Harmonic Patterns: Advanced Charting Techniques for Traders

Harmonic patterns are technical analysis tools that are very popular in speculating price movements in the financial markets. Traders use these patterns to identify potential entry and exit points and trend reversals to make short- or long-term profits. In the ever-dynamic world of Contract for Difference (CFD) trading, traders have the freedom to bet on price changes of assets without actually owning them. Here, harmonic patterns play a very important role. 

By using the harmonic patterns, traders can understand where the trends may reverse or continue in their trajectory. As the CFD market is very fast-paced, these patterns come in handy when making quick decisions and taking swift actions is the only difference between profit and loss. Understanding harmonic patterns and their characteristics is very useful for a beginner or an advanced-level trader. In this article, we will take you through everything you need to know about such patterns, how to use them to the best of your abilities, and much more. 

What Are Harmonic Patterns?

Harmonic patterns are a combination of geometric price formation with specific Fibonacci ratios that traders use to predict future market movements. Such harmonic patterns are used in advanced technical analysis in financial markets by traders of all levels and expertise. There are three main key components of the harmonic patterns, and they include:

Geometric Structures 

Harmonic patterns form specific shapes on price charts that may resemble the English alphabet letters M or W

Fibonacci Ratios

These patterns rely on Fibonacci numbers and their respective derivatives. A few of the key ratios include:

• Primary ratios: 0.618 (Golden Ratio) and 1.618
• Derived ratios: 0.786, 0.886, 1.13, 1.27
• Complementary ratios: 0,382, 0,50, 20, 2.618, and others 

Price Legs

Harmonic patterns typically consist of five points, which are typically labelled X, A, B, C, and D. These points form distinct price swings or legs and each leg relates to the other through specific Fibonacci ratios. 

The harmonic patterns are built on the theory that price movements rely on symmetrical relationships based on Fibonacci ratios, which are the sequences 1, 2, 3, 5, 8, 13, 21, and so on. This symmetry is believed to reflect the natural market rhythms, market psychology, and buyer and seller behaviour. These patterns use the Fibonacci patterns to identify key moments in price action that traders can use to their advantage. While reading a harmonic pattern, a critical area where multiple Fibonacci levels seem to converge is known as the Potential Reversal Zone or PRZ. This zone indicates a high probability of a price reversal. Consequently, a harmonic pattern is considered complete when all the legs have formed, and the price reaches the PRZ. Here, traders look for entry positions and make short-term or long-term positions based on their strategy. 

Harmonic patterns offer traders a structured approach to engaging with and analysing them to their advantage. By using these patterns and other visual chart analysis tools, traders can predict price movements and enhance their trading strategies. For beginners in trading, it is crucial that they practice on demo accounts and build their experience before using such patterns or most charting tools to trade with real capital. 

Common Harmonic Patterns

There are quite a few types of harmonic patterns that can be used in various trading asset classes. Here, we list a few of the most common harmonic patterns:

Gartley Pattern 

The Gartley pattern is most famously named after H.M Gartley, who first discovered in 1935. It is one of the most common and reliable harmonic patterns. The following are its key characteristics:

• This pattern forms an “M” shape in an uptrend or a “W” shape in a downtrend
• It consists of five points: X, A, B, C, and D
• The AB leg: Retraces 61.8% of XA
• The BC leg: Retraces 38.2% to 88.6% of AB
• The CD leg: Extends to 127.2% to 161.8% of BC
• The D point: Completed at a 78.6% retracements of XA 

Visually, this pattern can be described as a zigzag pattern where each turn is related to the previous moves by specific ratios. The pattern starts at X, moves to A, pulls back to B, rises to C, and finally reaches the last point, D, where a potential reversal is expected. Because of its formation, this pattern is considered as a continuation pattern. It suggests that even after the pattern is completed at point D, the price is most likely to move in the direction of the XA leg. 

Butterfly Pattern

Bryce Gilmore discovered the butterfly pattern is technically a reversal pattern that signals a potential trend change. The structure of such a pattern includes the following key points:

• It consists of five points: X, A, B, C, and D
• The AB leg: Retraces 78.6% of XA
• The BC leg: Retraces 38.2% to 88.6% of A
• The CD leg: Extends to 127.2% to 161.8% of XA

Visually, this pattern is very similar to the Gartley pattern but extends further. It forms a more profound “M” or “W” shape where the final leg (CD) stretches beyond the starting point X. Traders use this pattern to look for potential trend reversals at point D, which is where the PRZ typically forms. If this pattern is used in conjunction with key support or resistance levels, it is considered one of the most potent patterns out there. 

