Market prices always keep following a trend; either an uptrend or a downtrend, which is then followed by a correction period or a consolidation period and then by a re-trend behavior. The prices rarely reverse their trends to turn and form a single trend from a previous trend. This phase is called the transitional phase, where you as a forex trader can experience price fluctuations and trading ranges. Because of these ranges that are formed one can easily predict what trend and pattern are going to be followed in the future looking at similar patterns and identification spots. There are various chart patterns that are basic that let us know if the trend is going to continue or reverse. One of the more advanced tools that you can add to you forex toolbox is the harmonic price patterns.
History of Harmonic Price Patterns
In 1932, harmonic price patterns were for the first time introduced and laid down by H.M. Gartley in his book ‘Profits in the Stock Market’. This pattern he founded and wrote was basically about a 5-point pattern which is commonly known as Gartley in the forex world. Other traders and authors also worked on this pattern and came up with remarkable achievements in the pattern theory. Some of these notable authors include Larry Pesavento and Scott Carney. These authors worked, introduced, and established new rules for this pattern working them alongside with Fibonacci Ratios and patterns visible as ‘Crab’, ‘Bat’, and ‘Butterflies’ collectively referred as Animals respectively.
The pioneering work of these people together for Harmonic Price pattern is truly impressive as it has opened new trading styles and opportunities for those who want to be or are a part of this world.
Understanding Harmonic Price Patterns
As previously discussed, Harmonic Price Patterns are a form of chart formations that help you spot possible retracements of recent trends. It basically involved the use of Fibonacci retracement and extension ratios in combination to itself.
The combination of these two helps you in identifying key turning points, the extensions or the retracements, and a series of the swing high or swing lows that are formed in the process. These spots that you are able to identify with the help of this combination gives you the key price levels for Targets or Stops, and further allows you to follow the rule of thumb which instructs you to be patient enough and wait until the entire formation that is under construction completes before you enter to take long or short positions in the market.
Kinds of Harmonic Price Patterns
Harmonic Price Patterns are available in six main kinds. We would start off with the more basic ones and build our way to the more advanced ones.
- ABCD Pattern
- Three-Drive Pattern
- Gartley Pattern
- Crab Pattern
- Bat Pattern
- Butterfly Pattern
You must be noticing that the names of the last three chart patterns are a bit unique. The name of these chart patterns is based on animals because of the shape that they form on the chart. It also makes easier for the trader to analyze and predict what chart pattern is forming or is about to form.
The ABCD Pattern
This is the most basic pattern of all and in order to identify this pattern you need to be extremely vigilant, have ultra-sharp hawk eyes, and should carefully observe when this pattern is formed along with the Fibonacci Ratios chart tool. This chart is composed of lines that are AB and CD which are known as the legs, whereas, BC is known as the retracement or the correction line for both, bullish or bearish, patterns.
So, when applying Fibonacci chart tools on this pattern and specifically on leg AB first what you should be seeing is that the retracement line BC should reach the 0.618 level. The next line, which is the leg CD, should be the Fibonacci extension of BC at the level of 1.272. What you need to keep in mind is to let the pattern complete itself once it has started forming, before entering into any long or short positions.
Below are a few line formation examples for you to better understand this pattern.
To follow a stricter ABCD pattern here are a couple of rules that you can follow.
- The length of the two legs, AB and CD, should be equal to each other
- The time it takes for the price to climb up from A and reach the point B should be same for the price to move up from C and reach D
The Three-Drive Pattern
As the name suggests, the three-drive pattern requires three legs for it to be formed rather than two as were the case in the ABCD pattern, and two retracement or correction lines as compared to one in the ABCD pattern.
This pattern is also considered to be a variation of the basic 5-3 Elliot Wave Pattern. Even for this pattern, you need to be focused and have hawk eyes to identify the presence or formation of one.
As evident from the bullish and bearish three-drive chart pattern, it clearly shows that point A should be a 61.8% retracement of drive 1, and similarly, point B should be 0.618 retracement of drive 2. Next, drive 2 should be an extension of correction A at 1.272 levels and drive 3 of the three-drive chart pattern should be 1.272 extension of correction B.
Once the whole three-drive pattern is completed, and then only as per the rule of thumb, you should pull the trigger on your trades, either long or short.
Usually, it is suggested by experts of this field that when the price reaches point B in the three-drive pattern, this is where you can already take positions, long or short, which is at the 1.272 extension so that you become a part of the game. But don’t get too hasty to enter and better check the rules first that we have here for you to see if they hold true.
