Summary: Harmonic Price Patterns

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summary-harmonic-price-patterns

Harmonic price patterns enable us to distinguish possible areas for a continuation of the overall trend.

There are six harmonic price patterns:

    • The ABCD Pattern

 

    • The Three-Drive Pattern

 

    • The Gartley Pattern

 

    • The Crab Pattern

 

    • The Bat Pattern

 

  • The Butterfly Pattern

The three basic steps in spotting harmonic price patterns are the following

    • Step 1: Locate a potential harmonic price pattern

 

    • Step 2: Measure the potential harmonic price pattern

 

  • Step 3: Buy or sell on the completion of the harmonic price pattern

Again, harmonic price patterns are so perfect that they are very difficult to spot.
More than knowing the steps, you need to have hawk-like eyes to spot potential harmonic price patterns and a lot of patience to avoid jumping the gun and entering before the pattern is completed.

With enough practice and experience, trading using harmonic price patterns can yield a lot of pips!

source: www.babypips.com

3 Steps in Trading Harmonic Price Patterns

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As you may have guessed, profiting off Harmonic Price Patterns is all about being able to spot those “perfect” patterns and buying or selling on their completion.

There are three basic steps in spotting Harmonic Price Patterns:

  • Step 1: Locate a potential Harmonic Price Pattern
  • Step 2: Measure the potential Harmonic Price Pattern
  • Step 3: Buy or sell on the completion of the Harmonic Price Pattern

By following these three basic steps, you can find high probability setups that will help you grab those oh-so-lovely pips.

Let’s see this process in action!

Step 1: Locate a potential Harmonic Price Pattern

harmonic-example1

Oh wow, that looks like a potential Harmonic Price Pattern! At this point in time, we’re not exactly sure what kind of pattern that is. It LOOKS like a three-drive, but it could be a Bat or a Crab…

Heck, it could even be a Moose! In any case, let’s label those reversal points.

Step 2: Measure the potential Harmonic Price Pattern

Using the Fibonacci tool, a pen, and a piece of paper, let us list down our observations.

harmonic-example2
  1. Move BC is .618 retracement of move AB.
  2. Move CD is 1.272 extension of move BC.
  3. The length of AB is roughly equal to the length of CD.

This pattern qualifies for a bullish ABCD pattern, which is a strong buy signal.

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Step 3: Buy or sell on the completion of the Harmonic Price Pattern

harmonic-example3

Once the pattern is complete, all you have to do is respond appropriately with a buy or sell order.

In this case, you should buy at point D, which is the 1.272 Fibonacci extension of move CB, and put your stop loss a couple of pips below your entry price.

Is it really that easy?

Not exactly.

The problem with harmonic price patterns is that they are so perfect that they are so difficult to spot, kind of like a diamond in the rough.

Check out this excellent forum thread discussing Gartley setups.

More than knowing the steps, you need to have hawk-like eyes to spot potential harmonic price patterns and a lot of patience to avoid jumping the gun and entering before the pattern is completed.

source: www.babypips.com
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The Gartley and the Animals

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Once upon a time, there was this insanely smart trader dude named Harold McKinley Gartley.

He had a stock market advisory service in the mid-1930s with a huge following. This service was one of the first to apply scientific and statistical methods to analyze the stock market behavior.

According to Gartley, he was finally able to solve two of the biggest problems of traders: what and when to buy.

Soon enough, traders realized that these patterns could also be applied to other markets. Since then, various books, trading software, and other patterns (discussed below) have been made based on the Gartleys.

Gartley a.k.a. “222” Pattern

The Gartley “222” pattern is named for the page number it is found on in H.M. Gartleys book, Profits in the Stock Market. Gartleys are patterns that include the basic ABCD pattern we’ve already talked about, but are preceded by a significant high or low.

Now, these patterns normally form when a correction of the overall trend is taking place and look like ‘M’ (or ‘W’ for bearish patterns). These patterns are used to help traders find good entry points to jump in on the overall trend.

