Harmonic Patterns: Meaning, Type, Advantage & Disadvantage

Introduction

Harmonic patterns are chart patterns that are a component of a trading technique. By anticipating future market moves, they enable traders to identify price trends. In order to spot possible price shifts or trend reversals, they use Fibonacci numbers to generate geometric price patterns. These patterns may be recognized by traders, who can then utilize them to guide their upcoming trading choices.
There are several chart patterns available, and each one may be utilized to identify a certain trend. To always be able to make the finest – and quickest – trading decisions, it is crucial to remember that before implementing any pattern, you should have faith in your capacity to do your own technical analysis.
By using Fibonacci numbers to pinpoint exact turning points, harmonic price patterns elevate geometric price patterns to a new level. Harmonic trading, in contrast to other more popular trading strategies, aims to forecast future moves.

Why do patterns form?

Harmonic patterns are mostly useful for forecasting price changes.
Day traders can attempt to predict the future movement of financial instruments like stocks, options, and more by identifying patterns of various magnitudes and durations and applying Fibonacci coefficients to them.
Finding reversals requires an understanding of harmonic patterns. They are a very accurate tool that can identify very exact price fluctuations.

What is Harmonic patterns

M. Gartley developed the idea of harmonic patterns in 1932. In his book Profits in the Stock Market, Gartley discussed a 5-point pattern known as Gartley. In his book Fibonacci Ratios with Pattern Recognition, Larry Pesavento enhanced this pattern using Fibonacci ratios and created guidelines for trading the “Gartley” pattern.
There are a few other authors who have contributed to this pattern theory, but to my knowledge, Scott Carney’s “Harmonic Trading” volumes include the greatest work. The trading patterns “Crab,” “Bat,” “Shark,” and “5-0” were also created by Scott Carney, who also provided a significant depth of understanding to their trading rules, viability, and risk/money management.
The fundamental principle underlying harmonic patterns is based on price/time movements that follow the symmetry of the Fibonacci ratios in markets. Any market may benefit from Fibonacci ratio research, and any period chart can be used.
These ratios are mostly used to locate significant turning points, retracements, and extensions as well as a string of swing high and swing low points. Key price levels for Targets or Stops will be determined by projections and retracements obtained utilizing these swing points (Highs and Lows).
Fibonacci sequences are used by harmonic patterns to create geometric pattern structures (retracement and projection swings/legs). These harmonic patterns, which have been defined as specific harmonic patterns, provide traders a variety of possibilities, including prospective price movements and significant turning or trend reversal points.
Because harmonic patterns try to offer extremely reliable information on price entrances, stops, and targets, this element gives traders an advantage. This might make a significant difference in how other indicators/oscillators operate.

Examples of Harmonic patterns

Prices on the market consistently display trend, consolidation, and re-trend tendencies. They seldom shift from a prior trend on a single bar, reversing their trends and transitional phases instead. They go through trading ranges and price swings throughout this transitory stage.
Identifiable price patterns are defined by this range activity. Sometimes, before they develop, these consolidation stages support existing trends and continue them in that direction.
These patterns are known as “continuation” patterns. Flags, Cup and Handle, and Symmetrical Triangle are a few examples of these designs. Some phases lead to a continuation of the new direction while reversing the previous tendency. Reversal patterns are what we name them. These designs, such as Head and Shoulders, Double Bottoms, and Broadening Patterns, are examples.

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

Types of Harmonic patterns

The ABCD Schema

The ABCD (or AB=CD) pattern has three motions and four points, and is possibly the simplest of all. Prior to the corrective movement (BC), the impulsive movement (AB) is made, which is subsequently followed by another impulsive movement (DC) in the same direction.
Using the AB leg as a reference, the BC leg should precisely reach 0.618. The time it takes for the price to travel from point A to point B should be the same as the time it takes for the price to move from point C to point D, and the CD line will be of equal length to the AB line.
The Potential Reversal Zone (PRZ), which is defined as the area at the C point, is where traders may put their entry orders. Alternatively, they can wait until the full pattern is formed before opening a long or short position from the D point.

BAT Pattern

The completed bat-shaped item is where the BAT design gets its name. The BAT pattern, identified as a PRZ by Scott Carney in 2001, is made up of certain components.
Compared to the ABCD pattern, it features one more leg and an additional point named X. There will be a BC retracement after the first leg (XA). You’re looking at a BAT pattern if the retracement to point B stops at 50% of the original XA movement. The CD extension can go up to 2.618 times the BC keg but must be at least 1.618 times. The figure is invalid if the CD extension is smaller than the BC extension.
By virtue of the end point (D) of the PRZ, traders have the option of opening positions to trade either a bullish price reversal or a negative price inversion.

The Gartley Method

The two basic rules of the Gartley pattern, created by HM Gartley, are:

The retracement at Point B must be 0.618 of XA.
The retracement of the XA movement at Point D must be 0.786.

Similar to the BAT pattern, the XA leg results in a BC retracement; however, point B’s retracement must be precisely 0.618 of XA. Point X is usually used as the stop-loss point and point C as the take-profit point.

