Trading with Harmonic Patterns
Harmonic patterns in the financial markets are a powerful tool for traders. These patterns are geometric shapes that can be observed in price charts, and they are based on Fibonacci numbers, a mathematical concept discovered by Leonardo Fibonacci in the 13th century. Traders use harmonic patterns to identify potential reversal points in the market, which can be a very profitable trading strategy when used correctly.
Understanding Harmonic Patterns
Harmonic trading patterns are precise, patient, and require knowledge of the ‘Fibonacci ratios’. The patterns use price data and Fibonacci ratios to determine potential future moves. The basic harmonic patterns consist of four price moves which are contrary to each other. The four main harmonic patterns that traders can use are the Gartley pattern, the Bat pattern, the Butterfly pattern, and the Crab pattern.
The Gartley Pattern
The Gartley pattern, also known as the 222 pattern, 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 pattern is named after H.M Gartley, who introduced it in his book “Profits in the Stock Market” in 1932.
The Bat Pattern
The Bat pattern is a variation of the Gartley pattern, and was discovered by Scott Carney. The Bat pattern is identified by the .886 retracement of move XA as Potential Reversal Zone. The Bat pattern has the following characteristics: move AB should be the .382 or .500 retracement of move XA; move BC can be either .382 or .886 retracement of move AB; if the retracement of move BC is .382 of move AB, then CD should be 1.618 extension of move BC. Consequently, if move BC is .886 of move AB, then CD should extend 1.618 of move XA.
The Butterfly Pattern
The Butterfly pattern, discovered by Bryce Gilmore, is a reversal chart pattern that consists of four distinct swings in the market. The pattern is composed of a structure that includes an initial leg, a retracement, a second leg, a second retracement, and a final leg. The pattern is considered complete when the market has formed all five points of the pattern.
The Crab Pattern
The Crab pattern, also discovered by Scott Carney, is a relatively new harmonic pattern. The Crab pattern 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.
Trading with Harmonic Patterns
Trading with harmonic patterns requires patience and discipline. The key to success is to wait for the pattern to complete and then place your trade at the potential reversal zone (PRZ). The PRZ is the area where the harmonic pattern is expected to complete and where the trader should look for a potential trade.
Identifying Harmonic Patterns
Identifying harmonic patterns in the trading chart requires the trader to have a keen eye and knowledge of the geometric patterns. The trader needs to identify the starting point X, and from there, use the Fibonacci ratios to determine the other points in the pattern.
Placing the Trade
Once the harmonic pattern is identified, the trader can place a trade at the completion of the pattern, at the PRZ. The stop loss should be placed just above the highest point of the pattern for a sell trade, or just below the lowest point for a buy trade. The take profit should be placed at a point that corresponds to a Fibonacci retracement level.
Managing the Trade
After placing the trade, the trader needs to manage the trade by monitoring the price action and adjusting the stop loss and take profit levels as necessary. The trader should also be prepared to close the trade if the price action indicates that the pattern is not playing out as expected.
Conclusion
Harmonic trading patterns provide a way for traders to identify potential reversal points in the market, and can be a very profitable trading strategy when used correctly. However, like any trading strategy, it requires practice, discipline, and a solid understanding of the underlying principles.
