Mastering Harmonic Pattern
Harmonic price patterns are those that take geometric price patterns to the next level by utilizing Fibonacci numbers to define precise turning points. Unlike other more common trading methods, harmonic trading attempts to predict future movements.
Let’s look at some examples of how harmonic price patterns are used to trade currencies in the Crypto markets.
KEY TAKEAWAYS
- Harmonic trading refers to the idea that trends are harmonic phenomena, meaning they can subdivided into smaller or larger waves that may predict price direction.
- Harmonic trading relies on Fibonacci numbers, which are used to create technical indicators.
- The Fibonacci sequence of numbers, starting with zero and one, is created by adding the previous two numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.
- This sequence can then be broken down into ratios which some believe provide clues as to where a given financial market will move to.
- The Gartley, bat, butterfly and crab are among the most popular harmonic patterns available to technical traders.
Geometry and Fibonacci Numbers
Harmonic trading combines patterns and math into a trading method that is precise and based on the premise that patterns repeat themselves. At the root of the methodology is the primary ratio, or some derivative of it (0.618 or 1.618). Complementing ratios include: 0.382, 0.50, 1.41, 2.0, 2.24, 2.618, 3.14 and 3.618. The primary ratio is found in almost all natural and environmental structures and events; it is also found in man-made structures. Since the pattern repeats throughout nature and within society, the ratio is also seen in the financial markets, which are affected by the environments and societies in which they trade.
By finding patterns of varying lengths and magnitudes, the trader can then apply Fibonacci ratios to the patterns and try to predict future movements. The trading method is largely attributed to Scott Carney,1 although others have contributed or found patterns and levels that enhance performance.
Issues with Harmonics
Harmonic price patterns are precise, requiring the pattern to show movements of a particular magnitude in order for the unfolding of the pattern to provide an accurate reversal point. A trader may often see a pattern that looks like a harmonic pattern, but the Fibonacci levels will not align in the pattern, thus rendering the pattern unreliable in terms of the harmonic approach. This can be an advantage, as it requires the trader to be patient and wait for ideal set-ups.
Harmonic patterns can gauge how long current moves will last, but they can also be used to isolate reversal points. The danger occurs when a trader takes a position in the reversal area and the pattern fails. When this happens, the trader can be caught in a trade where the trend rapidly extends against them. Therefore, as with all trading strategies, risk must be controlled.
It is important to note that patterns may exist within other patterns, and it is also possible that non-harmonic patterns may (and likely will) exist within the context of harmonic patterns. These can be used to aid in the effectiveness of the harmonic pattern and enhance entry and exit performance. Several price waves may also exist within a single harmonic wave (for instance, a CD wave or AB wave). Prices are constantly gyrating; therefore, it is important to focus 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 largest time frames.
To use the method, a trader will benefit from a chart platform that allows them to plot multiple Fibonacci retracements to measure each wave.
Types of Harmonic Patterns
There is quite an assortment of harmonic patterns, although there are four that seem most popular. These are the Gartley, butterfly, bat, and crab patterns.
The Gartley
The Gartley was originally published by H.M. Gartley in his book Profits in the Stock Market2 and the Fibonacci levels were later added by Scott Carney in his book The Harmonic Trader.3 The levels discussed below are from that book. Over the years, some other traders have come up with some other common ratios. When relevant, those are mentioned as well.
- Example Bullish Case :
The bullish pattern is often seen early in a trend, and it is a sign the corrective waves are ending and an upward move will ensue following point D. All patterns may be within the context of a broader trend or range and traders must be aware of that.
Example How to trade based on the chart above :
- Short Entry :
- Long Entry :
It’s a lot of information to absorb, but this is how to read the chart. We will use the bullish example. The price moves up to A, it then corrects and B is a 0.618 retracement of wave A. The price moves up via BC and is a 0.382 to 0.886 retracement of AB. The next move is down via CD, and it is an extension of 1.13 to 1.618 of AB. Point D is a 0.786 retracement of XA. Many traders look for CD to extend 1.27 to 1.618 of AB.
