Harmonic Patterns

ChartSchool » Trading Strategies and Models » Harmonic Patterns

Introduction
Chart Pattern recognition is the basic and primary ability any trader develops
in Technical Analysis. It may be basic development, but the perfection of
pattern recognition takes extensive practice and repetitive exposure. The
expert recognition of patterns helps traders to quantify and react to the
changing market environment. Chart patterns are categorized into
“continuous” and “reversal” patterns, which are further classified as simple
and complex patterns. The complex patterns structures may consist of
collections of simple patterns and combination of prior swings. The knowledge
of this classification of pattern recognition and its properties give traders
greater potential to react and adapt to a wider range of trading conditions.

Why Do Patterns Form?

Market prices always exhibit trend, consolidation and re-trend behavior. They
rarely reverse their trends and transitional phases to turn from a previous
trend on a single bar. During this transitional phase, they experience trading
ranges and price fluctuations. This ranging action defines identifiable price
patterns. These consolidation phases occasionally favor prevailing trends prior
to their formation and continue their direction. These are called
“continuation” patterns. Examples of these patterns include Symmetrical
Triangle, Flags and Cup and Handle. Some phases result in a reversal of the
prior trend and continuing in the new direction. These are called “reversal”
patterns. Examples of these patterns include Head and Shoulders, Double
Bottoms and Broadening Patterns.

Harmonic Patterns
The concept of Harmonic Patterns was established by H.M. Gartley in 1932.
Gartley wrote about a 5-point pattern (known as Gartley) in his book Profits
in the Stock Market. Larry Pesavento has improved this pattern with
Fibonacci ratios and established rules on how to trade the “Gartley” pattern in
his book Fibonacci Ratios with Pattern Recognition. There are few other
authors who have worked on this pattern theory, but the best work to my
knowledge is done by Scott Carney in his books of “Harmonic Trading.” Scott
Carney also invented patterns like “Crab,” “Bat,” “Shark” and “5-0” and added
real depth of knowledge for their trading rules, validity and risk/money
management.
The primary theory behind harmonic patterns is based on price/time
movements which adhere to Fibonacci ratio relationships and its symmetry in
markets. Fibonacci ratio analysis works well with any market and on any
timeframe chart. The basic idea of using these ratios is to identify key turning
points, retracements and extensions along with a series of the swing high and
the swing low points. The derived projections and retracements using these
swing points (Highs and Lows) will give key price levels for Targets or Stops.
Harmonic patterns construct geometric pattern structures (retracement and
projection swings/legs) using Fibonacci sequences. These harmonic structures
identified as specified (harmonic) patterns provide unique opportunities for
traders, such as potential price movements and key turning or trend reversal
points. This factor adds an edge for traders as harmonic patterns attempt to
provide highly trustworthy information on price entries, stops and targets
information. This may be a key differentiation with other
indicators/oscillators and how they work.

Examples of Harmonic Patterns

The Gartley pattern shown below is a 5-point bullish pattern. These patterns
resemble “M” or “W” patterns and are defined by 5 key pivot points. Gartley
patterns are built by 2 retracement legs and 2 impulse swing legs, forming a 5-
point pattern. All of these swings are interrelated and associated with
Fibonacci ratios. The center (eye) of the pattern is “B,” which defines the
pattern, while “D” is the action or trigger point where trades are taken. The
pattern shows trade entry, stop and target levels from the “D” level.
The following chart shows another 5-point harmonic pattern (Butterfly
Bearish). This pattern is similar to the above 5-point Gartley pattern, but in
reverse. Here the pattern is “W”-shaped with “B” being the center (eye) of the
pattern. The pattern shows trade entry, stop and target levels from “D” levels
using the “XA” leg.
List of Harmonic Patterns
 ABC Bullish/Bearish
 AB=CD Bullish/Bearish
 3-Drives Bullish/Bearish
 Gartley Bullish/Bearish
 Butterfly Bullish/Bearish
 Bat Bullish/Bearish
 Crab Bullish/Bearish
 Shark Bullish/Bearish
 Cypher Bullish/Bearish

