Harmonic price patterns are a type of geometric price pattern, but they integrate Fibonacci numbers for precision in locating key turning points in the markets.
Combining Geometry with Fibonacci Numbers
Harmonic patterns work under the premise that patterns repeat themselves – even price patterns in asset markets. The root of the methodology uses a primary ratio that will be familiar to anyone who’s seen the Fibonacci Golden ratio before – 0.618 or 1.618.
This primary ratio is one that repeats itself throughout the natural world, in man-made structures, and presumably in financial markets due to the involvement of humans in the pricing mechanism.
Harmonic price pattern theory says that by finding patterns within price action, traders can apply Fibonacci ratios and predict future price movements. The trading method was developed by Scott Carney, although there are others who have been involved with finding new patterns over the years.
Harmonic Price Patterns
The very first price pattern identified is called the Gartley Pattern, after H.M. Gartley, who introduced it in his book Profits in the Stock Markets. It is sometimes called the Gartley 222 pattern, because it was described on page 222 of the book.
All other commonly used harmonic price patterns were derived from this first pattern, most of them by Scott Carney. The most popular include the Butterfly Pattern, Bat Pattern, Crab Pattern, Shark Pattern, Cypher Pattern, ABC Pattern, AB=CD Pattern and 3-Drives Pattern.
The image above shows the Gartley bullish and bearish pattern. As you can see, the bearish pattern looks like a “W” and the bullish pattern looks like an “M”
Ideal Gartley patterns have the following characteristics:
- Move AB is a .618 retracement of XA
- Move BC is either a .382 or a .886 retracement of AB
- If move BC is .382 of move AB, then CD will be 1.272 of move BC
- Otherwise, if move BC is .886 of AB, then CD should extend 1.618 of move BC
- Move CD is a .786 retracement of move XA
Trades from the Gartley pattern are made when it reaches point D. That is the key reversal point. Depending on whether it is a bullish or bearish pattern short or long trades are entered at that point.
Harmonic Price Pattern Issues
As you might expect since they are based on mathematical calculations and ratios, harmonic price patterns are extremely precise. This means traders must closely monitor the development of patterns. Prices must show precise magnitudes in their movement to provide accurate signals.
There are many times when a trader will see a pattern that looks like a harmonic pattern, but when applying Fibonacci levels they will find a lack of alignment which invalidates the pattern. It’s important that traders are able to discard patterns that are invalidated. Harmonic price patterns require a huge degree of patience, which can be both a curse and a blessing. Those who haven’t the patience to wait for a proper set-up will be cursed, while those who do have the required patience can be blessed with solid set-ups.
With harmonic patterns you can find how long a move will last, and you can also identify the reversal points in the price action. As with any trading strategy, failures do occur. In some cases a trade is initiated in a reversal area, but the pattern fails, and the trend extends itself rapidly against the trader’s position. This is why risk management protocols must be used at all times.
Traders using harmonic patterns should understand that they will almost certainly find patterns within patterns, and they will also certainly find patterns that are non-harmonic. These don’t need to be ignored but can be used as a way to increase the effectiveness of the harmonic pattern analysis, and to identify ideal entry and exit points.
Harmonic price patterns are fractal in nature, just like Elliott Waves, and this allows them to be applied on any timeframe of the market, from tick charts to monthly price charts.
Traders will find it beneficial to find chart platforms that allow plotting for multiple Fibonacci retracements, so that they are able to measure multiple waves in the price pattern.
Those who appreciate precision and exact mathematical price analysis will appreciate adding harmonic price patterns to their trading strategy. It’s important to note that becoming proficient with harmonic price patterns will take hours of study, plenty of practice, and extreme levels of patience. Only then can you hope to master the harmonic price patterns.
Always remember that any measurements that don’t align properly will invalidate a pattern. You will likely find many more invalid patterns than valid patterns when beginning, but that’s a part of the learning curve. Entries are made in the reversal zone and stop losses should always be used for risk management purposes.