires complete precision and accuracy otherwise it won’t be able to work at the best of its abilities. The biggest drawback is probably that when you compare the risk/reward with using this method, it is quite low so most of the time, it is not even worth it.
Should You Use Harmonic Patterns In Trading
Harmonic patterns are a precise approach to trade, and they may be beneficial for traders who appreciate analyzing price charts and trading patterns. Harmonic patterns can be found in many different markets. It is essential to keep in mind that harmonic patterns are not necessarily successful in every situation. It is possible that the price will not reverse when it reaches probable reversal zones. If it does reverse, however, it is possible that the price may not go as far as anticipated before turning back the other way. As a result, stop-loss orders are an essential component of effective risk management.
After a trade has been initiated, a stop-loss order can be put at the swing high or low that is located close to point D. Stop-loss orders, despite the fact that they might be helpful in risk management, do not take into consideration the volatility of the market. When you trade harmonic patterns, you need to decide at which Fibonacci levels you want to start taking profits in order to maximize your potential returns. This can assist to limit any subjectivity that may be involved in trading these patterns even more.
Before entering a transaction, you may use this information to assist evaluate your risk-to-reward ratio. If the possible gain is only slightly more than the danger, then you might want to avoid entering into the trade altogether. However, if the potential gain is far greater than the potential loss, the transaction might be executed. A comprehensive harmonic trading strategy is formed when each of these components is brought together.
Forex signals are a great way to get profitable trades, even if you don’t know how to analyze chart patterns yet. Expert analysts will provide you with appropriate risk management strategies, so you don’t make the top forex mistakes like every trader. Don’t trade all the time. Trade only at the best trade set up with Forex GDP.