We consider pattern recognition and identification as the basic qualities for a technical analyst and also for a trader who trades based on technical analysis. Price moves on its own influenced by several factors all of which are hard to scale. There is no calculation discovered yet that can take into account all these factors and quantify them.
For this particular reason, technical analysis and pattern identification have become a very popular way to analyze price movement and understand the probable upcoming price movements.
The chart patterns are usually categorized into two types, the continuous type and the reversal type. These chart patterns can be further classified into simple and complex types. Besides the simple types of patterns, the complex type consists of a combination of simple patterns and previous swings. Understanding these patterns and knowing their properties give a trader a great advantage in trading and the ability to cope with different trading environments.
What Are Harmonic Patterns?
Harmonic price patterns are those price patterns that can be found by using geometric patterns and numerical patterns to find harmony in price action. The numerical pattern found in Fibonacci numbers is used to find the Harmonic pattern.
As early as 1932, H.M. Gartley first found the concept of the Harmonic pattern. Later many other researchers worked on his theory and refined it to the present Harmonic pattern concepts that we see today.
The harmonic theory pattern is based on the price movements concerning time. It is found that such price/time movement adheres to the symmetry found in the Fibonacci sequence. The Fibonacci ratios work well with market movement. Combining geometric figures with Fibonacci ratios using price data we find the Harmonic pattern. The Fibonacci ratio analysis helps to find important price junctures like key support and resistance levels, reversal, etc.
In this method, Fibonacci ratio analysis is used to find key price turning points. Then we use these data to identify a geometric harmony in price pattern. After we find the Harmonic pattern, we use it to project future price patterns and to find continuation or reversal patterns.
The geometrically harmonious patterns are of different types. Interpretation of these patterns helps us to find bullish and bearish patterns and price reversals. Also, such patterns provide the trader with nearly accurate entry, exit and stop-loss prices. Using Harmonic patterns have these advantages over market oscillator indicators.
How Do Harmonic Patterns Form Actually?
Price action typically shows different phases of their action. In the course of movement, the price either moves in one direction or moves in a range. Directional moves are known as trends and the range-bound moves are often known as consolidation phases.
The patterns are more likely to form in consolidation phases when the price moves in a range. Also usually a trend results in a consolidation phase later. And these consolidation phases give rise to the continuation of the previous trend. Else a new reverse trend in opposite direction may occur.
There may be a continuous pattern in the consolidation phase which will help the market to continue the previous trend. Examples of such continuous patterns are the Symmetrical Triangle, the Cup and Handle, and the Flag. Some patterns give indications of a potential price reversal in the future. These patterns are Head and Shoulder, Double Bottom.
Geometry and Fibonacci Numbers Behind Harmonic Patterns
Harmonic patterns use mathematics and geometric pattern to find trading opportunities. The Primary Ratio or its derivatives are used to find key data. The derivatives are 0.618, 1.618 and similar numbers. The complimenting sequential ratios are 0.382, 0.50, 1.41, 2.0, 2.24, 2.618, 3.14 and 3.618. The Primary Ratio is so named because we find applications of such proportions in nature and the environment. To many, this ratio has mystic significance. Myth apart, these ratios have great application in stock market data analysis.
Using these numbers we find important price points which are then employed to find a geometric pattern. Using the belief that the patterns repeat themselves, we use these patterns to project future price movement.
Also, these mathematical ratios are found in nature, environment, astrological patterns, ancient architecture and social activities as well. Traders being part of nature and society itself, these ratios may be found in their activities and thought processes as well. Thus we conclude that trading activities will also follow the same mathematical analysis, as the trading activity expresses the human psychology of greed and fear.
And yes, we find true reflections of the primary ratio in price analyses. This is the logic behind using a combination of the Fibonacci ratio and geometric pattern to find the Harmonic trading pattern.
In stock market trading we use the following set of Fibonacci numbers.
Key set of ratios derived from Fibonacci numbers: 0.382, 0.618, 0.786, 1.0, 1, 1, 2.0, 2.62, 3.62, 4.62
The Secondary set of ratios obtained from Fibonacci numbers: 0.236, 0.886, 1.13, 2.236, 3.14, 4.236
These sets of Fibonacci ratios are used in pattern identification and in trading Harmonic geometric price patterns.