Forex00295
A Gartley forms when the price action has been going on a recent uptrend (or downtrend) but has started to show signs of a correction.

What makes the Gartley such a nice setup when it forms is the reversal points are a Fibonacci retracement and Fibonacci extension level. This gives a stronger indication that the pair may actually reverse.

This pattern can be hard to spot and once you do, it can get confusing when you pop up all those Fibonacci tools. The key to avoiding all the confusion is to take things one step at a time.

In any case, the pattern contains a bullish or bearish ABCD pattern, but is preceded by a point (X) that is beyond point D. The “perfect” Gartley pattern has the following characteristics:

  1. Move AB should be the .618 retracement of move XA.
  2. Move BC should be either .382 or .886 retracement of move AB.
  3. If the retracement of move BC is .382 of move AB, then CD should be 1.272 of move BC. Consquently, if move BC is .886 of move AB, then CD should extend 1.618 of move BC.
  4. Move CD should be .786 retracement of move XA

The Animals

As time went by, the popularity of the Gartley pattern grew and people eventually came up with their own variations.

For some odd reason, the discoverers of these variations decided to name them after animals (Maybe they were part of PETA?).Without further ado, here comes the animal pack…

The Crab

Forex00298

In 2000, Scott Carney, a firm believer in harmonic price patterns, discovered the “Crab”.

According to him, this is the most accurate among all the harmonic patterns because of how extreme the Potential Reversal Zone (sometimes called “price better reverse or imma gonna lose my shirt” point) from move XA.

This pattern has a high reward-to-risk ratio because you can put a very tight stop loss. The “perfect” crab pattern must have the following aspects:

  1. Move AB should be the .382 or .618 retracement of move XA.
  2. Move BC can be either .382 or .886 retracement of move AB.
  3. If the retracement of move BC is .382 of move AB, then CD should be 2.24 of move BC. Consquently, if move BC is .886 of move AB, then CD should be 3.618 extension of move BC.
  4. CD should be 1.618 extension of move XA.

The Bat

Forex00299

Come 2001, Scott Carney founded another Harmonic Price Pattern called the “Bat.” The Bat is defined by the .886 retracement of move XA as Potential Reversal Zone. The Bat pattern has the following qualities:

  1. Move AB should be the .382 or .500 retracement of move XA.
  2. Move BC can be either .382 or .886 retracement of move AB.
  3. If the retracement of move BC is .382 of move AB, then CD should be 1.618 extension of move BC. Consquently, if move BC is .886 of move AB, then CD should be 2.618 extension of move BC.
  4. CD should be .886 retracement of move XA.

The Butterfly

Forex00300

Then, there is the Butterfly pattern. Like Muhammad Ali, if you spot this setup, you’ll surely be swinging for some knockout-sized pips!

Created by Bryce Gilmore, the perfect Butterfly pattern is defined by the .786 retracement of move AB with respect to move XA. The Butterfly contains these specific characteristics:

  1. Move AB should be the .786 retracement of move XA.
  2. Move BC can be either .382 or .886 retracement of move AB.
  3. If the retracement of move BC is .382 of move AB, then CD should be 1.618 extension of move BC. Consquently, if move BC is .886 of move AB, then CD should extend 2.618 of move BC.
  4. CD should be 1.27 or 1.618 extension of move XA.
source: www.babypips.com
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The ABCD and the Three-Drive The ABCD

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Let’s start this lesson with the simplest harmonic pattern, and what could be more basic than your good ole ABC’s? We’ll just pop in another letter right there (because we’re cool like that) and we’ve got the ABCD chart pattern!

To spot this chart pattern, all you need are ultra-sharp hawk eyes and the handy-dandy Fibonacci tool.

For both the bullish and bearish versions of the ABCD chart pattern, the lines AB and CD are known as the legs while BC is called the correction or retracement. If you use the Fibonacci retracement tool on leg AB, the retracement BC should reach until the 0.618 level. Then, the line CD should be the 1.272 Fibonacci extension of BC.

