Harmonic patterns, candlestick patterns, oscillators and technical indicators – technical analysis offers many tools that could help you analyze the markets. Let’s go into details about how to take the best out of harmonic pattern.
From this lesson, you will learn:
- What the idea of harmonic patterns is
- Why Fibonacci levels are crucial in harmonic investment
- What are the most popular harmonic patterns
Harmonic patterns, candlestick patterns, oscillators and technical indicators – technical analysis offers many tools that could help you analyze the markets. However, most of them are rather reactive, not proactive. That means they signal if the trend is up or down or if a breakdown or breakout has occurred. But most investors want to know what might happen, not what has happened. Harmonic price patterns could be the answer, although you need to be prepared for some mathematical calculations that are essential in such an analysis.
What are harmonic patterns?
Harmonic trading combines patterns and math into a trading method that is accurate and based on the premise that patterns repeat. Harmonic patterns are considered harmonic because these structures have an integral relationship with the Fibonacci number series. Let’s recall some of the most important ratios: 0.382, 0.50, 1.41, 2.0, 2.24, 2.618, 3.14 and 3.618. The harmonic patterns identified refer to the crucial Fibonacci levels. As you already know, Fibonacci numbers can be seen all around us in the natural world, and these harmonic ratios are also present in the financial markets. By finding patterns of varying lengths and magnitudes, the trader can then apply Fibonacci ratios to the patterns and try to predict future movements.
Harmonic trading involves the identification and analysis of a handful of chart patterns. In most cases, these patterns consist of four price movements, all conforming to specific Fibonacci levels. That’s why you should know the idea of Fibonacci levels before you even try to analyze the market using harmonic patterns. However, you should remember one crucial rule – sometimes a pattern might look like a harmonic pattern, but it must be confirmed by the Fibonacci figures. If the levels do not line up in the pattern, they are not reliable in terms of the concept of harmonic price patterns.
The most popular harmonic patterns
Harmonic patterns can measure the duration of current motion, but they can also be used to isolate reversal points. The three most popular harmonic patterns are: Gartley, Bat and Butterfly Let’s take a look at them.
Gartley harmonic pattern
The Gartley pattern, as its name suggests, was introduced by H.M. Gartley. An interesting fact is that the model is also known as “Gartley 222”. Why? Because the idea was presented in a book that contains exactly 222 pages. You didn’t expect such an explanation, did you? But let’s get back to the concept of this model. In fact, Gartley is the “mother” of all harmonic patterns, which means that all other patterns are a modification of Gartley. As for the construction of the latter, it has 5 feet:
XA: This could be any movement on the chart and there are no specific requirements for this movement to be a Gartley start
AB: This one is opposite of the XA movement and should be about 61.8% of the XA movement.
BC: This price movement should be opposite the AB movement and it should be 38.2% or 88.6% of the AB movement.
CD: The last price movement is opposite to BC and it should be 127.2% (extension) of CD if BC is 38.2% of BC. If BC is 88.6% of BC, then CD should be 161.8% (extension) of BC.
AD: The overall price movement between A and D should be 78.6% of XA
As you can see, Garley could signal an upward or downward movement. The bullish pattern is often seen at the beginning of a trend and usually signals the end of a correction.
Bat harmonic pattern
As mentioned, the bat is a modification of Gartley. It is similar to it in appearance, but not in measurement. The name of this figure comes from its resemblance to the popular animal. The pattern is a little more symmetrical than Gartley and its crucial part is the 88.6% Fibonacci level.
XA: This can be any movement on the chart and there are no specific requirements for this movement to be a start of the Bat pattern
AB: This movement is opposite the XA movement and should be about 38.2% or 50.0% of XA.
BC: This movement should be opposite the AB movement and it should be 38.2% or 88.6% of AB.
CD: The last price move is opposite to BC and it should be 161.8% (extension) of BC move if BC is 38.2% of BC. If BC is 88.6% of BC, then CD should 261.8% (extension) of BC.
AD: The overall price movement between A and D should be 88.6% of XA
There are two types of bat patterns – bullish and bearish. As you can also see, the pattern is similar to Gartley, but with different retracement levels. Both are also considered internal patterns, as the last wave (CD) is within the initial move (XA).
Butterfly harmonic pattern
The butterfly is another Gartley modification, but unlike the bat, it is not an internal pattern. The idea of the butterfly is similar to the previous ones, as it also consists of four price movements. The retracement levels, however, are slightly different, with the last wave ending outside the initial wave.
XA: This can be any movement on the chart and there are no specific requirements for this movement to be a start of the Butterfly pattern
AB: This movement is opposite to the XA movement and should be about 78.6% of XA.
BC: This movement should be opposite the AB movement and it should be 38.2% or 88.6% of AB.
CD: The last price move is opposite to BC and it should be 161.80% (extension) of BC move if BC is 38.2% of BC. If BC is 88.6% of AB, then CD should 261.80% (extension) of BC.
AD: The overall price movement between A and D should be 127% or 161.80% of XA
As you can see, point D is above or below the starting point, which differentiates the Butterfly from the Bat and Gartley. In this way, the Butterfly is considered an external formation. But this is not the only difference. Unlike Gartley, the Butterfly focuses on finding reversals to new lows or new highs.
Patience, practice, and again patience
Harmonic trading is an advanced, precise and mathematical way of trading, but it requires patience, practice and a lot of study to master the patterns. However, remember that moves that are not aligned with correct measurements cannot be considered as harmonic patterns. But if the latter could be recognized, some important rules should be followed. Stop losses should be placed just beyond point D after the price confirms the pattern and a move reverses. Secondly, there are also four potential targets of the next move – points A, B, C and the 161.8% extension of the CD wave. As you can see, harmonic trading consists of a lot of rules to follow, so it’s a method reserved for disciplined and consistent traders.
Source: https://patternswizard.com/technical-analysis/patterns/harmonic-patterns/