Pattern of the Butterfly

In order to find probable retracements, Bryce Gilmore combined several Fibonacci ratios and came up with the butterfly pattern. It has four legs that are reversal patterns with the labels X-A, A-B, B-C, and C-D.
The most crucial ratio to determine is the XA leg’s 0.786 retracement. As a result, it is easier to map point B, which makes it easier for traders to locate the PRZ.

The Crab Pattern

Another Scott Carney discovery, The Crab, allows traders to join the market at extremely high or low prices by following an X-A, A-B, B-C, and C-D pattern. The most crucial aspect of the crab pattern is the 1.618 extension of the XA movement that establishes the PRZ.
In the bullish version of the Crab, the first leg develops when the price rapidly increases from point X to point A. The AB leg repeats XA by 38.2% to 61.8%. The extreme projection of BC (2.618, 3.14, and 3.618) that follows reveals a probable location for pattern completion and trend reversal.

6. Fibonacci discussion

Fibonacci numbers must be mentioned in any discussion of harmonic patterns since these patterns heavily rely on these ratios. The cosmos is filled with Fibonacci numbers, which were first discovered by Leonardo Fibonacci. The Golden Ratio is the fundamental Fibonacci ratio, or “Fib ratio.” (1.618). Each number in a fibonacci number sequence is calculated by adding the two preceding numbers.
Fib Numbers start off as 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 317, 610.
The idea behind how these numbers appear in nature and the financial world is well-documented in a variety of publications and books. Below is a list of the most significant Fibonacci ratios, which are obtained by squaring, square-rooting, and repeating the real Fibonacci sequence.
Fibonacci ratios used in trading include: 0.382, 0.618, 0.786, 1.0, 1, 1, 2.0, 2.62, 3.62, and 4.62.
236, 0.886, 1.13, 2.236, 3.14, and 4.236 are further Fibonacci-derived ratios used in trading.
The Fibonacci sequence is used extensively in technical analysis. Fibonacci projections, Fibonacci Fans, Fibonacci Arcs, Fibonacci Time Zones, and Fibonacci Price and Time Clusters are a few examples of uses.
The majority of trading software programs feature capabilities for generating Fibonacci sequences that can display projections, extensions, and retracements. Fibonacci numbers may also be used in trading to determine “time” and “price.”

Advantages and disadvantages of Harmonic patterns

Advantages:

Act as leading indicators by providing forward-looking forecasts and stops.
Regular, consistent, dependable, and produces high-probability configurations
Fibonacci ratios are used to fairly standardize trading procedures.
Perform well by following the guidelines for Measured Moves, Symmetry, and the Market Context
Work across all market instruments and timeframes.
They can be utilized in conjunction with other indicator theories (CCI, RSI, MACD, DeMark, etc.).

Disadvantages:

It’s complicated and quite technical, making it challenging to comprehend
Harmonic pattern recognition and automation (coding) correctly is challenging.
Finding reversal or projection zones can be challenging when there are conflicting Fibonacci retracements or projections.
When competing patterns develop from either the same swings or separate swings/timeframes, complexity results.
Non-symmetric and low-ranked patterns have relatively low risk/reward ratios.

How to trade Harmonic patterns

Pattern identification

When using Fibonacci tools, harmonic patterns are reasonably simple to see if a trader understands the pattern structure. Harmonic patterns can be a little difficult to notice with the naked eye. The most common harmonic patterns are 5-point patterns, including Gartley, Butterfly, Crab, Bat, Shark, and Cypher. Three-point (ABC) or four-point (ABCD) patterns are incorporated in these patterns. All price fluctuations between these places are connected and feature Fibonacci-based harmonic ratios. In the case of 3-drives, patterns are either developing or have finished “M” or “W”-shaped structures, or mixtures of “M” and “W.” Harmonic patterns (5-point) consist of a crucial origin (X), an impulse wave (XA), a corrective wave, and an eye (B) that completes the AB leg.
Next came a trend wave (BC), and finally a corrective leg brought everything to a close. (CD). A pattern’s name and whether it is extension- or retracement-based are determined by the crucial harmonic ratios between these legs. (Gartley, Butterfly, Crab, Bat, Shark, and Cypher). The fact that all 5-point and 4-point harmonic patterns have embedded ABC (3-Point) patterns is one of the key things to keep in mind.
Gartley, Butterfly, Crab, Bat, Shark, and Cypher are all examples of 5-point harmonic patterns. Even though they have different leg-length ratios and critical node positions (X, A, B, C, and D), if you get one pattern, it will be rather simple to comprehend the others. Instead of using their eyes alone to search for or force patterns, traders may find it helpful to employ an automatic pattern recognition program to recognize these patterns.

Trade identification

When the first three legs of a harmonic pattern setup are finished, a trade is recognized. (in 5-point patterns). For instance, if the XA, AB, and BC legs of the Gartley Bullish pattern are finished and the CD leg is beginning to develop, you would know a possible trade may be in the works. In order to locate a probable Pattern Completion Zone (PCZ) and D point of the pattern, we may form a price cluster using the projections and retracements of the XA and BC legs as well as the Fibonacci ratios.