The area at D is known as the potential reversal zone. This is where long positions could be entered, although waiting for some confirmation of the price starting to rise is encouraged. A stop-loss is placed not far below entry, although addition stop loss tactics are discussed in a later section.
For the bearish pattern, look to short trade near D, with a stop loss not far above.
The Butterfly
The butterfly pattern is different than the Gartley in that the butterfly has point D extending beyond point X.
- Bearish Case Example :
Example How to trade based on the chart above :
- Long Entry :
- Short Entry :
Here we will look at the bearish example to break down the numbers. The price is dropping to A. The up wave of AB is a 0.786 retracement of XA. BC is a 0.382 to 0.886 retracement of AB. CD is a 1.618 to 2.24 extension of AB. D is at a 1.27 extension of the XA wave. D is an area to consider a short trade, although waiting for some confirmation of the price starting to move lower is encouraged. Place a stop loss not far above.
With all these patterns, some traders look for any ratio between the numbers mentioned, while others look for one or the other. For example, above it was mentioned that CD is a 1.618 to 2.24 extension of AB. Some traders will only look for 1.618 or 2.24, and disregard numbers in between unless they are very close to these specific numbers.
The Bat
The bat pattern is similar to Gartley in appearance, but not in measurement.
- Bullish Case Example :
Example How to trade based on the chart above :
- Short Entry :
- Long Entry :
Let’s look at the bullish example. There is a rise via XA. B retraces 0.382 to 0.5 of XA. BC retraces 0.382 to 0.886 of AB. CD is a 1.618 to 2.618 extension of AB. D is at a 0.886 retracement of XA. D is the area to look for a long, although the wait for the price to start rising before doing so. A stop loss can be placed not far below.
For the bearish pattern, look to short near D, with a stop loss not far above.
The Crab
The crab is considered by Carney to be one of the most precise of the patterns, providing reversals in extremely close proximity to what the Fibonacci numbers indicate.
This pattern is similar to the butterfly, yet different in measurement.
- Bullish Case Example :
Example How to trade based on the chart above :
- Short Entry :
- Long Entry :
In a bullish pattern, point B will pullback 0.382 to 0.618 of XA. BC will retrace 0.382 to 0.886 of AB. CD extends 2.618 to 3.618 of AB. Point D is a 1.618 extension of XA. Take longs near D, with a stop loss not far below.
For the bearish pattern, enter a short near D, with a stop loss not far above.
Fine-Tune Entries and Stop Losses
Each pattern provides a potential reversal zone (PRZ), and not necessarily an exact price. This is because two different projections are forming point D. If all projected levels are within close proximity, the trader can enter a position at that area. If the projection zone is spread out, such as on longer-term charts where the levels may be 50 points or more apart, look for some other confirmation of the price moving in the expected direction. This could be from an indicator, or simply watching price action.
A stop loss can also be placed outside the furthest projection. This means the stop loss is unlikely to be reached unless the pattern invalidates itself by moving too far.
The Bottom Line
Harmonic trading is a precise and mathematical way to trade, but it requires patience, practice, and a lot of studies to master the patterns. The basic measurements are just the beginning. Movements that do not align with proper pattern measurements invalidate a pattern and can lead traders astray.
The Gartley, butterfly, bat, and crab are the better-known patterns that traders watch for. Entries are made in the potential reversal zone when price confirmation indicates a reversal, and stop losses are placed just below a long entry or above a short entry, or alternatively outside the furthest projection of the pattern.
The explanation above is a basic guidance regarding harmonic patterns, now I will try to describe this pattern and examples of its use directly in the market.
