Dragon pattern is an interesting and exotic type of harmonic pattern which is also a reversal model of technical analysis in trading. It has a head followed by two feet. It is quite similar to the ‘W’ pattern or the double bottom pattern. In fact, it is a failed double bottom pattern. It is called a Dragon pattern because the pattern looks like a dragon.
Dragon pattern usually forms in a falling market. This pattern works in all time frames and provides excellent trading opportunities with great risk/reward ratios. Similar to the dragon patterns, there are also inverse dragon patterns (bearish) or ‘M’ patterns (failed double top patterns). The instructions for the reverse dragon patterns are similar but in reverse.
Formation of the Dragon Pattern
Dragon pattern starts with a head. Then the price falls from the swing high level to a swing low to create the first leg of the Dragon. From the head level, there is a continuous decline in the price that leads to the formation of the two legs of the dragon or the two lows. After the first leg, there is a rise in the price. The rise is usually 38% to 50% of the previous swing forming the ‘hump’ of the dragon. There is a 5-10% price difference between the two legs. The second leg strongly indicates a reversal. The completion of the second leg signals a potential Dragon formation. There is usually a spike in the volume after the price rise of the second leg.
The price-action from the second leg should show key reversal bars or a divergence in any momentum-based indicators. Traders enter the trade at the completion of the second leg.
Trading the Dragon pattern
Draw a trend line connecting the head of the dragon to the hump. Wait for the completion of the second leg. You can confirm the completion of the second leg when the price closes above the trend line. Once it is confirmed, enter a long trade. You can confirm a strong reversal in price action through divergence in any momentum-based oscillator like RSI. To be more sure, you can wait for a candle or bar closing price to be above the trend line. Some traders enter the trade when the price closes above the hump level.
Setting Stop Loss and Target Price
Place the stop loss below the lowest low of two swing lows. Set the first target at 61.8% to 78.6% of the swing range of the head to the first leg measured from the second leg level. Set the second target at 100% of swing range and the third target range is set at 127.2% to 161.8% of the swing. Once the price reaches the first target, we recommend moving the stop loss to break even to minimize the risks.
You can also use Fibonacci levels to set the take profit levels. To do that, apply the Fibonacci grid on the dragon pattern starting from feet to head. Then you can set the target levels at important Fibonacci levels such as 38.2%, 50% and 100%.