Pattern completion zone

There are designated Pattern Completion Zones for each harmonic pattern. (PCZ). The completed swing (legs) convergence of Fibonacci extensions, retracements, and price predictions results in these PCZs, also called as price clusters. In the PCZ, the patterns often finish their CD leg before reversing. In this area, trades are expected and opened in response to a price reversal.

The Pattern Completion Zone (PCZ) for the Bullish Gartley pattern, for instance, is created using the Fibonacci projections and extensions shown below:

0.78 XA

1.27 BC

1.62 BC

AB = CD

Market context conditions

The majority of technical traders place trades using chart analysis and market context ideas. Indicators’ performance in relation to historical price conditions (such as oversold, overbought), where/how patterns are developing in the current timeframe or multiple timeframes, etc. are all examples of the market context concept.
Pivots, support and resistance levels, moving averages, and other levels are examples of current price reacting to certain levels. Each trader creates a unique market setting in which to operate. By using a Fibonacci Grid structure, market context may be defined in an attractive way. Fibonacci bands, pivot levels, and market structures make up the Fibonacci Grid, which displays price response and trending information. (to show potential turning points).
To determine how the current price is responding to the Fibonacci bands, whether the price is exhausted, whether it is trading above or below the extreme bands, and whether it is responding to the support and resistance levels indicated by pivots, a Fibonacci Grid layout is plotted on any trading chart.
A trader may make a wise choice based on the convergence of these Fibonacci Grid levels, evolving pattern structure, and pattern target/stop levels.
Trading patterns are particularly exact since each pattern has unique entry/stop and target rules. Harmonic pattern analysis and market context provide traders a significant advantage. Harmonic patterns have a chance of failing, but those chances are well-defined and are understood in advance of the transaction. Thus, compared to other trading strategies, harmonic pattern trading offers a lot more advantages.
Divergence, Multiple Timeframes, Fibonacci Bands, Andrew’s Pitchfork Analysis, Moving Averages, Pivots, Channels, Trendlines, Volume, and Volatility are additional market context/confirmation conditions and indicators.

Trade entries and stop

Instead of trading harmonic patterns blindly at retracement levels or reversal zones as is recommended by harmonic trading experts, this author prefers to trade them with calculated entry levels.
Most harmonic traders seek to trade these patterns in the “reversal zone” because they believe the pattern will reverse, but they usually wind up taking contrarian (against the trend) trades. I prefer confirmation of reversal price action together with a reversal trend change from the “reversal zones” before entering a trade.
The “D” position in the reversal zone is where most harmonic pattern trade entry happen. It may be a Sell (in patterns that are bearish) or a Buy. (in bearish patterns).
The “reversal zone,” often known as “D,” is typically recognized by a convergence of projections, retracements, and extensions of previous swings (legs).
My opinion is that as prices started to move into this area, it was suggesting a prospective trading opportunity rather than a signal to start trading right now.
Other elements including present volatility, underlying trend, volume structure inside the pattern, and market internals, among others, influence the entry criterion and pattern validity.
If the pattern is legitimate and the market internals and underlying trend support the harmonic pattern reversal, entry levels (EL) can be determined using price ranges, volatility, or a mix of both. Stop is positioned above or below the most recent major pivot (in 5 and 4-Point patterns it is below D for the bullish pattern, above D for bearish patterns).

Target zones

Target zones for harmonic patterns are calculated using Fibonacci ratios, impulse/corrective swing extensions, and retracements from the pattern’s action point. For instance, the target zones in the Gartley bullish pattern are calculated using the XA leg from the trade action point. (D).
Fibonacci ratios, such as 62% or 78.6% of the XA leg, are used to calculate the projections, which are then added to the action point. (D). For conceivable target levels, extension ratios such as 1., 1.27, 1.62, 2., 2.27, or 2.62 are computed.
The major target zones are calculated from D, with the first target zone being 62%-78.6% of the XA leg and the second target zone being 127%-162%.

Zone 1 of the target: (D + XA*0.62 to (D+XA*.786)

(D + XA*1.27) to (D+XA*1.62) is the Target Zone 2.

It is crucial to remember that prospective target zones in harmonic patterns are calculated probabilistically rather than with certainty.
Any pattern trading success requires a thorough understanding of the pattern, as well as strong money and risk management principles.

Conclusions

Traders employ harmonic patterns to forecast future market moves. Traders might have a bullish or a bearish stance. A likely market decline is indicated by bearish harmonic patterns. Bullish harmonic patterns suggest that the market may be about to turn up. By creating a trading account, you may engage in harmonic pattern trading.
Harmonic trading is an exact and quantitative method of trading, but learning the patterns requires a lot of study, practice, and effort. The basic metrics are only the start. Movements that are out of sync with the proper pattern measures invalidate the pattern and put traders in danger.
The most well-known patterns that traders search for are the Gartley, butterfly, bat, and crab patterns. Entry is made in the probable reversal zone and stop losses are set just below or above a long entry, just above a short entry, or alternatively outside the pattern’s furthest projection when price confirmation shows a reversal.