Harmonic patterns in the FX market. How to detect them? Focus on ABCD’s
Harmonic patterns tutorials and books are everywhere around the internet. If there’s one source I would recommend, It would be Scott Carney’s books. They are very well explained with lots of examples. In this article, we will see how to detect some harmonic patterns with a focus on the famous ABCD which is also the continuation of the simple ABC corrective Elliot wave.
THE ABCD PATTERN
The principal Fibonacci retracements (left) and reciprocals (right) we’re interested in are shown in the table below:
0.382 | 2.240
0.500 | 2.000
0.618 | 1.618
0.707 | 1.410
0.786 | 1.272
0.886 | 1.130
It should be clear that the Fibonacci reciprocal is simply 1 / X of the Fibonacci retracement. Many harmonic patterns exist and they differ in complexity and profitability but we will be discussing first the simplest and the best one, the ABCD pattern.
What is an ABCD pattern?
It refers to three legs defined by two impulse waves and one correction wave between them before the last corrective wave is forecasted. The optimal target for an ABCD pattern is 38.2% of the whole length of the pattern. We will see many examples below and it should be clear by the end of the section how to properly use ABCD’s.
The chart below shows a trading configuration on the EURGBP pair through the hourly time frame. The trader should notice the pattern around mid-way between the C point and the D point. The grey box is subjective and takes into account early and late reversal, that is, if we expect prices to reverse around 0.8900, the grey box also known as potential reversal zone — PRZ — can be between 0.8890 and 0.8910. The target is as mentioned before lies at the 38.2% retracement level of the whole ABCD move, we trace the target level as soon as prices touch the PRZ level.
Huge shortcut: Do not memorize the reciprocals or any retracement. You should know that using simple maths logic would lead you to know that it’s a symmetrical pattern, i.e. AB equals the CD leg and hence you can use the Fibonacci expansion tool to measure a leg and its correction and then project it at a 100.00% level. This is why the ABCD pattern is also referred to as AB=CD or Elliot wave’s corrective zigzag. As a rule of thumb, the 0.618 | 1.618 symmetry works better from my experience.
FIGURE 1 EURGBP on an hourly chart with explanatory comments showing the target and the PRZ.
Although harmonic patterns in many times show extreme reversals, it is safer to use them as corrective patterns. We should not see them as key trend inflection points but rather a consolidation or a correction in the prevailing trend. Combining a harmonic pattern with other technical indicators is a very powerful way to validate the conviction as we will see in the next examples. In the above chart, the trader initiates a short position when prices touch the grey box which is the 1.410 retracement of the BC move of simply the symmetrical CD relative to AB.
FIGURE 2 EURCHF chart on an hourly chart showing a bullish ABCD pattern with perfect initiation.
FIGURE 3 EURNZD on a daily time frame. A low-risk ABCD pattern showing limited volatility.
The EURNZD trade shows another example of a low-volatility trade in which prices did not even exceed their entry point, let alone risk getting stopped-out. The beauty of harmonic patterns is that they offer some accurate points and a lot of times only the candlestick’s wick will touch the PRZ, making the pattern perfect. Possibly the main disadvantage of the patterns is that they’re good for forecasting up until their 38.2% target so you also have a big chance of missing a big move like the above, notice how we cut our profitable position at almost 40% of the bullish move. Opportunity cost is not very important in the long-term when you have a good risk-reward ratio. The next chart shows the EURUSD daily time frame. Normally, with harmonic trading, one would go cash out of the position by now as it just hit its target.
FIGURE 4 EURUSD daily correction following the completion of an ABCD pattern.
Detecting ABCD patterns should be easy and visible. The less zig zag patterns there are inside an ABCD, the clearer it is and the better it will perform.
FIGURE 5 Gold reversing from the PRZ with the RSI being in the oversold zone. A high-conviction trade.
