Harmonic patterns are technical formations that may help traders understand price action and forecast where prices may go next. A trader may forecast where and how much an asset’s price will move by analysing harmonic pattern formations on price charts.
Harmonics, like other pattern types, are most potent when traded after they have been formed. A common mistake is to assume that a pattern will form and then trade it before it has fully materialised. Harmonics take patience, but when employed correctly, they may give valuable insight into potential future price movements.
In this post, we will look at how to spot harmonic patterns on trading charts, and trade them using the advanced drawing tools available on many online trading platforms.
Market prices usually exhibit trend, consolidation, and re-trend behaviour. They rarely reverse their trends and transitional phases to turn off from a previous trend on a single bar. They undergo trading ranges and price fluctuations throughout this transitional phase. This ranging action defines identifiable price patterns.
Before their formation, these consolidation phases occasionally favour prevailing trends and continue their direction. These are referred to as “continuation” patterns.
Symmetrical Triangles, Flags, and Cup & Handle are some examples of these patterns. Some phases result in a reversal of the previous trend and a continuation of the new trend.
These are known as “reversal” patterns. Head and Shoulders, Double Bottoms, and Broadening Patterns are examples of these patterns (more on chart patterns here).
H.M. Gartley created the concept of Harmonic Patterns. In his book Profits in the Stock Market, Gartley discussed a 5-point pattern (known as Gartley). Larry Pesavento refined this pattern using Fibonacci ratios and provided guidelines for trading the “Gartley” pattern in his book Fibonacci Ratios with Pattern Recognition.
A few other authors have worked on this pattern theory, but the best work, to my knowledge, has been done by Scott Carney. In his book “Harmonic Trading,” where he invented patterns like “Crab,” “Bat,” “Shark,” and “5-0” and added a real depth of knowledge for their trading rules, validity, and risk/money management.
The underlying harmonic patterns’ primary idea is based on price/time movements that follow Fibonacci ratio connections and market symmetry. Fibonacci ratio analysis applies to every market and timeframe chart.
The basic concept behind employing these ratios is to detect significant turning points, retracements, and extensions, besides the series of high and low swing points. The projections and retracements produced from these swing points (Highs and Lows) will provide crucial price levels for targets and stops.
Using Fibonacci sequences, harmonic patterns create geometric pattern structures (retracement and projection swings/legs). These harmonic structures offer traders unique options such as potential price movements and essential turning or trend reversal points.
This element gives traders an advantage since harmonic patterns strive to deliver highly trustworthy information on price entries, stops, and targets. This might be a crucial distinction between other indicators/oscillators and how they function.
Traditional price charts display various harmonic patterns, including the Bat, Gartley, butterfly, 5.0, crab, and AB=CD patterns. Each has a bearish and bullish variant, which means that when the pattern is upside down, it might depict a price rise or fall. Each pattern has a specific formation and, more crucially, specific Fibonacci ratios that must be matched for the pattern to be valid and forecast future price movement.
Harmonic patterns may be applied to all financial markets, including stocks, commodities, and forex. Each pattern presented below is associated with a trading strategy, including entry points, stop losses and profit targets.
On the EUR/USD four-hour price chart, the example below illustrates a bullish Bat pattern. The numbers mark the retracement or extensions within the pattern’s parameters. A Fibonacci retracement to the pattern’s right displays possible profit target levels, of which the common targets of 0.50 and 1.0 were reached.
The bullish Bat pattern resembles a stretched-out “M.” The price rises, forming an X-to-A leg higher, retracing less than 0.618 of the XA leg. The ideal retracement here is 0.382 to 0.50. Then there is another move up, as illustrated by “BC,” which retraces wave AB from 0.382 to 0.886. This is followed by a lower-level wave called CD, which is a 1.618 to 2.618 extension of BC.
Point D should be near a retracement of XA of 0.886. From this potential reversal zone, the price is expected to rally. Many traders wait for the price to start rising before entering the market. A stop-loss order is set below the most recent swing low, either near D or below X.
Profit targets are based on Fibonacci ratios between points A and D, with the possibility of extending higher than A. Popular take-profit levels include 0.50, 0.618, 1 (at A), and 1.618 (above A) since they might act as future support and resistance levels.
Bearish Bat harmonic pattern resembles a stretched-out “W.” The ratios are identical, except the pattern starts with a price decline from X to A. AB represents a move higher, BC represents a move lower, and CD represents a wave higher. Point D represents where traders will watch for a price decline, which explains why it is a bearish pattern.
The Gartley pattern resembles the Bat in appearance, but the ratios are different. The bearish Gartley pattern has the same ratios as the bullish Gartley pattern; only it begins with a XA leg down.
However, for a bullish Gartley pattern:
The EUR/GBP daily chart shows an example of a bearish Gartley pattern. Once the price begins to fall, the stop-loss is placed immediately above the swing high at D. It might also be positioned above X, but this would significantly increase the stop-loss size.
Profit targets include AD retracement and extension levels of 0.50, 0.618, 1, and 1.618. In the future, they might act as both support and resistance.
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The harmonic Butterfly pattern looks like the preceding patterns but with different ratios, and point D extends longer than point X.
The Fibonacci levels for a bearish butterfly pattern are as follows:
The bullish Butterfly pattern has the same ratios as the bearish Butterfly pattern, except it begins with an up XA wave. The following is a bearish Butterfly example on a one-hour NZD/JPY price chart. There is a XA leg down there. The B wave retraces to 0.886, slightly over ideal but reasonably close. D is 1.23 of XA, while BC retraces 0.75 of AB.
The price drops lower off D in anticipation of a potential short trade, and the stop-loss order rises above the swing high at D. Profit targets are based on AD Fibonacci ratios. The most common take-profit levels are 0.50, 0.618, 1, and 1.618.
