Trading with Harmonic Patterns
Introduction to Harmonic Patterns
Harmonic trading is a methodology that utilizes the recognition of specific price patterns and the alignment of exact Fibonacci ratios to determine highly probable reversal points in the financial markets. This methodology assumes that trading patterns or cycles, like many patterns and cycles in life, repeat themselves. The primary harmonic patterns include the ABCD pattern, the Three-Drive pattern, the Gartley pattern, the Bat pattern, the Butterfly pattern, and the Cypher pattern.
The Basic Understanding of Harmonic Patterns
The ABCD Pattern
The ABCD pattern is the basic foundation for all harmonic patterns. Traders would monitor for a D point to form where they can take a short or long, depending on the overall direction of the pattern.
The Three-Drive Pattern
The Three-Drive pattern is a lot like the ABCD pattern except that it has three legs (now known as drives) and two retracements.
The Gartley Pattern
The Gartley pattern, also known as the Gartley 222, is a powerful and multi-rule based trade set-up that takes advantage of exhaustion in the market and provides great risk: reward ratios.
The Bat Pattern
The Bat pattern is similar to the Gartley pattern in appearance, but the retracement of the BC leg is usually to the .886 level rather than the .786 in the Gartley.
The Butterfly Pattern
The Butterfly pattern has the same character traits as the Gartley and Bat. However, the Butterfly pattern must contain the specific retracements that are stated below.
The Cypher Pattern
The Cypher pattern is visually similar to the other harmonic patterns but has different Fibonacci measurements that make it unique.
How to Trade with Harmonic Patterns
Identify the Pattern
The first step in trading with harmonic patterns is identifying potential patterns in the market. This can be done by using a harmonic pattern indicator or by scanning the market manually.
Wait for the Pattern to Complete
Once a potential pattern has been identified, the next step is to wait for the pattern to complete. This is when the price action meets all the Fibonacci retracement levels that define the pattern.
Enter the Trade
After the pattern has completed, a trader can enter a trade at the D point of the pattern. The D point is the potential reversal point of the pattern and is therefore the point at which the trader should enter the market.
Set Stop Loss and Take Profit Levels
After entering the trade, the trader should set their stop loss and take profit levels. The stop loss should be set just below the D point of the pattern, while the take profit should be set at a level that gives a good risk to reward ratio.
Conclusion
Harmonic patterns can be a very effective way to trade the markets, but like all trading strategies, they should be used in conjunction with other forms of analysis and risk management techniques. It is also important to note that while harmonic patterns can be very profitable, they are not foolproof and there will be times when the patterns fail. Therefore, always ensure you are managing your risk effectively when trading with harmonic patterns.