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Harmonic patterns

Harmonic patterns are specific formations used in technical analysis that can help traders understand price action and forecast where prices may go next. When analysing harmonic patterns in price charts, a trader can make predictions about where and to what extent an asset’s price might move.

Like all pattern types, harmonics are most powerful when they are traded once formed. A classic error is to assume that a pattern will form and attempt to trade it before it fully materialises. Harmonics require patience, yet they provide great insight into potential future price movements when correctly used. In this article, we explore how to identify harmonic patterns on trading charts and how to trade them using advanced drawing tools from our Next Generation online trading platform​.

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Harmonic pattern rules

Unlike traditional chart trading patterns, such as triangles, head and shoulders, and wedges, a harmonic pattern must meet specific movement requirements to be considered valid and thus tradable. This removes a lot of the subjectivity of trading traditional chart patterns and makes trading more objective. The movement requirements are based on Fibonacci retracements and extensions, so knowledge of these Fibonacci tools is a requirement for trading harmonics. Read more about how to calculate Fibonacci retracements here.

Best harmonic patterns in trading

There are a number of harmonic patterns shown on traditional price charts, which includes the bat, Gartley, butterfly, 5.0, crab, and AB=CD patterns. Each of these has a bearish and bullish version, meaning that the pattern’s formation can signal a rise or fall in price when the pattern is upside down. Each pattern has a specific formation and, more importantly, specific Fibonacci ratios that must be met for the pattern to be valid and project future price action​.

Harmonic patterns can be applied to all financial markets, including stocks, commodities, and the forex market. Each of the patterns discussed below has a trading strategy attached to it, including entry points, stop-losses, and profit targets.

Bat harmonic pattern

The example below shows a bullish Bat pattern on the EUR/USD four-hour price chart. The numbers mark the retracement or extensions that fall within the parameters of the pattern. To the right of the pattern, a Fibonacci retracement shows possible profit target levels, of which the common targets of 0.50 and 1.0 were reached.

With the bullish Bat pattern, it looks like a stretched-out “M”. The price rises, forming an X-to-A leg higher, then pulls back, retracing less than 0.618 of XA. Here, the ideal retracement is 0.382 to 0.50. Then there is another move up as shown by “BC”, which retraces 0.382 to 0.886 of wave AB. This is followed by a further down wave called CD, which is a 1.618 to 2.618 extension of BC.

Point D should be near a 0.886 retracement of XA. The price is expected to rally from this potential reversal zone. Many traders wait for the price to start rising before entering. A stop-loss order is placed below the recent swing low near D or below X.

Profit targets are based on Fibonacci ratios, between points A and D, potentially extending higher than A. Popular take-profit levels are 0.50, 0.618, 1 (at A) and 1.618 (which is above A), as these could act as support and resistance levels​ in the future.

The bearish Bat harmonic pattern looks like a stretched-out “W”. The ratios are the same, except the pattern starts with a price decline from X to A. AB is a move higher, BC is a move lower and CD is a wave higher. Point D represents where traders will watch for a decline in price, which explains why it is a bearish pattern.

Gartley harmonic pattern

The Gartley pattern is similar to the Bat in appearance, except that some ratios are different. The bearish Gartley pattern has all the same ratios, except that the pattern starts with an XA leg down. However, for a bullish Gartley pattern:

  • XA is a leg up
  • AB is a correction of 0.618 of XA
  • BC is a leg up, retracing 0.382 to 0.886 of AB
  • CD is a leg down, extending 1.13 to 1.618 of BC
  • Point D is at a 0.786 retracement level of XA

Below is an example of a bearish Gartley pattern on the EUR/GBP daily chart. With the bearish pattern, the stop-loss goes just above the swing high at D once the price starts to lower. Alternatively, it could be placed above X, but this can increase the stop-loss size dramatically.

A profit target is the retracement and extension levels of AD, including 0.50, 0.618, 1, and 1.618. These could act as support and resistance in the future.

Harmonic Butterfly pattern

The harmonic Butterfly pattern looks similar to the above patterns, but with different ratios and the fact that point D extends out further than X. Here are the Fibonacci levels for a bearish Butterfly pattern:

  • XA is a wave down
  • AB is a wave up that retraces near 0.786 of XA
  • BC is a wave down that retraces 0.382 to 0.886 of AB
  • CD is a wave up that extends 1.618 to 2.24 of AB
  • D is higher than X, with an XA extension of roughly 1.27

The bullish Butterfly pattern has the same ratios, but the pattern starts with an up XA wave up. The following is a bearish example of the Butterfly on a one-hour NZD/JPY price chart. There is a XA leg down. The B wave retraces to 0.886, which is just slightly beyond but it still quite close to ideal. BC retraces 0.75 of AB and D is 1.23 of XA.

The price moves lower off D for a potential short trade and then, the stop-loss order​ goes above the swing high at D. Profit targets are projected based on Fibonacci ratios from AD. Common take-profit levels are 0.50, 0.618, 1, and 1.618.

Crab harmonic pattern

The bullish Crab harmonic pattern has the following Fibonacci levels:

  • XA is an up wave
  • AB is a down wave, retracing 0.382 to 0.618 of XA
  • BC is an up wave, retracing 0.382 to 0.886 of AB
  • CD is 2.618 to 3.618 of BC
  • D is a 1.618 extension beyond XA

In the above example, traders could choose to enter once the price starts moving up from D. A stop-loss goes below the swing low at D. Profit targets are based on retracement levels of AD, typically at 0.50, 0.618, and 1. As with the other harmonic patterns, the bearish Crab pattern has the same Fibonacci levels, but the pattern is flipped upside down.

