Harmonic Patterns: The key to identifying reversals

Harmonic patterns are a type of complex patterns that you can notice in trading charts. The first of these patterns were used by H.M. Gartley. He introduced Harmonic patterns to the trading world in 1932. He developed a pattern called Gartley pattern and wrote about it in his book ‘Profits in the Stock Market’. When Gartley introduced his pattern, there was no connection between the patterns and Fibonacci ratios. Later, Larry Pesavento improved  Gartley’s pattern by applying Fibonacci ratios to it. Larry wrote about it in his book ‘ Fibonacci Ratios with Pattern Recognition’. Since then, traders have been using Fibonacci retracement and extensions a lot with harmonic patterns. These patterns help to notice possible retracements of recent trends.

Harmonic patterns

1. Bat
2. Butterfly
3. Gartley
4. Cypher
5. Crab
6. Deep Crab
7. Shark
8. Cypher
9. AB=CD
10. 5-0

We will have a look at 6 important Harmonic patterns in this article.

ABCD pattern: The first among the harmonic patterns

ABCD is a  wave pattern in which AB and CD are known as legs while BC is called correction or retracement. It can be either bearish or bullish.

Here are the rules:

1. If you use the Fibonacci retracement tool on leg AB, the retracement BC should reach until the 0.618 level. Next, the line CD should be the 1.272 Fibonacci extension of BC.
2. The length of the lines AB and CD should be the same.
3. The time taken for the price to go from A to B should be equal to the time taken for the price to move from C to D.

Three wave: A variant of ABCD harmonic pattern

Three wave pattern is similar to the ABCD pattern. But it has three legs or drives and two retracements/corrections.
Here are the rules:

1. Point A should be the 61.8% retracement of drive 1.
2. Point B should be the 0.618 retracement of drive 2.
3. Drive 2 should be the 1.272 extension of correction A.
4. Drive 3 should be the 1.272 extension of correction B.
5. The time it takes the price to complete drive 2 should be equal to the time it takes to complete drive 3.
6. The time to complete retracements A and B should be equal

Gartley or the ‘222’ pattern

Now we are going to see the pattern used by H.M. Gartley which is also called by his name. It is a simple ABCD pattern preceded by a significant high or low.

Usually, you can spot a Gartley when you see signs of corrections on a recent uptrend. So, along with ABCD, we can name the spot X which is a point that is beyond ‘D’.

Here are the rules:

1. Move AB should be the .618 retracement of move XA.
2. Move BC should be either .382 or .886 retracement of move AB.
3. If the retracement of move BC is .382 of move AB, the CD should be 1.272 of move BC. If move BC is .886 of move AB, the CD should extend 1.618 of move BC.
4. Move CD should be .786 retracement of move XA

Crab pattern

Discovered by Scott Carney in the year 2000, crab patterns have a high reward-to-risk ratio. Scott Carney believed that this is the most accurate among all the harmonic patterns.

Rules:

1. Move AB should be the .382 or .618 retracement of move XA.
2. Move BC can be either .382 or .886 retracement of move AB.
3. If the retracement of move BC is .382 of move AB, the CD should be 2.24 of move BC. If move BC is .886 of move AB, the CD should be 3.618 extension of move BC.
4. CD should be 1.618 extension of move XA.

The Bat pattern

In 2001, Scott Carney discovered another pattern called Bat pattern. Here are the rules for the bat pattern:

1. Move AB should be the .382 or .500 retracement of move XA.
2. Move BC can be either .382 or .886 retracement of move AB.
3. If the retracement of move BC is .382 of move AB, the CD should be 1.618 extension of move BC. IF move BC is .886 of move AB, then CD should be 2.618 extension of move BC.
4. CD should be .886 retracement of move XA.

The Butterfly pattern

Trader Bryce Gilmore created the butterfly pattern. It has the following qualities:

1. Move AB should be the .786 retracement of move XA.
2. Move BC can be either .382 or .886 retracement of move AB.
3. If the retracement of move BC is .382 of move AB, the CD should be 1.618 extension of move BC. If move BC is .886 of move AB, the CD should extend 2.618 of move BC.
4. CD should be 1.27 or 1.618 extension of move XA.

Trading Harmonic patterns

One of the challenges in using harmonic patterns is identifying them on a chart. It is too difficult to spot harmonic patterns using the naked eye. But you can use Fibonacci tools to easily spot them. The important harmonic patterns are the 5 point harmonic patterns (Gartley, Butterfly, Crab, Bat, Shark, Cypher). They have embedded ABC (3 point) or ABCD (4-point) patterns.

Harmonic patterns are a bit complicated. Once you understand one pattern, it is easy to understand others. You identify the trade when the first 3 legs of the harmonic pattern are completed. When the pattern starts to form the CD leg, you can use your measuring tools and identify a potential trade set up according to the ongoing trend.