Bullish Bat Pattern 

Scott Carney developed the bullish bat pattern, which is similar to the Gartley pattern but with different Fibonacci ratios. This bullish pattern occurs in an uptrend, and traders use this pattern to look for potential entry points before an uptrend. It has the following key elements:

• XA is the initial upward move
• AB: Retraces 38.2% to 50%of XA
• BC: Retraces 38.2% to 88.6% of AB
• CD: Extends to 161.8% of BC

The bullish bat pattern can be visualised when the price makes an initial move up (XA), retraces down (AB), moves up again but not as high as A (BC), and finally moves down to point D, which is about the starting point X. Typically, this pattern is extensively used in entering long-term positions when the price reaches point D and shows a sign of reversal.

 It is important to consider that while these patterns are potent predictors of price movements, confirming the movement using additional indicators before entering a trade is crucial. Additional indicators include candlestick patterns, support/resistance levels, or other technical indicators. First, traders should practice heavily on demo accounts so they get the hang of the patterns and how they play out. Second, a risk mitigation strategy should always be in place so that if the time comes, your losses are minimised. 

Advanced Harmonic Patterns

The advanced harmonic patterns go beyond the basic patterns and incorporate advanced structures that are not very subtle to visualise. These patterns include the crab, cypher, and highly flexible XABCD patterns. These patterns allow traders to trade in speculative markets with great precision and offer unique opportunities to capitalise on price extensions and reversals. Following is a list of the advanced harmonic patterns:

Crab Pattern 

Scott Carney discovered the crab pattern in the year 2000, and it is now one of the most highly precise harmonic patterns and is known for their deep extensions. It allows traders to identify price exhaustion points where sharp reversals are most likely to occur in the trade. This pattern has the following key characteristics:

• The crab pattern’s defining feature is the extreme extension of the final leg (CD), which often reaches 161.8% or even 224% of the XA leg.
• Key Fibonacci ratios are:
  • AB retraces 38.2% to 61.8% of XA.
  • BC retraces between 38.2% and 88.6% of AB.
  • CD extends to 161.8% or more of XA.

The crab pattern effectively identifies high-probability reversal zones in highly volatile markets. Its precision at extreme price levels makes it particularly useful in speculative trading, as traders look for these when they need to make quick moves. 

Cypher Pattern 

The cypher pattern is a relatively newer harmonic structure and differs from traditional harmonic patterns in its Fibonacci ratios. It is known to be highly reliable even in very fast-moving markets. The following are its key Fibonacci ratios:

• AB retraces 38.2% to 61.8% of XA.
• BC extends from 127.2% to 141.4% of XA.
• CD retraces to 78.6% of XC.

This type of pattern is helpful for speculative traders because it can highlight sudden and significant price reversals. 

XABCD Pattern 

The XACBD pattern is not really a specific harmonic pattern but rather a flexible framework that traders can use to identify custom harmonic structures. It mostly emphasises price formations that deviate from predefined ratios, which allows traders to adapt to complex and ever-changing market conditions. The key characteristics of the XACBD pattern include:

• An initial XA leg followed by retracement and extension legs (AB, BC, and CD).
• Flexible Fibonacci levels tailored to the specific market or asset.
• Traders can often customise ratios and rely on additional indicators to confirm the pattern. 

This pattern is ideal for speculative markets, as it allows traders to identify unique price movements that do not fit the standard harmonic patterns. 

Advanced harmonic patterns provide traders with an edge by uncovering hidden opportunities in speculative markets. Such patterns are relevant because they can identify precise entry and exit points in complex situations, which traders can use to form strategies. 

Bullish vs Bearish Patterns

Harmonic patterns can either be bearish or bullish in nature, and traders use both of these types to predict potential market reversals. While both the patterns use the Fibonacci principles and the same geometric laws, their interpretation may differ based on their direction in the trade. Here, we discuss the difference between the bullish and bearish harmonic patterns.

A bullish harmonic pattern signals a price reversal from a downtrend to an uptrend. They indicate a buying opportunity at or near the end of the pattern’s completion point, which typically is labelled as “D”. A few examples of such a pattern include Bullish Gartley, Bullish Bat, and Bullish Butterfly patterns. The characteristics of such a pattern include:

• The pattern forms after a price decline, which then identifies areas where buyers may gain control over the sellers
• The CD leg of the pattern extends downward, often completing at a Fibonacci retracement level (e.g. 88.6% for the bat pattern or 161.88% for the crab pattern)

On the other hand, a bearish harmonic pattern signals a potential price reversal from an uptrend to a downward trend. This helps traders identify selling opportunities at or near the pattern’s completion. A few examples of such a pattern include Bearish Gartley, Bearish Bat, and Bearish Butterfly patterns.  The characteristics of such a pattern include:

• The pattern forms after a price rally and indicates the areas where sellers may dominate soon 
• The CD leg of the pattern extends upward, completing a Fibonacci extension or retracement level. 