Fibonacci Discussion

Any discussion on harmonic patterns must include Fibonacci numbers, as

these patterns use Fibonacci ratios extensively. Fibonacci numbers are
pervasive in the universe and were originally derived by Leonardo Fibonacci.
The basic Fibonacci ratio or “Fib ratio” is the Golden Ratio (1.618). Fibonacci
numbers are a sequence of numbers where each number is the sum of the
previous two numbers.
The series of Fib Numbers begin as follows:
1,1,2,3,5,8,13,21,34,55,89,144,233,317,610….
There are plenty of materials and books about the theory of how these
numbers exist in nature and in the financial world. A list of the most
important Fib ratios in the financial world, which are derived by squaring,
square-rooting and reciprocating the actual Fibonacci sequence, is shown
below.
Key set of Fibonacci-derived ratios in trading: 0.382, 0.618, 0.786, 1.0,
1, 1, 2.0, 2.62, 3.62, 4.62
Secondary set of Fibonacci-derived ratios in trading: 0.236, 0.886,
1.13, 2.236, 3.14, 4.236
There are many applications of Fibonacci in technical analysis. Some of the
applications include Fibonacci retracements, Fibonacci projections, Fibonacci
Fans, Fibonacci Arcs, Fibonacci Time Zones and Fibonacci Price and Time
Clusters, among others.
Most trading software packages have Fibonacci drawing tools which can show
Fibonacci retracements, extensions and projections. Additionally, Fibonacci
numbers can also be applied to “time” and “price” in trading.
The graphic below illustrates how Fibonacci ratios are used to apply
retracement, extension, projection and expansion swings.
Advantages & Disadvantages of Harmonic
Patterns

Advantages:
1. Provide future projections and stops in advance, making them leading
indicators
2. Frequent, repeatable, reliable and produce high probable setups
3. Trading rules are relatively standardized using Fibonacci ratios
4. Work well with defined Market Context, Symmetry and Measured Moves
rules
5. Work in all timeframes and in all market instruments
6. Other indicator theories (CCI, RSI, MACD, DeMark…) can be used along
with them

Disadvantages:
1. Complex and highly technical, making it difficult to understand
2. Correct identification and automation (coding) of harmonic patterns is
difficult
3. Conflicting Fibonacci retracements/projections can create difficulty in
identifying reversal or projection zones
4. Complexity arises when opposing patterns form from either the same
swings or other swings/timeframes
5. Risk/reward factors from non-symmetric and low-ranked patterns are
pretty low

How to Trade Harmonic Patterns

Pattern Identification
Harmonic patterns can be a bit hard to spot with the naked eye, but, once a
trader understands the pattern structure, they can be relatively easily spotted
by Fibonacci tools. The primary harmonic patterns are 5-point (Gartley,
Butterfly, Crab, Bat, Shark and Cypher) patterns. These patterns have
embedded 3-point (ABC) or 4-point (ABCD) patterns. All the price swings
between these points are interrelated and have harmonic ratios based on
Fibonacci. Patterns are either forming or have completed “M”- or “W”-shaped
structures or combinations of “M” and “W,” in the case of 3-drives. Harmonic
patterns (5-point) have a critical origin (X) followed by an impulse wave (XA)
followed by a corrective wave to form the “EYE” at (B) completing AB leg.
Then followed by a trend wave (BC) and finally completed by a corrective leg
(CD). The critical harmonic ratios between these legs determine whether a
pattern is a retracement-based or extension-based pattern, as well as its name
(Gartley, Butterfly, Crab, Bat, Shark, and Cypher). One of the significant
points to remember is that all 5-point and 4-point harmonic patterns have
embedded ABC (3-Point) patterns.
All 5-point harmonic patterns (Gartley, Butterfly, Crab, Bat, Shark, Cypher)
have similar principles and structures. Though they differ in terms of their leg-
length ratios and locations of key nodes (X, A, B, C, D), once you understand
one pattern, it will be relatively easy to understand the others. It may help for
traders to use an automated pattern recognition software to identify these
patterns, rather than using the naked eye to find or force the patterns.
Example: The following chart shows an example of the Bullish Bat pattern
with embedded the ABC Bearish pattern. The identification pivots and ratios
are marked on the pattern; the pattern also shows the entry, stop and target
levels.