Yet another Scott Carney discovery, the Crab follows an X-A, A-B, B-C, and C-D pattern, allowing traders to enter the market at extreme highs or lows. The 1.618 extension of the XA movement that determines the PRZ is the most crucial feature of the crab pattern.
The first leg of the Crab in its bullish version forms when the price rises sharply from point X to point A. The AB leg retraces 38.2% to 61.8% of XA. This is followed by an extreme projection of BC (2.618 – 3.14 – 3.618), which identifies a good area for the pattern’s completion and the potential reversal of the current trend.
A bearish crab will follow a drop from point X to point A, then a modest price rise, a slight drop, and then a sharp rise to point D.
This is a slightly different version of the Crab pattern outlined above. The retracement of point B, which must be 0.886 of the XA movement without exceeding point X, is the sole difference.
The BC projection might range from 2.24 and 3.618.
The AB=CD pattern functions slightly differently than the others. In the case of a bullish AB=CD pattern:
On the daily gold chart, we can notice a bearish AB=CD pattern in the example below. The ratios are the same. The CD line is identical to line AB on the chart, while the dotted line represents a possible reversal zone. As the price approaches this zone, traders may enter to go short if the price falls away from the zone. A stop-loss order is placed above the most recent swing high.
Because the trend might be pretty intense and you’re trading a possible reversal trend, you should consider setting your targets between points D and C. A Fibonacci retracement tool, for example, might be used to set targets around 0.50, 0.618, or 1.
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This is a slightly more complicated pattern since it contains an AB=CD and the waves before it.
Here are the Fibonacci levels to watch for a bullish 5.0 harmonic pattern:
The CAD/JPY daily chart shows an example of a bullish 5.0 Harmonic pattern. The price is now at point D, which must rise to initiate a trade. This is how harmonic patterns will appear throughout a trade. We do not yet know if the price will move as expected; therefore, if the price continues to fall, there is no trade. There will only be a trade if the price rises.
Once the price rises, a stop-loss is placed below the low swing created at point D. Targets are anticipated between D and C, although they might also be projected above C. The bearish pattern functions similarly, except that the up waves move downward while the down waves move upward.
The Fibonacci retracement tool is the leading technical indicator for harmonic trading. It is used to verify each wave of the pattern and to indicate potential profit targets after the pattern has finished. Once the initial wave has formed for each pattern, you may use the Fibonacci retracement tool to verify the succeeding waves are of the proper size to match the harmonic pattern.
Harmonic price patterns are precise in that they must display movements of a particular size for the pattern’s unfolding to produce an accurate reversal point.
A trader may notice a pattern that looks to be a harmonic pattern. Still, the Fibonacci levels do not align in the pattern, rendering the pattern unreliable in terms of the harmonic approach. This might be advantageous since it necessitates the trader’s patience in waiting for ideal setups.
Harmonic patterns may gauge how long current moves persist, but they can also isolate reversal points. The danger arises when a trader takes a position in the reversal area, and the pattern fails. When this happens, the trader may get caught in a trade in which the trend rapidly extends against them. As a result, risk must be controlled, as with any trading strategy.
It is essential to realise that patterns may exist inside other patterns, and non-harmonic patterns can (and almost certainly will) exist within the context of harmonic patterns. These may aid the harmonic pattern’s effectiveness and enhance entry and exit performance.
A single harmonic wave may exist in multiple price waves (for instance, a CD wave or AB wave). Prices are constantly gyrating; thus, it is vital to concentrate on the bigger picture of the time frame being traded. The fractal nature of the markets allows the theory to be applied from the smallest to the most significant periods.
A chart platform that allows a trader to plot multiple Fibonacci retracements to measure each wave is required to utilise the method.
Harmonic trading mixes patterns and arithmetic into a precise trading method based on repeating patterns. The main ratio, or a derivation of it, is at the heart of the technique (0.618 or 1.618). Complementary ratios include: 0.382, 0.50, 1.41, 2.0, 2.24, 2.618, 3.14, and 3.618.
The primary ratio may be found in all-natural and environmental structures and events and in manufactured structures. Because the pattern repeats across nature and culture, the ratio may be found in financial markets, which are influenced by the surroundings and societies in which they operate.
The trader may use Fibonacci ratios to anticipate future movements after identifying patterns of varying durations and magnitudes. The trading method is generally credited to Scott Carney; others have contributed or found patterns and levels that enhance performance.
Harmonic patterns are a precise trading method that may benefit traders who appreciate analysing price charts and trading patterns. It’s important to understand that harmonic patterns don’t always work. Price may not reverse in potential reversal zones, or if it does, it may not move as far as expected before reversing. Candlestick patterns can also assist in your analysis by giving direction on price movement.
As a result, stop-loss orders are essential for risk management. Once a trade is initiated, a stop-loss order may be put at the swing high/low near point D. While stop-loss orders may help to limit risk, they do not account for market volatility, namely gapping or slippage on price charts.
Instead, guaranteed stop-losses may be utilised for a modest fee to close out your position at a specific price under these dangerous conditions.
When trading harmonic patterns, you should decide where you want to take profit regarding Fibonacci levels. This may help to remove any subjectivity associated with trading these patterns. This may also help calculate your risk/reward ratio before the trade.
If the potential profit is slightly higher than the risk, you may pass on the trade, but the trade might be executed if the reward is much more than the risk. All of these aspects combine to form an entire harmonic trading strategy.
Harmonic patterns are a form of technical analysis that may indicate if a price will reverse or continue in the same pattern. While many forex indicators predict a general change in price or trend, harmonic patterns are exact and work with precise price movements.
