Harmonic patterns trading are a type of technical analysis. It makes use of some frequently repeating patterns in the market. A harmonic pattern can be either a reversal or a continuation pattern. As such, they can form during corrections in a trend. The concept of harmonic trading was made famous by H.M Gartley in early 1930’s. Since then, harmonic pattern trading has caught on with a number of technical analysts. Further modifications from Scott Carney resulted in identifying new patterns expanding the family of harmonic patterns. While there are many variations to the harmonic patterns, a few have stood the test of time. This is because they occur more frequently on the price charts.
What is a Harmonic Pattern?
A Harmonic Pattern is a price based pattern. Patterns based trading is nothing new for traders. Some of the famous price action patterns include the head and shoulders, double tops and bottoms to name a few. What’s unique about Harmonic Patterns is that they also need to adhere to Fibonacci retracement levels. This is one of the main points that separate Harmonic Patterns from other chart patterns.
The different turning points in price each have their own criteria to validate the pattern as one of the Harmonic Patterns. When a Harmonic Pattern satisfies the Fibonacci ratio levels, traders can then expect and project the potential move in price. The projected price is also based on the Fibonacci ratios.
Why is Harmonic Pattern trading effective?
Harmonic Pattern trading is effective because when a pattern is validated, it can project the near term behavior of price. Furthermore, harmonic patterns occur at key support and resistance levels. Because price moves in trends, traders can also apply the current trend and trade the harmonic pattern more effectively.
These price patterns occur across different time frames. This is another reason why they are effective and more widely used. A swing trader can look at harmonic patterns occurring on the daily or weekly chart. Likewise, a short term day trader can easily look at the harmonic patterns occurring on short term time frames such as 5 or 15 minute charts.
Harmonic Patterns are geometric in structure. As a result, the patterns form what is known as Potential Reversal Zone (PRZ). The potential reversal zone is where there is a high likelihood of price to reverse. As you can see, this brings an advantage. When a trader can identify a high probability reversal zone, it is easy to keep emotions aside. With tight stop losses, there is a higher chance of profiting from winning trades.
Different Types of Harmonic Patterns
All the harmonic trading patterns are based from 5 turning points in price. We name these points X, A, B, C and D. Below are the rules that each of the harmonic patterns must follow.
The Gartley Harmonic Pattern
A Gartley pattern must follow the rules:
- AB leg should retrace about 61.8% of leg XA
- BC should retrace 38.2% – 88.6% XA
- CD is at least a 78.6% retracement of leg XA
There are times when the point D can be an extension of 127% – 161.8% extension of the BC leg.
The chart below shows a bullish Gartley pattern. The reverse is the true for a bearish Gartley pattern.
The Gartley Harmonic Pattern
The Butterfly Harmonic Pattern
The Butterfly Harmonic Pattern
A butterfly pattern must satisfy the following rules:
- AB should be a 78.6% retracement of the XA leg
- BC must be between 38.2% and 88.6% of the AB leg
- CD must be a between 161.8% – 261.8% extension of the AB leg
- CD must be between 127.2% – 161.8% extension of the XA leg
The example below shows a Butterfly pattern.
The Butterfly Harmonic Pattern
The Crab Harmonic Pattern
The Crab Harmonic Pattern
The Crab Pattern is another Harmonic Pattern which works the same way as the previous.
The rules for a Harmonic Pattern to become a crab pattern are:
- AB should retrace between 38.2% – 61.8% of XA leg
- BC should retrace between 38.2% – 88.6% of AB leg. C should never exceed point A’s high (or low)
- CD is the longest leg and it should extend to 161.8% of XA. In some extreme cases, CD can extend between 224.0% – 361.8% of BC leg.
The example below shows the Crab Pattern.
