Harmonic Patterns.

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How To Trade Harmonic Patterns.
The following video provides a visual step-by-step guide for how to trade harmonic patterns. Classical chart patterns are a great way to identify trend continuation or reversal setups. Harmonic Patterns are perhaps lesser known, but also have their strength in understanding potential price movements.

Issues with Harmonics.
Harmonic price patterns are precise, requiring the pattern to show movements of a particular magnitude in order for the unfolding of the pattern to provide an accurate reversal point. A trader may often see a pattern that looks like a harmonic pattern, but the Fibonacci levels will not align in the pattern, thus rendering the pattern unreliable in terms of the harmonic approach. This can be an advantage, as it requires the trader to be patient and wait for ideal set-ups.

Harmonic patterns can gauge how long current moves will last, but they can also be used to isolate reversal points. The danger occurs when a trader takes a position in the reversal area and the pattern fails. When this happens, the trader can be caught in a trade where the trend rapidly extends against him. Therefore, as with all trading strategies, risk must be controlled.

It is important to note that patterns may exist within other patterns, and it is also possible that non-harmonic patterns may (and likely will) exist within the context of harmonic patterns. These can be used to aid in the effectiveness of the harmonic pattern and enhance entry and exit performance. Several price waves may also exist within a single harmonic wave (for instance, a CD wave or AB wave). Prices are constantly gyrating; therefore, it is important to focus on the bigger picture of the time frame being traded. The fractal nature of the markets allows the theory to be applied from the smallest to largest time frames.

To use the method, a trader will benefit from a chart platform that allows him to plot multiple Fibonacci retracements to measure each wave.

Types of Harmonic Patterns.
There is quite an assortment of harmonic patterns, although there are four that seem most popular. These are the Gartley, butterfly, bat,ABCD , and crab patterns.

The Gartley.
The Gartley was originally published by H.M. Gartley in his book Profits in the Stock Market and the Fibonacci levels were later added by Scott Carney in his book The Harmonic Trader. The levels discussed below are from that book. Over the years, some other traders have come up with some other common ratios. When relevant, those are mentioned as well.

The bullish pattern is often seen early in a trend, and it is a sign the corrective waves are ending and an upward move will ensue following point D. All patterns may be within the context of a broader trend or range and traders must be aware of that. (For related insight, see “Elliott Wave Theory”).

It’s a lot of information to absorb, but this is how to read the chart. We will use the bullish example. The price moves up to A, it then corrects and B is a 0.618 retracement of wave A. The price moves up via BC and is a 0.382 to 0.886 retracement of AB. The next move is down via CD, and it is an extension of 1.13 to 1.618 of AB. Point D is a 0.786 retracement of XA. Many traders look for CD to extend 1.27 to 1.618 of AB.

The area at D is known as the potential reversal zone. This is where long positions could be entered, although waiting for some confirmation of the price starting to rise is encouraged. A stop-loss is placed not far below entry, although addition stop loss tactics are discussed in a later section.

For the bearish pattern, look to short trade near D, with a stop loss not far above.

The Butterfly.
The butterfly pattern is different than the Gartley in that the butterfly has point D extending beyond point X.

Here we will look at the bearish example to break down the numbers. The price is dropping to A. The up wave of AB is a 0.786 retracement of XA. BC is a 0.382 to 0.886 retracement of AB. CD is a 1.618 to 2.24 extension of AB. D is at a 1.27 extension of the XA wave. D is an area to consider a short trade, although waiting for some confirmation of the price starting to move lower is encouraged. Place a stop loss not far above.

With all these patterns, some traders look for any ratio between the numbers mentioned, while others look for one or the other. For example, above it was mentioned that CD is a 1.618 to 2.24 extension of AB. Some traders will only look for 1.618 or 2.24, and disregard numbers in between unless they are very close to these specific numbers.

The Bat.
The bat pattern is similar to Gartley in appearance, but not in measurement.