Trade Identification
In harmonic pattern setups, a trade is identified when the first 3 legs are
completed (in 5-point patterns). For example, in Gartley Bullish pattern, the
XA, AB and BC legs are completed and it starts to form the CD leg, you would
identify a potential trade may be in the works. Using the projections and
retracements of the XA and BC legs, along with the Fibonacci ratios, we can
build a price cluster to identify a potential Pattern Completion Zone (PCZ) and
D point of the pattern.
Pattern Completion Zone (PCZ)
All harmonic patterns have defined Pattern Completion Zones (PCZ). These
PCZs, which are also known as price clusters, are formed by the completed
swing (legs) confluence of Fibonacci extensions, retracements and price
projections. The patterns generally complete their CD leg in the PCZ, then
reverse. Trades are anticipated in this zone and entered on price reversal
action.
As an example, the Pattern Completion Zone (PCZ) for the Bullish Gartley
pattern is constructed using the following Fibonacci extensions and
projections:
0.78 XA
1.27 BC
1.62 BC
AB = CD
Below is an example of idealized Potential Completion Zone (PCZ)
formation:

Below is an example of real-world Potential Completion Zone (PCZ)

formation:
Market Context Conditions
Most technical traders use chart analysis with market context concepts to
trade. Market context concept is described as how current price is reacting to
certain levels (pivots, support and resistance, MAs), how indicators are
performing relative to historic price conditions (like oversold, overbought)
and where/how patterns are developing in the current timeframe or multiple
timeframes, etc. Each trader develops his own market context to trade. One of
the elegant ways to define market context is through a Fibonacci Grid
structure. Fibonacci Grid consists of Fibonacci bands (showing price reaction,
trends), pivot levels (to show historic Support/Resistance areas) and Market
Structures (to show potential turning points). On any trading chart, Fibonacci
Grid layout is plotted to understand how the current price is reacting to the
Fibonacci bands and whether the price is exhausted, whether price is trading
above/below the extreme bands and whether or not the price is reacting to the
support and resistance levels defined by pivots.
The confluence of these levels in the Fibonacci Grid structure, along with
emerging pattern structure (and pattern target/stop levels), helps a trader
make a good decision. Pattern trading is very precise, as each pattern has
specific rules to entry/stop and targets. When combined, harmonic pattern
analysis and market context give a great edge to trade. Harmonic patterns can
fail, but their failure levels are well-defined and that information is clearly
known prior to the trade. Hence, Harmonic pattern trading has many more
positives than other trading methods.
Other market context/confirmation conditions and indicators include
Divergence, Multiple Timeframes, Fibonacci Bands, Andrew's Pitchfork
Analysis, Moving Averages, Pivots, Channels, Trendlines, Volume and
Volatility.
Example: The following example shows how Market Context is used with
pattern analysis. This example shows AAPL (date: Feb. 07, 2014) forming a
Bullish Crab pattern above 200-SMA and outside the Fibonacci Bands (A, C
points) and a D point is formed near the lower Fibonacci Bands with Crab
pattern. Also, notice the pattern traded below mid-Fibonacci band level and
trading near lower Fibonacci band, signaling a potential exhaustion setup.
After completing Bullish Crab setup, price traded above the EL to signal a
Long entry to the setup. The overall trend of AAPL is also bullish, as price
slope is positive above 200-SMA. On Feb. 07, 2014, a Long bullish trade is
entered above 73.71 with a Stop below 70.50 (-3.21). Target levels are 77.7 to
79.7 for the Target Zone1, 85.3 -89.4 for Target Zone2.
The following chart (June 9, 2014) shows AAPL Bullish Crab pattern
progression and completion of targets.
Trade Entries and Stops
Trading harmonic patterns with computed entry levels are this author's
preference rather than trading them blindly at retracement levels or reversal
zones advocated by harmonic trading pundits. Most harmonic traders
anticipate the pattern to reverse and attempt to trade these patterns in the
“reversal zone” and end up taking contrarian (counter trend) trades. To enter
a trade, I prefer a confirmation of reversal price-action combined with a
reversal trend change from the “reversal zones.”
Most harmonic pattern trade entries occur around “D” point within the
reversal zone. It could be a Buy (in bullish patterns) or a Sell (in bearish
patterns). Usually, “D” is identified by a confluence of projections,
retracements, and extensions of prior swings (legs), universally called as
“reversal zone.” In my view, when prices started to reach this zone, it is
signaling an opportunity for potential trade, not a signal to trade yet. The
entry criteria and pattern validity are determined by various other factors like
current volatility, underlying trend, volume structure within the pattern and
market internals etc. If the pattern is valid and the underlying trend and
market internals agreeing with the harmonic pattern reversal, then Entry
levels (EL) can be calculated using price-ranges, volatility or some
combination. Stop is placed above/below the last significant pivot (in 5 and 4-
Point patterns it is below D for the bullish pattern, above D for bearish
patterns).