The Crab Harmonic Pattern
The Bat Pattern
The Bat Harmonic Pattern
The Bat pattern gets its name because the pattern looks like a bat with outstretched arms. The rules for a Harmonic Pattern to qualify as a bat pattern are:
- AB should retrace 38.2% – 50% of XA leg
- BC should retrace 38.2% – 88.6% of AB leg
- CD should retrace 88.6% of XA or can exceed to 161.8% – 261.8% of AB leg.
The picture below depicts a bat pattern.
The Bat Harmonic Pattern
The Shark Pattern
The Shark Harmonic Pattern
The shark pattern looks a bit similar to the crab pattern. The retracement rules are:
- AB leg extends between 113% – 161.8% of XA
- CD should extend BC between 161.8% – 224%
- CD should also be between 88.6% – 113% of XA
The chart below shows an example of the shark pattern.
The Shark Pattern
The Cypher Pattern
The Cypher pattern is rather simple. The rules are:
- AB should retrace 38.2% – 61.8% of XA
- BC should extend 113% – 141.4% of XA
- CD should retrace to 78.6% of XC
Below is an example of the Cypher pattern.
The Cypher Pattern
Pitfalls of trading Harmonic Patterns
Although Harmonic Pattern trading is easy, there are some inherent pitfalls. For one, it is not uncommon to see multiple patterns forming from within. For example, a bullish Gartley Pattern could very well result in a smaller scale bearish Crab pattern. This can confuse the trader as a result. Despite the high probability of the pattern, such multiple patterns can lead to confusion and losing trades.
Secondly, due to the tight stop loss, there are many instances when price can spike through the stop loss only to reverse course again. Last but not the least Harmonic Pattern is purely technical. Therefore, there are chances that major news could potentially wreak havoc with the setup.
How to make Harmonic Patterns more reliable
There are a number of ways to make Harmonic Patterns more reliable. For starters, paying attention to support and resistance levels can help. Combining this with price action reversal patterns such as bearish or bullish engulfing or inside bars can bring some confidence to the trades. It is also important that you set the stop loss and target levels to a reasonable price level.
For example, stop losses across all Harmonic Patterns can be set to a few pips above the high or below the low of X, the first starting point of the Harmonic Pattern.
Take profit levels are set to 38.2% and 61.8% of the CD leg.
You could also make use of other technical indicators. One indicator that can be very valuable is the Stochastic oscillator. Because the Stochastic oscillator identifies oversold and overbought levels, traders can use this information to further validate their trades. However, it is easier said than done. Given that a good amount of time is required to validate an evolving Harmonic Pattern, the above mentioned methods require further time to analyze the set ups. The example below shows how you can use Harmonic Patterns alongside the Stochastic oscillator to validate the potential reversal zone.
How to make Harmonic Patterns more reliable
In the above chart you can see that after the point D is identified. Following this, instead of blindly going short, it is best to wait for the Stochastics to signal a turn around. This can be found after price bounces back slightly. The Stochastics, although not in the oversold level triggers a sell signal.
Selling on this trigger from the Stochastic gives you a more valid entry point into the trade. Also note that because Harmonic Patterns take profit at 38.2% and 61.8%, it is best to cover your stop loss to break even or even lock some profits after the first target is met. Another example below shows a bullish Harmonic Pattern.
Bullish Harmonic Pattern with Stochastic
In the above example, you can see how the bullish Harmonic Pattern can be traded with confidence based on the buy signal from the Stochastic. Here, the Stochastic triggers a buy signal following which traders can go long on the trade.
Harmonic Pattern Trading Strategy
In conclusion, the Harmonic Patterns are basically different versions with varying levels of Fibonacci retracement and extension levels. By adding other methods such as price action or Stochastic you would be able to improve your harmonic trading. Remember that you shouldn’t get too stuck up on the Fibonacci levels. Allow a bit of flexibility on the retracements. Last but most importantly, never jump into a Harmonic Pattern trade. Wait until price reverses off point D and then look for validation from the Stochastic in order to trade confidently.
If you want a shortcut to trading the Harmonic Pattern, then you should really invest in a powerful Harmonic Pattern Scanner.
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