Read more: Understanding Fibonacci Series
Rules of Harmonic Patterns
Unlike visible chart patterns, Harmonic patterns require specific price movement to consider a valid pattern and tradable. As this pattern is based on mathematical calculations, lots of trading subjectivity is omitted and trading becomes more objective.
But the trader has to have a good grasp of Fibonacci numbers and Fibonacci ratio analysis. Whichever type of geometric harmony is found, it cannot be formed without Fibonacci ratios.
Do Harmonic Patterns Work?
Harmonic patterns are far more accurate than visible patterns like Morning Star, Engulfing patterns or any standard oscillators. Because mathematics is the base of Harmonic patterns.
The fig above shows a XABCD pattern that looks almost like W. This is a 5-point harmonic pattern. All the price points X, A, B, C and D correspond to the Fibonacci ratio. The projected price pattern from D is shown by a dotted line.
This is a pretty precise technical analysis instrument that gives you true price reversal and projection data. It is believed that as the shown price points correspond to Fibonacci ratios, the projected price will also follow the Fibonacci ratio pattern.
Read more: List of Best Technical Indicators
The projected price is not pure guesswork, as you can see. These are found to be pretty accurate most of the time.
8 Important Harmonic Patterns with Explanation
Since the advent of Harmonic patterns, researchers have done much research on Harmonic patterns. Gartley showed us a few patterns. Later others have come up with a few other patterns. The Harmonic patterns can be divided broadly into the following categories.
The Gartley pattern
The Bullish Gartley is a Harmonic pattern. These are seen as waves. This pattern is usually seen in the early phase of a trend. These waves show the corrective waves are coming to an end and a new bullish trend is about to emerge
We analyze it through the XABCD data points. The price goes to A and then comes back to B. Again the price pushes up to C and comes back to D. These data points surprisingly conform with the Fibonacci ratio.
X is a random point from which we have tried to construct the pattern. Price moves to A and then retraces to B. B is standing at 0.618 retracements from A. Again C, to which the price goes up from B, is at 0.382 or 0.886 of AB. Then the price comes down to D. CD is 1,272 or 1.618 extension of AB. The point D is also 0.786 retracement of XA.
A trader should ideally enter at D, but many prefer price confirmation towards the extension zone to happen.
The stop loss is placed not far below the entry price or just below X. Because, if the price goes below the entry price, it can be considered that the projection is a failed one and therefore the trader should exit.
The target price can be calculated as follows. The target prices are computed from point D. Target is fixed with respect to the XA leg using Fibonacci ratios. There can be primary and secondary targets.
The primary target range: (D + 0.628 of XA or 62.8% of XA ) to (D+0.786 of XA or 78.6% of XA)
The secondary target zone: (D + 1.272 of XA or 127.2% of XA) to (D+1.618 of XA or 161.8% of XA)
The Bearish Gartley is very much similar to the Bullish Gartley pattern. Only from point D, the price is expected to take a downturn. The trader creates a short position at point D.
The stop-loss and target prices are similarly done using the Fibonacci ratios.
The primary target range: (D – 0.628 of XA or 62.8% of XA ) to (D – 0.786 of XA or 78.6% of XA)
The secondary target zone: (D – 1.272 of XA or 127.2% of XA) to (D – 1.618 of XA or 161.8% of XA)
The Bat Harmonic pattern
The Bat Harmonic pattern is another pattern. Here also we have the bullish and bearish patterns.
The Bullish Bat Harmonic pattern is a little different from the Gartley pattern. This pattern looks like the alphabet M, with the legs stretched out sideways. The price from X to A moves to a comparatively higher point A. Then the price goes down to B. AB is equivalent to 0.382 or 0.50 of XA. It shows that the price retraces to 38.2% or 50% of XA, but should be less than 61.8% retracement.
From B, the price moves up to point C. Again the price moves up to 38.2% to 88.6% of AB, i.e. 0.382 to 0.886 of AB. Following this wave pattern, the price comes down to D. CD is 1.682 or 2.618 of BC. It means that the price will come down 168.2% to 261.8% of BC till point D.
The trader enters at D. Trader buys the stock at D, expecting the price to move along the green line (shown in the diagram).