In figure 5, the RSI makes an appearance to help with filtering the directional bias. On the gold chart, the PRZ coincides with an oversold zone on the RSI, giving a better conviction of a correction to happen. However, we must be careful with higher volatility assets such as gold, notice the wick the candle has made when it touched the PRZ. A conservative trader would have gotten stopped out on this trade even though the configuration and the forecast turned out to be correct. Placing stops is as much art as determining the direction of prices, it takes time to understand volatility and master self-control. For now, the best strategy is to stick with a minimum risk-reward of 2:1 which is about half the distance from the PRZ to the target (38.2% of the whole ABCD).
FIGURE 6 NZDCAD reversing from the PRZ with the RSI diverging from prices. A high-conviction trade.
The other method of using the RSI is to notice when it is diverging from prices. This is an early signal that the prevailing trend is weakening and although it lacks timing indications, the pattern more than makes-up for that part. Divergence started well before prices reversed which was exactly when prices hit the PRZ.
FIGURE 7 EURAUD reversing from the PRZ with the RSI diverging from prices. A high-conviction trade.
Figure 7 shows another example of divergence occurring around the PRZ on EURAUD. It becomes clear now that the more you combine robust techniques, the more your chances are for being profitable.
FIGURE 8 EURSEK chart showing a confluence of two patterns which can result in a big PRZ.
The confluence of patterns can be a double-edged sword. On one hand, multiple patterns reinforce the view but on the other hand, they may cause the PRZ to be too big for an acceptable risk-reward zone. In figure 1.42 we see an example on EURSEK where two ABCD patterns giving a wide PRZ. The best thing to do here is to either not trade on the patterns or to trade on the furthest one thus lowering the risk of getting stopped-out but increasing the risk of not getting filled in case the correction happens sooner. I think we can agree that not getting filled and missing out is better than getting filled and stopped-out.
FIGURE 9 Different tradeable ABCD patterns on the EURUSD daily time frame. Note that pattern III is a bit different and is discussed below
This is a chart of the EURUSD I had for all of the tradeable patterns I have seen, and although I only traded 3 out of the 5, it is nice to have 3 consecutive winning trades on this pair especially on a daily time horizon where even the simplest tweet can change the course of the market in a few seconds. Let’s go through it one step at a time. Pattern I is a simple 0.886–1.130 pattern, no need to elaborate more on that. Pattern II: Another simple ABCD pattern of the 0.786–1.272 type. Pattern III: This pattern is a reciprocal ABCD as opposed to the standard ABCD patterns that we have been seeing in the chapter. It is merely a reversed version in which the reciprocal is before the retracement. In pattern III, prices have retraced back to 1.130 (reciprocal) and then retraced back to 0.886 where a bullish position could have been initiated. Pattern IV: This was not tradeable as prices did not reach the optimal entry point inside the grey box. It is not wise to open a position way too early as there is always the risk of the pattern failing or a volatility spike causing the stop-loss orders to be triggered. Pattern V: A great short opportunity based on a 0.707–1.410 pattern with low volatility that resulted in an actual reversal rather than just a simple correction. Below is an example of when to start planning for an ABCD trade. Notice, that we are around mid-way of the pattern and the PRZ level is already outlined. All we need is to wait for it to reach the PRZ, evaluate the situation one more time and then decide if we want to act or not around 2.10.
FIGURE 10 A chart on GBPNZD showing how can a PRZ be anticipated in advance. Depending on the elements at the time prices touch the PRZ, the trader should evaluate the situation and decides on the proper action to take.
GARTLEY, BAT, AND THE CRAB PATTERNS
Now, off to some more complex patterns that require better visualization. Sarting with the perfect Gartley pattern that should resemble the below figure:
A perfect example can be seen below on the GBPUSD:
A graph showing the evolution of detecting a Gartley pattern on the USDJPY:
The crab pattern looks something like this:
And finally, the Bat pattern has the following figure:
In conclusion, it is safe to say that adding this technique into your arsenal will help you find get more conviction in your trades if used properly.