Target Zones
Target zones in harmonic patterns are computed based on the retracement,
extensions or projections of impulse/corrective swings and Fibonacci ratios
from the action point of the pattern structure. For example, in Gartley bullish
pattern, the target zones are computed using the XA leg from the trade action
point (D). The projections are computed using Fibonacci ratios like 62% or
78.6% of the XA leg and added to the action point (D). The extension ratios
like 1., 1.27, 1.62, 2., 2.27 or 2.62 are computed for potential target levels. The
primary target zones are computed from D, with 62%-78.6% of the XA leg as
the first target zone and 127%-162% as the second target zone.
Target Zone1: (D + XA*0.62) to (D+XA*.786)
Target Zone2: (D + XA*1.27) to (D+XA*1.62)
It is important to note that potential target zones in harmonic patterns are
computed from a probability standpoint, not with absolute certainty. Strong
money and risk management rules and full working knowledge of the pattern
are necessary for any pattern trading success.
Example: The following chart shows a Bullish Gartley Pattern with an
entry level, stops and target zones. The target zones are projected using XA
swing length and Fibonacci ratios from D. Target Zone 1 comprises the
range of 62%-79%, while Target Zone 2 runs from 127% to 162%.
About the Author
This article was written by Suri Duddella, a private trader who uses
proprietary mathematical and algorithmic models and pattern recognition
methods. For more information about Suri or to follow his work, visit
SuriNotes.com or click here.
your own investment dechar

harmonic Patterns use the identification of quantified chart price action structures that
have specific and consecutive Fibonacci ratio alignments that form the visual structures.
Harmonic patterns calculate the Fibonacci levels of the price patterns to identify high
probability reversal points on the charts. This method believes that harmonic patterns or
cycles repeat on charts in cycles repeatedly. The key to using this strategy is to identify
these patterns and to use them for creating good risk/reward ratio entries and to exit when
a profit target is reached. Positions are taken based upon the odds that the same historic
patterns will repeat after entry.

🔹 Butterfly
The structure of the Butterfly pattern requires a specific alignment of Fibonacci
measurements at each point within the structure. Most important, a mandatory 0.786
retracement of the XA leg as the B point is the defining element of an Ideal Butterfly Pattern
and it acts as the primary measuring point to define a specific Potential Reversal Zone. In
many ways, the Ideal Butterfly Pattern is like the Gartley Pattern because it requires a
specific B point retracement and possesses a tighter array of Fibonacci ratios within the
structure. Specifically, the Butterfly incorporates a 1.27 XA projection with a “tame” BC
projection, which is usually only a 1.618. In addition, the Butterfly usually possesses an
equivalent AB=CD pattern or an alternate 1.27AB=CD pattern. Although the equivalent AB=CD
is a minimum requirement, valid Butterfly structures rarely exceed the alternate 1.27 AB=CD
completion point.

🔹 Shark
The Shark Pattern is dependent upon the powerful 88.6% retracement and the 113%
Reciprocal Ratio, works extremely well retesting prior support/resistance points (0.886/1.13)
as a strong counter-trend reaction. Represents a temporary extreme structure that seeks to
capitalize on the extended nature of the Extreme Harmonic Impulse Wave. Demands
immediate change in price action character immediately following pattern completion.
Extreme Harmonic Impulse Wave utilized depends upon location of 88.6% level – these are
minimum requirements. Requires an active management strategy to capture high probability
profit segments.