Let’s look at the bullish example. There is a rise via XA. B retraces 0.382 to 0.5 of XA. BC retraces 0.382 to 0.886 of AB. CD is a 1.618 to 2.618 extension of AB. D is at a 0.886 retracement of XA. D is the area to look for a long, although the wait for the price to start rising before doing so. A stop loss can be placed not far below.

For the bearish pattern, look to short near D, with a stop loss not far above.

The Crab.
The crab is considered by Carney to be one of the most precise of the patterns, providing reversals in extremely close proximity to what the Fibonacci numbers indicate.

This pattern is similar to the butterfly, yet different in measurement.

In a bullish pattern, point B will pullback 0.382 to 0.618 of XA. BC will retrace 0.382 to 0.886 of AB. CD extends 2.618 to 3.618 of AB. Point D is a 1.618 extension of XA. Take longs near D, with a stop loss not far below.

For the bearish pattern, enter a short near D, with a stop loss not far above.

The ABCD.
The ABCD is a basic harmonic pattern. All other patterns derive from it. The pattern consists of 3 price swings. The lines AB and CD are called “legs”, while the line BC is referred to as a correction or a retracement. AB and CD tend to have approximately the same size.

A bullish ABCD pattern follows a downtrend and means that a reversal to the upside is likely. A bearish ABCD pattern is formed after an uptrend and signals a potential bearish reversal at a certain level. The rules for trading bullish and bearish ABCD patterns are the same, you will just need to take into account the direction of the pattern you trade and the movement of the market it predicts.

There are several types of ABCD pattern (all the 3 patterns at the picture are bullish).

In the classic one, the point C should be at 61.8%-78.6% of AB (Use Fibonacci retracement tool on AB: the point C should be close to 61.8%). The point D, in its turn, should be at the 127.2%-161.8% Fibonacci expansion of BC.

Notice that a 61.8% retracement at the point C tends to result in the 161.8% projection of BC, while a 78.6% retracement at the C point will lead to the 127% projection.

There is also the so-called AB=CD pattern. Here CD has exactly the same length as AB. In addition, it takes the market the equal time to travel from A to B as from C to D. As a Result, AB and CD have the same angle. This type of ABCD pattern is seen quite often and is popular among traders.

The third type is when CD is the 127.2%-161.8% extension of AB. CD can be even 2 times (or more) bigger than AB. There actually are some signs that can hint that CD will be much longer than AB. They are a gap after point C or big candlesticks near point C.

How to trade ABCD pattern.

The key thing you should remember is that you can enter the trade only after the price reached the point D.

Study the chart looking at the price’s highs and lows. It may be helpful to use ZigZag indicator (Insert – Indicators – Custom – ZigZag) that marks the chart’s swings.
Watch the price as it forms AB and BC. In a bullish ABCD, C must be lower than A and should be the intermediate high after the low at B. Point D must be a new low below B.

When the market arrives at a point, where D may be situated, don’t rush into a trade. Use some techniques to make sure that the price reversed up (or down if it’s a bearish ABCD). The best scenario is a reversal candlestick pattern. A buy order may be set at or above the high of the candle at point D.

Fine-Tune Entries and Stop Losses.
Each pattern provides a potential reversal zone (PRZ), and not necessarily an exact price. This is because two different projections are forming point D. If all projected levels are within close proximity, the trader can enter a position at that area. If the projection zone is spread out, such as on longer-term charts where the levels may be 50 pips or more apart, look for some other confirmation of the price moving in the expected direction. This could be from an indicator, or simply watching price action.

A stop loss can also be placed outside the furthest projection. This means the stop loss is unlikely to be reached unless the pattern invalidates itself by moving too far.

The Bottom Line.
Harmonic trading is a precise and mathematical way to trade, but it requires patience, practice, and a lot of studies to master the patterns. The basic measurements are just the beginning. Movements that do not align with proper pattern measurements invalidate a pattern and can lead traders astray.

The Gartley, butterfly, bat,ABCD, and crab are the better-known patterns that traders watch for. Entries are made in the potential reversal zone when price confirmation indicates a reversal, and stop losses are placed just below a long entry or above a short entry, or alternatively outside the furthest projection of the pattern.

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