- The time price takes to complete should be equal for both the drives, drive 2 and drive 3.
- Retracements A and B should take equal time to complete
The Gartley Pattern
This pattern is basically based on the pattern found on page number 222 of Gartley’s book named ‘Profits in the Stock Market. This is the reason why this pattern is also known as The 222 Pattern. The formation of this pattern is based on the ABCD pattern but it is also preceded by a significant high or low. They are typically formed during the correction of consolidation of an overall trend and appear to as ‘M’ for bullish patterns and as ‘W’ for bearish patterns. To identify and understand the formation of these alphabets in these two market environments here are a few charts that you can look into and understand.
As earlier mentioned, Gartleys are formed when a price action starts showing signs of a correction. The reversal points on this pattern are marked by Fibonacci retracement and extension levels. These levels actually give a strong indication and strength to the reversal of the pair actually taking place.
As a general rule, the pattern contains an ABCD pattern which is either bullish or bearish but is then preceded by a point that is beyond point D.
The most common characteristics that a Gartley pattern holds for it to be perfect are
- Line or move of AB should be 0.618 retracement of move XA
- Move BC should be either 0.382 or 0.886 retracement of move AB
- If the retracement of move BC is .382 of move AB, then CD should be 1.272 of move BC. If move BC is .886 of move AB, then CD should extend 1.618 of move BC.
- Move CD should be .786 retracement of move XA
These animal patterns, also known as Gartley’s Mutants, were actually discovered and introduced by Scott Carney in 2000. He had extreme faith in this trading technique of Harmonic Price Pattern and therefore came up with variations of the basic 222 pattern based on different levels of Fibonacci extensions and retracements.
Starting with the first pattern that he came up with, he believed was the most accurate of all the Harmonic Price Patterns. He believed this because of how extreme the Potential Reversal Zone from move XA.
To understand how this pattern looks when it is formed we have shared pictures of both bearish and bullish crab patterns.
In this pattern, you can put a very tight stop loss which makes it be a pattern that has a high reward to high-risk ratio. Mentioned below are a few characteristics that help in identifying the perfect crab pattern.
- Line AB should be a retracement of 0.382 or 0.618 of move or line XA
- Move BC can either be a 0.382 or a 0.886 retracement of move AB
- If the retracement of move BC is .382 of move AB, then CD should be 2.24 of move BC. Consequently, if move BC is .886 of move AB, then CD should be 3.618 extension of move BC.
- The leg CD should be 1.618 extension of move or line XA
Scott Carney who still had faith and believed in the accuracy of Harmonic Price Patterns kept working and understanding them and came up with another animal pattern in its variation series called The Bat Pattern in 2001.
The pattern is called a bat because the M and W formed in bullish and bearish patterns respectively outlines the figure of this animal. For clarity, we have shared pictures of charts of this pattern in both market environments.
The Potential Reversal Zone of this pattern is described by the 0.886 retracement move of XA. Mentioned below are a few characteristics and qualities that help in identifying the perfect crab pattern.
- Move AB or line AB should be retracement of move XA either by 0.382 or by 0.500
- Move BC can be either .382 or .886 retracement of move AB.
- If the retracement of move BC is .382 of move AB, then CD should be 1.618 extension of move BC. Consequently, if move BC is .886 of move AB, then CD should be 2.618 extension of move BC.
- The leg CD should be 0.886 retracement of move or line XA
Finally, the last pattern in the mutant series, The Butterfly pattern, was developed and created by Bryce Gilmore. If you are able to spot this pattern at the right time and are able to enter into trades then you are up for a game to earn some big pips. This pattern can be classified as the 0.786 retracement of move AB with respect to move XA.
Some of the specific characteristics required to identify a perfect butterfly pattern are as follows.
- Leg AB should be 0.786 retracement of move XA
- The retracement move of BC can either be 0.382 or 0.886 of leg AB
- If the retracement of move BC is .382 of move AB, then CD should be 1.618 extension of move BC. Consequently, if move BC is .886 of move AB, then CD should extend 2.618 of move BC.
- Leg CD which is an extension should be 1.27 or 1.618 of move XA
Three Basic Steps to Trade Harmonic Price Patterns
The three basic steps that you as a trader need to follow to trade Harmonic price patterns to gain the maximum profits out your positions is to follow these three step mentioned below.
- Step #1: Identify a potential Harmonic Price Pattern
- Step # 2: Measure the potential pattern that you have identified
- Step # 3: Enter into a trade, long or short, once the market has completed the formation of a trend.