The term “Harmonic” applies in many sectors like physics, music, acoustics, and power.
In currency markets, the Harmonic Patterns describe that trends are harmonic in nature, meaning they can be divided into smaller or larger waves to predict the overall trend.
What are the Harmonic Patterns?
The basic idea of Harmonic trading is that patterns repeat themselves. It brings math into trading by relying on Fibonacci numbers.
The Fibonacci is a sequence of numbers that starts with 0 and 1. Other numbers enlarge the sequence by adding the previous two numbers. Like 0 ,1, 1, 2, 3, 5, 8, 13, and so on. These numbers, if broken into ratios, can predict the moves of financial markets.
The Fibonacci levels comes in two categories; primary ratio and complimentary ratio. The primary ratio of 0.618 is calculated by dividing any number in the sequence by the following number. For example, 8 divided by 13 equals to 0.61.
The complimentary ratio of 0.38, 0.23, 0.5, 2.0, 2.2, 2.6, 3.14, and 3.6 is calculated by dividing any number in the sequence by a number two, three, or four positions to its right. For example, 5 divided by 13 equals to 0.38, and 3 divided by 13 equals 0.23. The series of the complimentary ratio can be completed this way.
By using these ratios with the Harmonic Pattern, traders can help to analyse possible future market movements.
The term Harmonic trading was first coined by Scott Carney when he defined the Harmonic Patterns and applied Fibonacci ratios.
Types of Harmonic Patterns
There are three main types of Harmonic Patterns; Gartley, ABCD, and Three-Drive.
H.M. Gartley introduced the Gartley pattern in the book Profits in the Stock Market. Later Scott Carney included the Fibonacci levels to make it Gartley Harmonic Pattern.
The Gartley appears when the price in an uptrend or downtrend shows corrective waves. The corrective waves are part of Elliot Wave Theory that moves against the trend.
The pattern looks like the ABCD pattern with the extension of X.
The Gartley pattern comes in two variations; bullish and bearish Gartley. They indicate traders for going long or short.
This is what the pattern looks like:
The Gartley pattern has three types; Bat, butterfly, and Crab.
- The Bat appears similar to Gartley but differs in measurement. It also has a bearish and bullish pattern.
- The butterfly varies from Gartley as points D and X are connected with a long line. For going long or short, the butterfly provides with bullish and bearish patterns.
- According to Scott Carney, the Crab is the most reliable pattern as it provides close reversals to what Fibonacci levels describe.
The ABCD pattern develops when points A, B, C, and D are connected. The pattern seems to be a combat between the bulls and the bears.
There are two versions of the ABCD pattern; bullish and bearish. The lines AB and CD are known as legs of ABCD, while the BC is a correction line.
Traders wait for the pattern to complete, then enter short or long positions at point D.
This is how the pattern appears on the chart:
The Three-Drive appears similar to the ABCD pattern, but it has three legs and two corrections. Traders go long or short at point B after completion of the Three-Drive.
Here’s how it emerges on the chart:
How to use the Harmonic Patterns?
All the forms of Harmonic patterns provide entry and exit signals with the potential reversal zone. As for stop-losses, if the pattern doesn’t move too far, traders can set stop-losses below a long entry and above a sell entry, using levels that they feel comfortable with and according to their own trading strategy.
As with all forms of forex analysis, the Harmonic patterns can generate false signals. So, to verify the movement of the price, traders use other forms of technical analysis.
Harmonic Patterns conclusion
Although they can be hard for some traders to spot, Harmonic Patterns can give an idea of where the market may move. The Gartley pattern is amongst what some traders often look for as it can help to give some indication of possible price movements.
Harmonic Patterns can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy.
I would prefer to use the majority of price action analysis such as Harmonic Patterns on the 1-hour charts and above. I tend to find that these charts contain less market noise than the lower time frames and thus give more reliable signals for my forex trading strategies. This also means that I spend less time staring at charts and can also set alert notifications to let me know when price has reached certain levels, candlestick pattern has been formed or a particular indicator value has been reached.
Harmonic Patterns is just one method of market analysis amongst thousands. I would not build a trading system alone, but rather combine with other technical indicators such as moving averages, Parabolic SAR, Stochastic Oscillator, RSI, ADX and price action analysis.
Of course, every trading system will generate false signals which is why money management is so important. I would personally be implementing sensible money management and only take traders that give me a favorable risk to reward ratio, ideally of at least 1:3. This means that one losing trade does not wipe out consecutive winners.
The methods of implementing Harmonic Patterns into a trading strategy that are outlined within this article are just ideas. I would always ensure that I have good money management, trading discipline and a trading plan when using any forex strategy.
Furthermore, I would combine multiple technical analysis, fundamental analysis, price action analysis and sentiment analysis to filter all entries. You should trade forex in a way that suits your own individual style, needs and goals.
If you would like to practice trading with Harmonic Patterns, you can open an account with a forex broker and download a trading platform. If you are looking for a forex broker, you may wish to view my best forex brokers for some inspiration.