Understand Harmonic Trading Patterns
This article will provide traders with a detailed explanation of what Harmonic Trading Patterns are, how harmonic trading patterns are used in currency markets, as well as, exploring market harmonics, harmonic ratios, and much more! All of this is based on teachings from Scott M. Carney.
Depicted: Admirals MetaTrader 4 - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
The price action trading domain can be made significantly deeper by taking a look at the advanced trading method known as 'harmonic trading'. Scott M. Carney, President and Founder of HarmonicTrader.com, has defined a system of price pattern recognition and Fibonacci measurement techniques that comprise the Harmonic Trading approach.
He has named and defined harmonic patterns such as the Bat pattern, the ideal Gartley pattern, and the Crab pattern. He is the author of three books on the subject: The Harmonic Trader; Harmonic Trading of the Financial Markets: Volume One; and Harmonic Trading of the Financial Markets: Volume Two.
Harmonic Patterns in Currency Markets
Roots of Harmonic Trading can be tracked down to the Gartley pattern. The Gartley "222" pattern is named from the page number that can be found in H.M. Gartley's book "Profits in the Stock Market".
So, what is a Gartley pattern?
A Gartley pattern is very similar to a bullish W or bearish M. It appears when the price has been moving in an uptrend or downtrend but has started to show signs of correction.
Ideal Gartley patterns look something like this:
- Move AB should be the .618 retracement of move XA
- Move BC should be either a .382 or a .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
- Consequently, if move BC is .886 of move AB, then CD should extend 1.618 of move BC
- Move CD should be A .786 retracement of move XA
The Gartley pattern is traded from point D. Traders opt to buy or sell at point D, depending on the pattern direction.
Market Harmonics
As time has passed, the popularity of the Gartley pattern has grown, and traders have come up with their own variations. Scott M Carney and his harmonic trading techniques were among the most popular and successful. Harmonics is the process of identifying the market's rhythm or its pulse, and then exploiting its trading opportunities. They provide us with visual occurrences that have tendencies to repeat themselves over and over again.
This methodology assumes that trading patterns or cycles, like many other patterns and cycles in life, repeat themselves. The key is to identify these patterns and to then enter or exit a position, based on a high degree of probability that the same historic price action will occur. Although these patterns are not 100% accurate, the situations have been historically proven. If these setups are identified correctly, it is possible to identify significant opportunities with very limited risk.
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Harmonic Ratios
In Harmonic trading we distinguish between:
- Primary Ratios
- Primary Derived Ratios
- Complementary Derived Ratios.
Primary Ratios
Directly derived from the Fibonacci Number Sequence.
- 0.618 = Primary Ratio
- 1.618 = Primary Projection
Primary Derived Ratios
- 0.786 = Square root of 0.618
- 0.886 = Fourth roof of 0.618 or Square root of 0.786
- 1.130 = Fourth root of 1.618 or Square root of 1.27
- 1.270 = Square root of 1.618
Complementary Derived Ratios
- 0.382 = (1 - 0.618) or 0.618e2
- 0.500 = 0.770e2
- 0.707 = Square root of 0.50
- 1.410 = Square root of 2.0
- 2.000 = 1 + 1
- 2.240 = Square root of 5
- 2.618 = 1.618e2
- 3.141 = Pi
- 3.618 = 1 + 2.618
Harmonic Trading Patterns and PRZ
Harmonic patterns are defined by specific price structures, and quantified by Fibonacci calculations. These patterns represent price structures that contain combinations of distinct and consecutive Fibonacci retracements and projections. If we calculate various Fibonacci aspects of a specific price structure, we can identify harmonic pattern areas that will hint at potential turning points in price action.
Scott M. Carney has identified those reversal spots as the PRZ—The Potential Reversal Zone. A well-defined PRZ usually provides some type of initial reaction during the first test of most harmonic patterns. The initial test can occur quickly, and on high volatility it can immediately reject the price. Let's take a closer look at harmonic patterns as described by Scott M. Carney:
The Shark Pattern
The harmonic Shark pattern is identified as shown in the picture below and uses 0, X, A, B, C swing points to name the pivot/swing legs. It is occasionally referred to as an emerging 5-0 pattern. In the example below, we can see an example of the bearish shark pattern with its PRZ zone.