So, we understand that entry is at or near D and The stop-loss is below X. The target prices will be like the previous one.
The primary target range: (D + 0.628 of XA or 62.8% of XA ) to (D+0.786 of XA or 78.6% of XA)
The secondary target zone: (D + 1.272 of XA or 127.2% of XA) to (D+1.618 of XA or 161.8% of XA)
It is also expected that these Fibonacci numbers may act as future resistance levels., as per Fibonacci support and resistance levels.
As in the earlier pattern, the Bearish Bat pattern is very much similar to the Bullish Bat pattern. After D, the price goes down. The trader creates short trade or sells the stock at or near D.
The stop-loss is placed just above X. The price target should follow the Fibonacci retracement pattern.
The Crab
The Crab pattern is another trading pattern. There are some differences with the previous Harmonic patterns.
The Bullish Crab harmonic pattern also follows the Fibonacci ratios discussed earlier. This wave pattern also has four legs that look like M or W (for the bearish pattern) but are stretched. For the bullish Crab pattern, the XA leg is an up wave, which forms the first leg of this pattern.
The second leg, AB is a retracement wave retracing 0.382 to 0.618 of XA i.e. 38.2% to 61.8% retracement of XA.
The third leg BC is another up wave. It retraces 0.382 to 0.886 of aB or 38.2% to 88.6% of AB.
The fourth leg CD is 2.618 to 3.618 of BC. BC retracement range is from 261.8% to 361.8% of BC.
D point is the trader’s entry price. From D the price may reverse and extend beyond 161.8% of XA. That is the expected target price.
The trader enters at or near D, after trend confirmation. The stop loss is slightly below the entry price.
The Bearish Crab pattern is just the opposite of the Bullish Crab. The pattern is just the inverted Bullish Crab pattern. It is shown in the diagram containing both the patterns. The Fibonacci retracement levels are the same. Only the first leg starts with a down wave.
All the legs are following similar Fibonacci ratios. At the price point D, the trader takes a short/ sell position. The stop loss is placed a little above the selling price or above X. The target price follows the same method of the Bullish pattern.
The Butterfly pattern
The Butterfly pattern is another Harmonic pattern. It is a reversal pattern and is generally found near the end of a trend. Hence a trader can be prepared for reversal trades after these Harmonic patterns are found in the chart.
The Butterfly Harmonic patterns are found to be Bullish reversal patterns and Bearish reversal patterns. Both these patterns are five-point patterns comprising five key points, XABCD. D is known to be part of the potential reversal zone (PRZ) and also the entry price.
Let’s discuss the structure of the Bullish Butterfly pattern.
XA is a bullish wave.
AB retraces 78.6% of XA.
BC is an up wave retracing from 38.2% to 88.6% of AB. From C price comes down to D forming the last leg CD. CD is 161.8% to 261.8% of AB. Or it can be 127.2% to 161.8% of XA.
From D the price reversal starts.
The trader buys the stock at or near D after trend confirmation. The stop loss is below D.
The Bearish Butterfly pattern is the same as the bullish pattern but indicates a bearish reversal. The legs are similar. But the trader initiates a sell order at or near point D.
The stop-loss is above D. The target levels are similar.
The primary target range: (D – 0.628 of XA or 62.8% of XA ) to (D – 0.786 of XA or 78.6% of XA)
The secondary target zone: (D – 1.272 of XA or 127.2% of XA) to (D – 1.618 of XA or 161.8% of XA)
Cypher Harmonic pattern
The Cypher Harmonic pattern is a reversal pattern. This pattern has four legs like all other patterns following the XABCD model. This pattern follows Fibonacci ratios strictly.
The Cypher pattern must follow certain conditions to get validated.
After the price reaches A, it retraces to B. The AB retracement line should lie between 38.2% to 61.8% of XA. The retracement should be at least 38.2% of XA. If it retraces further, the lowest point of the candle should not touch the 61.8% of XA, point.
The BC leg goes beyond A, but it should not cross the 141.4% retracement point. If the move goes beyond that, the pattern is not valid.
The CD leg should go beyond 78.6% of XC.
Both the Bullish and Bearish Cypher Harmonic patterns must follow the conditions given above. The Bullish Cypher gives a bullish reversal from D and a bearish reversal for the bearish pattern.