Traders can interpret these patterns on the basis of their knowledge and expertise. For example, a trader analysing a forex market might identify a bullish butterfly pattern forming in a currency pair like EUR/USD. When the price completes the CD leg near the 161.8% extension of the XA leg, the trader can anticipate a reversal upward trend and may enter a long position. Similarly, a bearish Gartley pattern might be formed in the stock market after a prolonged rally in tech stock. After identifying the D point near the 78.6% retracements of the XA leg, the trader can potentially enter a short-term position and benefit from the expected declining price. 

M and W Patterns in Trading

The M and W patterns identify potential tops and bottoms in the price charts, respectively. These patterns often act as a precursor to potential reversals, making them invaluable tools for traders’ technical analysis. When these patterns are analysed in combination with harmonic patterns, including the Fibonacci patterns, they can describe precise trading opportunities for traders. The M pattern, also known as the double top, typically signals a market top and a potential reversal to a downtrend. It resembles the letter “M” with two peaks that are separated by a trough. Meanwhile, the W or double bottom pattern indicates a potential reversal to an uptrend. 

The M pattern reflects failed attempts by buyers to push prices higher; signalling weakened bullish momentum. The W pattern indicates unsuccessful attempts by sellers to push prices lower, showing a weakening bearish trend in the market. Traders may use the M pattern to enter short positions after the second peak fails to break the previous high. In contrast, the traders can use the W pattern to enter long positions as the second trough holds above the previous low and continues to move in an uptrend. These patterns often appear in a critical reversal zone, which traders can use to anticipate a change in market trends. 

How to Use Harmonic Patterns in CFDs

Traders can successfully use the harmonic patterns for trading Contracts for Difference (CFDs) because these patterns are known for their speculative and leveraging natures. If used effectively, these patterns can help traders identify potential price reversals and structure their strategies with more positive outcomes. Following are some of the practical tips that you should keep in mind when dealing with harmonic patterns in CFD trading strategies:

• Harmonic patterns like the Gartley or bat provide specific Fibonacci levels that act as the potential PRZ points that traders should religiously follow in CFD markets like forex, commodities, or indices for maximum outcomes. 
• CFDs are highly speculative, and relying solely on one technical analysis indicator is highly risky, which is why a combination of tools should be used to improve the accuracy of the patterns. 
• The D point is the most crucial part of any harmonic pattern as it marks the PRZ point, so always incorporate risk mitigation strategies like a stop-loss order around this point to cut losses. 
• CFDs are known for their flexibility in trade sizes and leverages, so use this feature to scale your trades based on the confidence level of the harmonic pattern. 

Using the harmonic pattern in CFD trading strategies can help traders identify high-probability setups in speculative markets. However, it is best to use additional indicators to confirm the trend before entering a trade. 

Brokers and CFD Trading

It is important to understand that brokers facilitate the trading process but do not provide strategies or guarantees of success in CFD trading. Brokers may offer platforms and tools to analyse candlestick patterns and execute trades, but traders are ultimately responsible for interpreting patterns, managing risks, and developing effective strategies.

While harmonic patterns can help traders identify speculative opportunities when trading Contracts for Difference (CFDs), success is not guaranteed. Traders should utilise additional technical indicators and analysis to confirm potential opportunities and manage the inherent risks of leveraged trading

FAQs About Harmonic Patterns

How Do I Identify Harmonic Patterns? 

Harmonic patterns can be identified by spotting distinct price swings that rely on the Fibonacci levels. Traders can use tools like the Fibonacci retracement and harmonic pattern recognition software to pinpoint harmonic patterns like Gartley, bat, and more. 

What Tools Can I Use For Harmonic Pattern Analysis?

Traders can use the following tools for harmonic pattern analysis:

• TradingView
• HarmonicTrader Software
• Thinkorswim 
• NinjaTrader

Conclusion

Harmonic patterns play a crucial role in technical analysis. Traders can use them to structure their trading strategy and identify potential exit and entry points in the trade. These patterns heavily rely on geometric shapes and the Fibonacci ratios, which makes them interesting to identify and mathematically invaluable. 

The effectiveness of these patterns lies in their interpretation and confirmation using various technical analysis tools and indicators in combination. All levels of traders can benefit from such patterns, but beginners should first practice on a demo account and then move to their application in the real world with real capital.