Simple, right? All you have to do is wait for the entire pattern to complete (reach point D) before taking any short or long positions.

Forex00296

Oh, but if you want to be extra strict about it, here are a couple more rules for a valid ABCD pattern:

  • The length of line AB should be equal to the length of line CD.
  • The time it takes for the price to go from A to B should be equal to the time it takes for the price to move from C to D.

Three-Drive

The three-drive pattern is a lot like the ABCD pattern except that it has three legs (now known as drives) and two corrections or retracements. Easy as pie! In fact, this three-drive pattern is the ancestor of the Elliott Wave pattern.

As usual, you’ll need your hawk eyes, the Fibonacci tool, and a smidge of patience on this one.

Forex00295

As you can see from the charts above, point A should be the 61.8% retracement of drive 1. Similarly, point B should be the 0.618 retracement of drive 2. Then, drive 2 should be the 1.272 extension of correction A and drive 3 should be the 1.272 extension of correction B.

By the time the whole three-drive pattern is complete, that’s when you can pull the trigger on your long or short trade. Typically, when the price reaches point B, you can already set your short or long orders at the 1.272 extension so that you won’t miss out!

But first, it’d be better to check if these rules also hold true:

  • The time it takes the price to complete drive 2 should be equal to the time it takes to complete drive 3.
  • Also, the time to complete retracements A and B should be equal.

Here’s a forum thread discussing the ABCD pattern and a trade setup with the three-drive pattern.

source: www.babypips.com

Harmonic Price Patterns

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harmonic-price-patterns

Now that you’ve got the basic chart patterns down, it’s time to move on and add some more advanced tools to your trading arsenal.

In this lesson, we’ll be looking at harmonic price patterns. These bad boys may be a little harder to grasp but once you spot these setups, it can lead to some very nice profits!

The whole idea of these patterns is that they help people spot possible retracements of recent trends. In fact, we’ll make use of other tools we’ve already covered – the Fibonacci retracement and extensions!

Combining these wonderful tools to spot these harmonic patterns, we’ll be able to distinguish possible areas for a continuation of the overall trend.

In this lesson, we’re going to discuss the following Harmonic Price Patterns:

  • ABCD Pattern
  • Three-Drive Pattern
  • Gartley Pattern
  • Crab Pattern
  • Bat Pattern
  • Butterfly Pattern

Phew! That’s quite a lot to cover!
But don’t you worry… Once you get the hang of things, it’ll be as easy as 1-2-3! We’ll start off with the more basic ABCD and three-drive patterns before moving on to Gartley and the animals.

After learning about them, we’ll take a look at the tools you need in order to trade these patterns successfully.

For all these harmonic patterns, the point is to wait for the entire pattern to complete before taking any short or long trades. You’ll see what we’re talking about later on so let’s get started!

 

source: www.babypips.com
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Summary: Elliott Wave Theory

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summary-elliott-wave-theory
  • Elliott Waves are fractals. Each wave can be split into parts, each of which is a very similar copy of the whole. Mathematicians like to call this property “self-similarity”.
  • A trending market moves in a 5-3 wave pattern.
  • The first 5-wave pattern is called impulse wave.
  • One of the three impulse waves (1, 3, or 5) will always be extended. Wave 3 is usually the extended one.
  • The second 3-wave pattern is called corrective wave. Letters are used instead of numbers to track the correction.
  • Waves 1, 3 and 5, are made up of a smaller 5-wave impulse pattern while Waves 2 and 4 are made up of smaller 3-wave corrective pattern.
  • There are 21 types of corrective patterns but they are just made up of three very simple, easy-to-understand formations.
  • The three fundamental corrective wave patterns are zig-zags, flats, and triangles.
  • There are three cardinal rules in labeling waves:
  • Rule Number 1: Wave 3 can NEVER be the shortest impulse wave
  • Rule Number 2: Wave 2 can NEVER go beyond the start of Wave 1
  • Rule Number 3: Wave 4 can NEVER cross in the same price area as Wave 1
  • If you look hard enough at a chart, you’ll see that the market really does move in waves.
  • Because the market never moves in text book perfect fashion, it will take many, many hours of practice analyzing waves before you start to get comfortable with Elliott waves. Stay diligent and never give up!
source: www.babypips.com