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Harmonic AB=CD pattern

The AB=CD pattern works in a slightly different way to the others. In a bullish AB=CD pattern:

  • AB is a down leg
  • BC is a pullback (higher), which retraces 0.382 to 0.886 of AB
  • Once C is established, point C, minus the length of AB, generates point D
  • Traders should look for a reversal higher at point D

In the example below, we can see a bearish AB=CD pattern on the daily gold chart. The ratios are the same. On the chart, the CD line is an exact replica of line AB, where the dotted line represents a possible reversal zone. As the price nears this zone, traders may choose to enter short if the price drops away from the zone. A stop-loss goes above the recent swing high.

Since the trend can be quite strong and you’re trading a possible reversal trend, you should consider placing targets between points D and C. A Fibonacci retracement tool could be used, placing targets at 0.50, 0.618, or 1, for example.

5.0 Harmonic pattern

This is a slightly more complex pattern, as it includes an AB=CD, but also incorporates the waves prior. For a bullish 5.0 harmonic pattern, here are the Fibonacci levels to watch:

  • A down wave labelled 0X and an up wave labelled XA
  • AB is a down wave and is a 1.13 to 1.618 extension beyond point X
  • BC is an up wave, extending 1.618 to 2.24 of XA
  • CD is a down wave that retraces 0.50 of BC
  • AB and CD are the same size
  • Look for a move higher of point D

Below is an example of a bullish 5.0 Harmonic pattern on the CAD/JPY daily chart. The price is currently at point D and it must move higher to trigger a trade. At the time of a trade, this is what the harmonic patterns will look like. We do not yet know if the price will move as expected, so in this case, if the price keeps dropping, there is no trade. There will only be a trade if the price rises.

A stop-loss goes below the low swing created at point D, once the price starts rising. Targets are between point D and C, or they could be projected above C as well. The bearish pattern works in the same way, except that the up waves move down and the down waves move up.

Harmonic pattern indicators

The main technical indicator for harmonic trading is the Fibonacci retracement tool. It is used to verify every wave within the pattern, as well as highlight potential profit targets once the pattern has completed. For each pattern, once the first wave has formed, you could use the Fibonacci retracement tool to ensure the following waves are of the correct size to meet the harmonic pattern.

How to draw harmonic patterns

Harmonic patterns are drawn using lines that connect X and A, A and B, B and C, plus C and D. Using our award-winning online trading platform, Next Generation, it is possible to put our drawing tools into action to both label the waves for reference and, if desired, to write the retracement/extension levels of the pattern’s waves.

Instead of drawing trendlines, some traders prefer to use our triangle tools, which shade in the pattern and help to estimate the retracement levels. Here is an example of the NZD/JPY Butterfly pattern with some triangles added through our drawing tools.

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Harmonic scanner

There are harmonic scanners that identify various patterns as they are forming or complete. Our pattern recognition scanner​ can be used to isolate some possible trade set-ups. For example, some of the harmonic patterns look like double tops or bottoms, or even triple tops and bottoms if you flip the patterns, so this scanner can help to identify these. By using our patterns search tool, some harmonic patterns may be highlighted. You can then go through the pattern and make sure that it meets the pattern requirements, such as levels and structure, before trading it.

Harmonic pattern indicator MT4

MetaTrader 4 (MT4) is another international trading platform that is available through our own software, which contains Expert Advisors (EAs) that are programmed for certain functions, such as finding and even trading harmonic patterns automatically. After registering for an MT4 account, traders can search for tools that relate to harmonic trading and other specific patterns, such as Gartley, to find tools for isolating or trading that pattern.

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Harmonic patterns in forex

As mentioned, harmonic patterns can be traded in any market, but they are very commonly used in forex trading​ because the ability to trade 24-hours around the clock allows more patterns to develop on all timeframes. Harmonics patterns frequently occur in the forex market because the market trades 24-hours per day. This means that patterns can extend across lower timeframes, such as one-minute, five-minute, 15-minute, or hourly charts from one day to the next.

Harmonic stock patterns

Intraday patterns covering more than one day are less common in stocks, since there are gaps overnight and big volatility changes at the open of the share market​, which can throw off a pattern. Harmonic patterns in stocks are more commonly used on four-hour or daily charts, where small daily price gaps do not affect the pattern too much.

Harmonic patterns can also be spotted intraday and traded that same day. Those that are spotted on a low timeframe may not continue forming the next day since there are nightly gaps and big price swings in many stocks at the open each day. Therefore, if a harmonic pattern starts forming on a one-minute chart heading into the close one day, it is unlikely that pattern will keep forming the following day. It may be better to look for new patterns on a new day, or trade longer-term patterns that form over many days.

Summary: harmonic trading

Harmonic patterns are a precise way to trade and they can be helpful for traders who enjoy studying price charts and trading patterns. It is important to remember that harmonic patterns are not always successful. The price may not reverse at potential reversal zones or, if it does reverse, the price may not move as far as expected before turning back the other way.

Therefore, stop-loss orders are important for controlling risk. Once a trade is triggered, a stop-loss can be placed at the swing high/low near point D. However, while stop-loss orders can help to manage risk, they do not take into account market volatility; in particular, gapping or slippage on price charts. Instead, guaranteed stop-losses can be used to close out your position at a specified price in these risky conditions, for a small charge. Read more about our execution tools​, such as stop-losses and take profit orders for more information.

As you trade harmonic patterns, you should define at which Fibonacci levels you would like to take profit. This can help to further reduce any subjectivity from trading these patterns. This can also help to calculate your risk/reward ratio​ before the trade. If the potential profit is only marginally larger than the risk, you may wish to pass the trade on, but, if the reward is much higher than the risk, then the trade could be taken. All these elements come together to create a complete harmonic trading strategy.

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