All other conditions like stop-loss, target and entry price follow the usual Harmonic patterns rules.
Harmonic AB=CD pattern
Unlike the patterns explained above, this pattern is a four-point, three-leg pattern. It works in a little different way. As the name suggests, it looks like a parallelogram, though actually, it is not so.
The Bullish AB=CD pattern works in the following manner.
The starting price in this pattern is point A. AB retraces down from A to B.
BC is an up wave. BC retracement level ranges from 38.2% to 88.6% of AB.
Once point C is established, we get the CD. If we subtract the length of AB from C, we can get CD.
D is the reversal point.
The Bearish AB=CD pattern is also similar. But compared to the bullish pattern it is upside down. AB starts with an upside move till the price reaches B. Then price retraces to C with a bearish move. After C, moves to a new high, which is point D. If A, B, C and D follow the Fibonacci ratio rule, then the price is supposed to reverse from D.
After entry at D, the stop-loss and target price will follow the previous Harmonic patterns rules.
5-0 Harmonic pattern
The 5-0 Harmonic candlestick pattern is somewhat similar to the AB=CD pattern but a more complex one. It includes the previous wave also. it is a six-point (OXABCD) five-leg pattern.
The Bullish 5-0 pattern works according to the following method.
It opens with a down wave OX. From X it goes up to A forming the XA leg.
Again from A, the price comes down to B. AB is 113% to 161.8% XA. It is a down wave.
BC is 161.8% to 224% of XA. It is an up wave.
CD is a down wave. It is 50% retracement ob BC.
AB and CD are almost equal. D is the bullish reversal point.
The bearish 5-0 Harmonic pattern is the upside-down figure of the bullish pattern.
D represents the bearish reversal points. Traders initiate a short position at or near D.
The rest are the same.
The Shark Harmonic Pattern
The Shark Harmonic pattern is a more extreme pattern than the others already discussed. This pattern occurs before the 5.0 pattern. Unlike other Harmonic patterns, the Shark pattern uses 0.886 and 1.13 reciprocal ratios. Shark patterns need active trade management.
This pattern also consists of O, X, A, B, C, and D points for pattern making. The Shark pattern structure falls with the 5-0 pattern. This pattern needs to satisfy that CD has to be 113% of OX.
Traders buy or sell at D. The target levels are between 50% to 61.8% of BC. The stop-loss rules are the same as other Harmonic patterns.
Advantages and Disadvantages of Harmonic patterns
The patterns discussed above have some inherent advantages and disadvantages.
Advantages of Harmonic patterns
- The Harmonic candlestick patterns are leading indicators. They provide future price projections.
- These patterns are stable and reliable and the accuracy percentage is high.
- The use of Fibonacci ratios makes them use standardized set-ups.
- The trading pattern is more objective. Do not depend on the traders’ subjective views.
- These patterns work well in all time frames and all market conditions.
- The RSI, CCI, DeMark, MACD and similar theories perform well in conjunction with these patterns.
Disadvantages of Harmonic patterns
- Highly technical and complex patterns are not easy to understand.
- Correct identification of patterns is required.
- Automatic trading through coding is difficult.
- Conflicting retracement or projection levels can create confusion while identifying the projection or reversal zones.
- Complexity arises if multiple patterns are formed within the same swings/ timeframes or other timeframes/swings.
- The risk/reward ratio does not always favor the traders in all these patterns.
Issues with Harmonic Numbers
These patterns are precise and therefore have high accuracy levels. But inside a chart when a pattern is visually confirmed, the price points must be confirmed using the Fibonacci ratios. If the price points do not agree with ratios, the pattern is invalid. In that case, the trader has to wait patiently for conditions to be fulfilled. One should not jump to a conclusion.
There can be patterns within patterns. These should be found out and information has to be used in trading these patterns.
Pattern may fail. Therefore stop-loss should be strictly maintained.
A trader should use some charting platforms which accommodate Fibonacci retracement levels.
The trader has to be knowledgeable. The bigger picture should always be kept in mind.
These patterns can be used on any market instrument and at any time frame. If the pattern and mathematical calculations hold true, the pattern is valid. This is the advantage of using these accurate patterns.