Riding Elliott’s Waves

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surfing

This is probably what you all have been waiting for – drumroll please – using the Elliott Wave Theory in trading! In this section, we will look at some setups and apply our knowledge of Elliott Wave to determine entry, stop loss, and exit points. Let’s get it on!

Hypothetical, will-most-probably-be-right scenario:

Let’s say you wanted to begin your wave count. You see that price seems to have bottomed out and has began a new move upwards. Using your knowledge of Elliott Wave, you label this move up as Wave 1 and the retracement as Wave 2.

elliott-wave-start

In order to find a good entry point, you head back to the School of Pipsology to find out which of the three cardinal rules and guidelines you could apply. Here’s what you found out:

  • Rule Number 2: Wave 2 can NEVER go beyond the start of Wave 1
  • Waves 2 and 4 frequently bounce off Fibonacci retracement levels

So, using your superior Elliott Waving trading skillz, you decide to pop the Fibonacci tool to see if price is at a Fib level. Holy mama! Price is just chillin’ like ice cream fillin’ around the 50% level. Hmm, this could be the start of Wave 3, which is a very strong buy signal.

elliott-wave-fibs

Since you’re a smart trader, you also take your stop into consideration.

Cardinal rule number 2 states that Wave 2 can never go beyond the start of Wave 1 so you set your stop below the former lows.

If price retraces more than 100% of Wave 1, then your wave count is wrong.

Let’s see what happens next…

elliott-wave-end

Your Elliott Wave analysis paid off and you caught a huge upward move! You go to Vegas (or Macau), blow all your profits on roulette, and end right back where you started. Lucky for you we have another hypothetical scenario where you can earn imaginary money again…

Scenario 2:

This time, let’s use your knowledge on corrective waves patterns to grab those pips.

elliott-wave-flat-example

You begin counting the waves on a downtrend and you notice that the ABC corrective waves are moving sideways. Hmm, is this a flat formation in the works? This means that price may just begin a new impulse wave once Wave C ends.

elliott-wave-entry1

Trusting your Elliott Wave skills, you go ahead and sell at market in hopes of catching a new impulse wave.

You place your stop just a couple of pips above the start of Wave 4 just incase your wave count is wrong.

elliot-wave-exit

Because we like happy endings, your trade idea works out and nets you a couple thousand pips on this day, which is not always the case.

You have also learned your lesson this time around so you skip Vegas and decide to use your profits to grow your trading capital instead.

Learn from your fellow traders and discuss Elliott Waves.

source: www.babypips.com
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The 3 Cardinal Rules and Some Guidelines

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3-rules

As you may have guessed, the key in using the Elliott Wave Theory in trading is all about being able to correctly identify waves.

By developing the right eye in recognizing what wave the market is in, you will be able to find out which side of the market to trade on, long or short.

There are three cardinal cannot-be-broken rules in labeling waves. So, before you jump right in to applying the Elliott Wave Theory to your trading, you must take note of the rules below.

Failing to label wave correctly can prove disastrous to your account.