- Fibonacci Set-Up
The most important thing to analyze using this pattern is of course the Fibonacci numbers, then what are the Fibonacci set-up numbers that are generally used?, I don’t know for sure, but here are the numbers that usually i use :
The numbers that usually i use are -0.382, -0.236, 0, 0.236, 0.382, 0.5, 0.618, 0.786, 0.886, 1, 1.13, 1.272, 1.414, 1.618, 2.24, 2.618, 3.618, 4.618.
then from these numbers, which numbers are the “most” important?.
The most numbers that usually i’m watching on it are 0.5, 0.618, 0.786, 0.886, 1.618.
numbers between 1–1.618 are also very mandatory to be used or monitored in actual use (application of harmonic use in actual price movements).
then what is the usecase of -0.236 and -0.382?, I use it in certain cases where its use is quite unique because it is quite tricky. So, forgot about -0.236 and -0.382, because maybe I’ll explain it at another time.
examples of using harmonics in actual price movements
Using harmonics in actual price movements can be said was an quite simple, but if you rely too much on the basic numbers of actual harmonic numbers it will be really stressfull, What does it mean? for example, when you find a gartley pattern where the XD range should be 0.786 Fibonacci XA, but once in the real price movements you will not found a pattern that is completely perfect in numbers, it could be that the gartley pattern earlier, the XD range didn’t stop at 0.786, could less or little bit more, as long as the range isn’t too far from the main numbers of the pattern, we can categorize the patterns that we found into the pattern earlier.
- Let’s try to found an harmonic pattern in the crypto markets.
Example on this ETH/USD Chart :
- At the beginning, I explained how to open a position using harmonics, but let’s go into more detail.
In the picture above, point C is the bottom area of the triangle. When you place a buy order in that area, your stop loss can’t be more than point A.
Why do I believe that the 0.618 fibo area that was used as the entry point will be the bottom point of the triangle?, Since the picture above is the daily timeframe, let’s zoom in to the 4h timeframe.
Sometimes to find a good entry point, you can use indicators such as EMA or others. now we have the entry and stop loss points, then how to determine the target?.
Another theory that will make us sure of the targets is that AB = CD, like these picture below :
well, we just discussed how to enter long with the ethereum chart example above. Now let’s try to find a short point on the based on the ethereum chart above.
After succesfully long from C point which are bottom of triangle, price move to point D as our target and take profit area for previous long entry. Then usually once price at the D area we will gonna short it (based on that ethereum chart/bearish pattern), Price stopped out around 1.618 fibs XA ( although wasn’t as perfect as that we hope). Did I also placed short entry around 1.618 Fibs of XA?, Sure. Why?, If you zoom in to smaller timeframe you will see the strong reversal signal. The how we conclude the stoploss?, This is the stressfully things that usually you will sense once you found an pattern that D point are higher than X. but don’t worry, based on the chart above price couldn’t broke the 1.618 fibs of XA. Then just place your stoploss at 2.618 exntension fibs of BC. Why?, Cause price seems reversed from 1.618 XA then it’s should be drop to 0.5 fibs of CD or around X point area (refer to this picture bellow) :
Why i just put my stoploss around 2.618 BC are quite simple, because if the price clear break from 1.618 fibs XA it’s mean that price should go to 2.618 XA. But going to be honest, Shorting D point are quite tricky because D can be unlimited. That’s why price atcion must be watched before take any position on the pattern that D is Higher than X (just reverse for the bullish pattern).
- Potential Gain and Stoploss
Allright, Still based on previous ethereum chart, let’s count about potential gain and loses of that ethereum chart.
- Long Entry
2. Short Entry
Here is some trick from me to count risk ratio at every position, If i targeting profits between 10%-30% then my stoploss can’t more than 5%. If i tergeting more than 50% then i should manage my stoploss more than 15% with the best money management that always being prepared before entering any position.
That’s a basic explanation from me about using harmonic patterns, next time i will add another learning materials in this article or maybe made an new article about harmonic or basic guide of trading.
Thanks for reading.