Depicted: EURUSD - MetaTrader 4 (MT4) chart - Bearish shark pattern - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
AB=CD Pattern
The AB=CD pattern is a 4-point price structure wherein the initial price segment is partially retraced and followed by an equidistant move from the completion of the pullback. In Classic AB=CD, the BC is a retracement of 61.8% – 78.6% of AB, with CD being the extension leg of 127.2% to 161.8% (equal in price distance). In AB=CD extension, CD leg is an extension of AB between 127.2% – 161.8%.
Depicted: EUR/USD - MT4 chart - AB=CD bullish pattern - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
The Crab Pattern
Key elements of the Crab pattern:
- B point is a 0.618 retracement of XA or less
- Extreme BC projection that is typically: 2.618, 3.14, or 3.618
- Alternate 1.27 or 1.618 AB=CD pattern required
- 1.618 XA projection: as the defining limit with the structure
- C point with range between 0.382 and 0.886
The pattern can display rapid price action movement, and that often results in fast reversals at the PRZ.
Depicted: EUR/USD - MT4 chart - Crab bearish pattern - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
The Bat Pattern
The Bat is a very accurate pattern, usually requiring a smaller stop-loss than most patterns. The pattern incorporates the powerful 0.886 XA retracement as the defining element within the PRZ. Other key elements of the Bat pattern are:
- Move AB should be the .382 or .500 retracement of move XA
- BC projection must be at least 1.618
- If the retracement of move BC is .382 of move AB, then CD should be a 1.618 extension of move BC
- AB=CD pattern is usually extended
- 0.886 XA retracement
- CD should be .886 retracement of move XA.
Depicted: EURJPY - MT4 chart - Bat bearish pattern - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
The Butterfly Pattern
Scott M. Carney believes that the ideal butterfly pattern needs to have a specific alignment of different Fibonacci measures at each point within the structure. The Butterfly is similar to the Gartley pattern, and the PRZ zone is defined by a mandatory retracement of the XA leg as the point. The ideal Butterfly has 0.786 as XB, but traders might also use various measurements such as 0.952 of the XB.
The key elements of this pattern are:
- Move AB should be the .786 retracement of move XA
- Move BC can be either a .382 or a .886 retracement of move AB
- If the retracement of move BC is .382 of move AB, then CD should be a 1.618 extension of move BC
- If The move BC is a .886 of move AB, then the CD should extend 2.618 of move BC
- CD should be 1.27 or a 1.618 extension of move XA.
Depicted: AUD/NZD - MT4 chart - Butterfly bullish pattern - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
Source: - Data Range: 13 Dec, 2016 (between 05.55 AM to 11:35 PM) - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
The Cypher Pattern
Originally discovered and defined by Darren Oglesbee, the Cypher pattern is a 4-leg pattern. It is not as common as other patterns, though it's widely used in Harmonic trading and analysis. Due to its rare occurrence, traders should make room for adjustments to the Fib levels that are used in the pattern charting.
The key elements of this pattern are:
- The Cypher pattern starts with the X and A points
- Point B retraces to the 0.382 – 0.618 Fibonacci level of the leg XA
- Point C is formed when prices extend the XA leg by at least 1.272 or within the 1.130 – 1.414 Fibonacci extension
- Point D is formed when it retraces the 0.782 Fibonacci level of XC.
Depicted: EUR/JPY - MT4 chart - Cypher bullish pattern - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
Harmonic Patterns: an Easier Way
For all traders that are interested in trading Harmonic patterns, It is highly recommended that you read the works of Scott M. Carney before you begin trading. When you arm yourself with a proper understanding of patterns, PRZ, terminal bars, and everything else that is important for harmonic trading, only then should you begin your search for automatic harmonic indicators.
There are several harmonic indicators and software programs that will automatically detect various harmonic trading patterns. Carney introduced a unique position management system based on a 0.382 Trailing Stop, measured from the reversal point to the reversal extreme.
Trade Management in Harmonic Trading
Depicted: AUD/NZD - MT4 chart - A Bullish Butterfly - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
Featured in the image above is an example of a bullish Butterfly pattern. The first target is related to point B on the chart. It is the level which indicates the price drop during the AB decrease. The second target marks the C point on the chart, and the price top after the BC increase. The third target is the high, which appears as a result of the XA increase.
Point D is the entry. Stops go below point D.
Harmonic Trading: A Deeper Look
It's always good to know more and nothing is better than learning from an expert. Jens Klatt, a professional trader, shares his insight on Harmonic Patterns in the free webinar below.
We hope that you have enjoyed learning about harmonic trading patterns. If you would like to learn more about trading, or perhaps some specific topics that were mentioned in this article, why not check out our range of trading articles?
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of, or recommendation for, any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