3 Cardinal Rules of the Elliott Wave Theory

  • Rule Number 1: Wave 3 can NEVER be the shortest impulse wave
  • Rule Number 2: Wave 2 can NEVER go beyond the start of Wave 1
  • Rule Number 3: Wave 4 can NEVER cross in the same price area as Wave 1

Then, there are the guidelines that help you in correctly labeling waves. Unlike the three cardinal rules, these guidelines can be broken. Here they are:

  • Conversely, sometimes, Wave 5 does not move beyond the end of wave 3. This is called truncation.
  • Wave 5, more often than not, goes beyond or “breaks through” the trend line drawn off Wave 3 parallel to a trend line connecting the start of Waves 3 and 5.
  • Wave 3 tends to be very long, sharp, and extended.
  • Waves 2 and 4 frequently bounce off Fibonacci retracement levels.
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Waves Within a Wave

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Like we mentioned earlier, Elliott waves are fractals. Each wave is made of sub-waves. Huh? Let me show you another picture. Pictures are great, aren’t they? Yee-haw!

 waves-within-a-wave
Do you see how Waves 1, 3, and 5 are made up of a smaller 5-wave impulse pattern while Waves 2 and 4 are made up of smaller 3-wave corrective pattern?

Always remember that each wave is comprised of smaller wave patterns. This pattern repeats itself…

FOREVER!

To make it easy to label these waves, the Elliott Wave Theory has assigned a series of categories to the waves in order of the largest to the smallest. They are:

  • Grand Supercycle
  • Supercycle
  • Cycle
  • Primary
  • Intermediate
  • Minor
  • Minute
  • Minuette
  • Sub-Minuette

A Grand Supercycle is made up of Supercycle waves which is made up of Cycle waves which is made up Primary waves, which is made up of Intermediate waves which is made up of Minor waves which is made up of Minute waves which is made up of Minuette waves which is made up of Sub-Minuette waves. Did you get all that?

Okay, to make things much clearer, let’s see how an Elliott Wave looks in real life.

real-life-waves

As you can see, waves aren’t shaped perfectly in real life. You’ll also learn it’s sometimes difficult to label waves. But the more you stare at charts the better you’ll get.

Besides, we’re not going to let you go at it alone! In the following sections, we’ll give you some tips on how to correctly and easily identify waves as well as teach you how to trade using Elliott Waves. Surf’s up!

 

source: www.babypips.com

ABC Correction

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The 5-wave trends are then corrected and reversed by 3-wave countertrends. Letters are used instead of numbers to track the correction. Check out this example of a smokin’ hot corrective 3-wave pattern!

abc-correction
Just because we’ve been using a bull market as my primary example doesn’t mean the Elliott Wave Theory doesn’t work on bear markets. The same 5-3 wave pattern can look like this:

reverse-abc-correction

Types of Corrective Wave Patterns

According to Elliott, there are 21 corrective ABC patterns ranging from simple to complex.

“Uh 21? I can’t memorize all of that! The basics of the Elliott Wave Theory are already mind-blowing!”

Take it easy, young padawan. The great thing about Elliott Wave is you don’t have to be above the legal drinking age to trade it! You don’t have to get a fake ID or memorize all 21 types of corrective ABC patterns because they are just made up of three very simple easy-to-understand formations.

Let’s take a look at these three formations. The examples below apply to uptrends, but you can just invert them if you’re dealing with a downtrend.

The Zig-Zag Formation

elliott-wave-zigzags
Zig-zag formations are very steep moves in price that goes against the predominant trend. Wave B is typically shortest in length compared to Waves A and C. These zig-zag patterns can happen twice or even thrice in a correction (2 to 3 zig-zag patterns linked together). Like with all waves, each of the waves in zig-zag patterns could be broken up into 5-wave patterns.

The Flat Formation

elliott-wave-flats
Flat formations are simple sideways corrective waves. In flats, the lengths of the waves are GENERALLY equal in length, with wave B reversing wave A’s move and wave C undoing wave B’s move. We say generally because wave B can sometimes go beyond the beginning of wave A.

The Triangle Formation

elliott-wave-triangle
Triangle formations are corrective patterns that are bound by either converging or diverging trend lines. Triangles are made up of 5-waves that move against the trend in a sideways fashion. These triangles can be symmetrical, descending, ascending, or expanding.

Drop by our forums if you want to see the bullish and bearish versions of these
source: www.babypips.com