🔹 Gartley
The important features of the Gartley are the specific location of the various points: X,A,B,C
and D. The X-A leg is the largest price move in the pattern. It is followed by a counter move
of A to B. The first leg, A to B, sets up the potential AB=CD, which is crucial to the completion
of the pattern and to the indication of the reversal zone. After a brief and smaller B to C
retracement, the C to D leg is established. A precise calculation of the AB=CD will provide a
significant potential reversal point. Ideal Gartley The ideal Gartley set-up will be defined by
specific Fibonacci retracements. One of the most important numbers in the pattern is the
completion of point D at the 0.786 of XA. Although the price action might exceed this number
slightly, it should not exceed point X. The pattern is a nice set-up, especially with the
convergence of an AB=CD.

🔹 Bat
The Bat pattern is probably the most accurate pattern in the entire Harmonic Trading arsenal.
The pattern possesses many distinct elements that define an excellent Potential Reversal
Zone. The pattern typically represents a deep retest of support or resistance that can
frequently be quite sharp. Quick reversals from Bat pattern PRZs are quite common. In fact,
valid reversals from Bat patterns frequently possess price action that is quite extreme. The
pattern incorporates the powerful 0.886XA retracement, as the defining element in the
Potential Reversal Zone. The B point retracement must be less than a 0.618, preferably a 0.50
or 0.382 of the XA leg. The most ideal B point alignment is the 50% retracement of the XA leg.
The B point is one of the primary ways to differentiate a Bat from a Gartley pattern. If a
pattern is forming and the B point aligns at a 0.50 of the XA leg, it is likely to be a Bat.

🔹 Three Drive
The three drives pattern consists of a series of higher highs or higher lows. It is similar to the
ABCD pattern. The difference is that a Three drives pattern is made of 5 legs, while an ABCD
pattern has only 4. Three-Drives is a reversal pattern, so it signals an upcoming change in a
trend. Point A is at the 61.8% retracement of the drive 1. Point B is at the 61.8% retracement
of the drive 2. Drive 2 is at the 127.2%-161.8% extension of A. Drive 3 is at the 127.2%-161.8%
extension of B. You can enter the market when you are sure that the market has formed the
point B (buy in a bearish Three-Drive and sell in a bullish Three Drive). Take Profit should be
around the 127.2%-161.8% extension of B.

🔹 Cypher
The Cypher pattern, which can be either bullish or bearish, has five points (X, A, B, C, and D)
and four legs (XA, AB, BC, and CD). Like any other harmonic pattern, the theory behind the
Cypher chart pattern is that there is a strong correlation between Fibonacci ratios and price
movements. Eventually, the market is expected to reverse from point D after the four market
swing wave movements – X to A, A to B, B to C, and C to D. B point retracement of the
primary XA leg ranges between 38.2% to 61.8% Fibonacci levels. C point is an extension leg
with a Fibonacci ratio that should be between 127.2% to 141.4% of the primary XA leg. D point
should break the 78.6 retracement level of XC.

🔹 AB=CD
In this pattern, the A to B leg is the first price move. After a brief retracement from point B
to point C, the pattern will complete the C to D leg, which is the same length as AB. Simply,
after the AB and BC legs have been established, you project the AB length from point C…
Although the price action will not always be exactly equivalent, the AB=CD legs usually will be
close enough to determine the reversal points. Sometimes, this pattern will be exact but I
usually wait for the CD leg to at least equal the AB leg. The Fibonacci numbers in the pattern
must occur at specific points. In an ideal AB=CD Pattern, the C point must retrace to either a
38.2% at a minimum to validate the structure. The maximum retracement of the AB leg is an
88.6% level that defines a less extreme AB=CD pattern formation but still valid.

🔹 Crab
The Crab is a distinct 5-point extension structure that utilizes a 1.618 projection of the XA leg
exclusively. This is the most critical aspect of the pattern and the defining level in the
Potential Reversal Zone (PRZ). The extreme (2.618, 3.14, 3.618) projection of the BC
compliments the 1.618 XA extension. In addition, the Crab primarily utilizes an alternate
AB=CD to compliment the PRZ. Although a minimum AB=CD completion is necessary for a valid
structure, the alternate 1.27 or 1.618 calculation are the most frequent cases. The 1.618
AB=CD pattern is the most common alternate calculation utilized in the structure. It is
important to note that the alternate AB=CD pattern within the Crab is the least important
number in the PRZ.