- March 30, 2023
- Posted by: CoachShane
- Category: Trading Article
The ABCD harmonic pattern is an important pattern in stock and options trading that can provide traders with greater insight into market movements and potential entry points for trades. But what is it, why should you use it, and how do you go about trading with it?
In this post, we’ll answer these questions by exploring the significance of the ABCD trading pattern, as well as a simple strategy that incorporates moving averages with the pattern.
What We Will Cover:
- What Is The ABCD Harmonic Pattern?
- Importance of ABCD Pattern
- How Do You Trade With The ABCD Pattern?
- Simple Trading Strategy Using Moving Average & ABCD Pattern
What Is The ABCD Harmonic Pattern?
The ABCD harmonic pattern is price pattern that is used by traders to identify potential price movements in the stock market. The original pattern is based on Fibonacci ratios and uses four points, A, B, C and D.
Traders use this pattern to determine whether prices are likely to form a bearish or bullish reversal. The key components that make up this pattern are:
• Point A – This represents where the pattern begins and a trader should start looking for an ABCD formation
• Point B – This indicates either a peak or trough in prices depending on the direction of A
• Point C – This shows where the counter trend move has ended
• Point D – This denotes when an ABCD formation has been completed
When all four points have been identified, traders can then look at how far apart each point is from one another using the Fibonacci ratios 0.618 (62%) and 127.2%-161.8%. These numbers represent how much retracement there will be between two points before prices reverse.
To have a valid ABCD pattern (Classic ABCD pattern), all four points must line up correctly according to these ratios (close is close enough).
The ABCD Harmonic Pattern is a powerful pattern for traders to identify potential reversals and trend continuations, making it an invaluable addition to any trading strategy.
Importance of ABCD Pattern
The ABCD pattern can be an important tool for traders as it helps identify potential entry and exit points in an instrument. It can be a reversal pattern at D or a continuation pattern at C depending on the context of price.
Traders can also use this pattern to identify potential support and resistance levels which can be used to set stop losses or take profits. For example, if a trader identifies that price has reached a certain level (point C) then they may decide to place a stop loss order below that level so that if price falls further, their position can be closed.
If price reaches another level (point D) then they may decide to take profits by closing their position.
Traders can also use this pattern to identify trends in an instrument.
If there is downtrend present then traders may look for opportunities where prices have retreated from point D yet remain below point C – suggesting that the move still has some downside potential. This is a price action trending structure of lower highs and lower lows.
A bullish ABCD pattern is traded in the opposite way. You would be looking for any break below the C leg of the pattern.
By understanding how this harmonic pattern works and what it indicates about current market conditions and trends, traders are better equipped to make informed trading decisions.
How Do You Trade With The ABCD Pattern?
Now that you know about the classic ABCD pattern, there is a better way to use this pattern. Trading patterns in price is a good approach but they do not have to fit such rigid rules.
The ABCD chart pattern is no exception. While the ideal pattern uses the ratios, simplest harmonic pattern is using the AB=CD chart pattern and is how I use it.
On the price chart above, we are looking at market direction to the downside. The pattern begins with a move down and finds support. This is our A-B leg of the move. We look for a rally in price and once price begins to break down, we are looking for the C-D leg with the profit target at the end of that move (the end of the red arrow).
We are looking for equivalent price legs and often times, that is what we actually get.
At the end of the move, we expect it to act as a reversal pattern and we either take profits or be aggressive with our stop loss.
Simple Trading Strategy Using Moving Average & ABCD Pattern
This strategy works best when there are no major news events that could affect price movements in either direction. For example, if looking for the release of earning reports, we’d wait until the smoke clears before looking to take a trade.
To identify trading opportunities, we will look for price to be near a long-term moving average (MA) line such as 50-day. We look for a leg up in price to identify the peak of the current market direction.
On this chart, we see price above the moving average and a gap up in price shows traders aggressively buying. We can easily plot the A-B move and we wait until we get the pullback. The end of that pullback is the start of our C-D leg and where we look for a trade entry.
Once in the trade, you measure the move from A-B and project from C. Some traders would place a sell order at D to exit the trade automatically. Other traders may sell half of their position at the 50% point of the C-D move.
Stop loss can go under the low at C.
When using moving averages as part of your trading strategy with the ABCD pattern, choose one that fits your timeframe and risk tolerance level. If you prefer shorter term trades if you are day trading, then a 10-day or 20-day MA may be more suitable than longer term ones like 50-day or 200-day MAs
Swing traders may want to explore everything from the 20 period SMA and upwards.
Once an appropriate MA has been selected and the pattern is visible, traders must decide how to enter their trade in line with their risk tolerance, entry techniques, and how they will take profits.
If an options trader, you may chose to purchase calls or puts with a strike price around the end of the C leg.
Is ABCD pattern good?
It is based on the idea that prices tend to move in repeating patterns over time. The stair stepping pattern consists of higher highs and higher lows (or the opposite) which is what a trending market does.
While this strategy has proven successful for traders, it should be noted that there are no guarantees when trading stocks or other financial instruments.
What is an ABCD setup?
Whether you use the specific Fibonacci ratios required for the original pattern or the simplified method, the pattern is the same.. It consists of four price points, A, B, C and D which form a symmetrical pattern. Point A marks the beginning of the trend while point B marks the highest peak or lowest trough in that trend. Point C marks the end of the retracement and point D marks an extension from point C. This setup can be used to find a probable end to the current trend.
The ABCD pattern is a powerful pattern for traders of all levels. It can be used to identify potential reversals, entry points, and provide insight into future price movements.
The key to success with this pattern is understanding how it works, why it works, and finding the obvious swing points to use. By combining the ABCD pattern with other technical indicators such as moving averages, you can create an effective trading strategy that uses the rhythm of the instrument you are trading.
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