Also known as the AB = CD pattern, the ABCD harmonic pattern is a widely known chart pattern because it is the building block of many other chart formations, even outside of the harmonic family. It is the most basic harmonic price formation and is a component of most other harmonic patterns, except the Shark and Cypher patterns.
Harmonic patterns are advanced chart patterns that can be used to identify potential price reversal areas. The price swings that make up the patterns are measured to specific Fibonacci levels, which helps to predict where the next price swing would end.
If you have been following our previous posts, you should be familiar with the more complex harmonic patterns, such as the Crab, Gartley, Bat, Butterfly, Cypher, and Shark patterns. In fact, we have discussed the Crab and Gartley patterns in detail. But here, we will be taking an in-depth look at the AB = CD pattern and its variations.
In this post, you will learn:
- What the ABCD harmonic pattern is
- The various types
- The significance of the pattern
- How to identify the pattern
- The guideline for trading the ABCD setup
What is the ABCD harmonic pattern?
Harold M. Gartley described the ABCD pattern, as a component of the harmonic pattern named after him, in his 1935 book: Profits in the Stock Market. But it is now considered as a standalone pattern on its own, making it the simplest of the harmonic patterns because it has fewer price swings and swing points.
The ABCD harmonic pattern is basically the normal zig-zag price swings seen on the chart and consists of three price swings and four swing points — points A, B, C, and D, with AB, BC, and CD swings. The pattern can be symmetrical or asymmetrical in price movement and time, which is an important element in its classification.
Comprising of fewer price swings, the ABCD pattern can occur as a part of other harmonic patterns or exist alone as a tradable chart structure. It can occur as part of the impulse waves in the trend direction, where it indicates a potential trend reversal or a possible pullback. The pattern can also occur as a multi-legged pullback during a trend, in which case, it can signal a potential trend continuation when the price reverses from the pullback direction.
You can also see the pattern in a range market. In this situation, the price moves in three swings from one boundary of the range to the other, rather than one extended swing from boundary to boundary. So, depending on the orientation of the pattern, it can create a bullish or bearish reversal signal.
Whatever the case, the ABCD pattern is easy to identify if you understand its structure. Initially, the pattern wasn’t explained with Fibonacci retracement and extension ratios, but Scott Carney and co have attached some Fibonacci ratios to the price swings in the pattern.
The structure of the ABCD harmonic pattern
With four swing points and three swings (legs), the AB = CD pattern is structured as follows:
- The AB leg: The pattern starts from swing point A, which could be a swing high or a swing low. From there the price moves to the B point, creating the AB swing or leg. This leg can be in the direction of the predominant trend or in the opposite direction, and its direction determines the direction of the other swings and the nature of the signal created.
- The BC leg: From swing point B, to swing point C, the BC leg is a pullback wave on the AB swing. It is usually between 38.2% to 78.6% retracement of the AB wave but 61.8% retracement is seen as the standard. Its depth would determine the extent the CD wave would move for it to be equal to the AB wave.
- The CD leg: Starting from point C to D, the CD leg is a continuation of the AB wave. It extends beyond the previous high/low at the B point to the D point where the pattern is completed. The CD leg is usually between 127.2% to 261.8% extension of the BC leg. If the entire pattern is in the direction of the trend, then, it is an impulse wave, and the pattern may lead to a full trend reversal or just a pullback. However, if the pattern occurs as an extended (2-legged) pullback, a trend continuation move is expected at the D point — also known as the potential reversal zone (PRZ).
Types of the ABCD harmonic pattern
Normally, the ABCD harmonic pattern is classified based on the type of signal it generates into a bullish pattern and a bearish pattern, and both can occur in any market situation — uptrend, downtrend, or a ranging market.
Bullish ABCD pattern
A bullish ABCD harmonic pattern is one whose structural orientation is pointing downward, so it has the capacity to bring a bullish reversal effect when the pattern completes at the D point, often regarded as the potential reversal zone (PRZ). It is formed by downward AB and CD waves with an intervening upward BC wave. The D point is, therefore, a lower low to B point.
This pattern can be seen in an uptrend as a two-legged extended pullback, which may lead to a continuation of the uptrend after the pattern is completed at the D point. It can also be seen in a downtrend where it can cause a pullback or an outright trend reversal. Of course, the pattern can be a downswing in a range market, which is followed by an upswing to the opposite boundary.
Bearish ABCD pattern
The bearish ABCD harmonic pattern has an upward structural orientation, which gives it the capacity to generate a bearish reversal signal when the pattern completes at the D point (PRZ). It consists of an upward AB, a downward BC wave, and an upward CD wave that extends above the B point to end at the D point, creating a higher high appearance.
A bearish ABCD pattern can occur in any market condition: In a downtrend, it can form as a two-legged extended pullback, which, when completed at the D point, can generate a trend continuation signal. It can also be seen in an up-trending market as a part of the impulse waves and may lead to a deep pullback or an outright bearish trend reversal. In a ranging market, the pattern can be the price swing to the upper boundary, creating an opportunity for a bearish move.
Variations of the ABCD harmonic pattern
The basic ABCD harmonic pattern is said to have AB = CD structure, which implies that the CD wave is equal to the AB wave both in price and time dimensions. It looks something like this:
However, the pattern rarely occurs that way. What you are likely to see are situations where the CD wave is equal to the AB wave in price dimension only, with the waves occurring over different periods of time, and situations where the CD wave is more than the AB wave. Let’s discuss the two common formations.
Classical ABCD pattern
The classical ABCD harmonic pattern is one that has a symmetrical structure, with the CD wave equal to the AB wave in price dimension. But the BC and CD waves can have varying Fibonacci retracement and extension ratios combinations that ensure the symmetrical structure.
For the AB wave to be equal to CD wave, the possible Fibonacci ratio combinations for the BC and CD waves are as follows:
- If the BC wave retraces to 38.2% of the AB wave, then, the CD would be a 261.8% extension of the BC wave
- If the BC wave retraces to 50% of the AB wave, then, the CD would be a 200% extension of the BC wave
- If the BC wave retraces to 61.8% of the AB wave, then, the CD would be a 161.8% extension of the BC wave
- If the BC wave retraces to 78.6% of the AB wave, then, the CD would be a 127.2% extension of the BC wave
Extended ABCD pattern
In this alternative ABCD pattern, the structure is not symmetrical as the CD wave can be less or more than the AB wave. Most times, the CD wave is longer than the AB wave in price and time. So, the CD wave is seen as overstretched. In that situation, the price is either overbought or oversold.
The CD wave can be anything from 1.27 times to more than twice the size of the AB wave, but the common extensions include:
- CD = 1.27 x AB
- CD = 1.618 x AB
- CD = 2.0 x AB
- CD = 2.618 x AB
What does the ABCD harmonic pattern signify?
The significance of the ABCD harmonic pattern depends on where the pattern occurs in the context of the market structure, as the pattern can occur in a downtrend or uptrend and can be a part of the trend or a pullback in a trend. It can also occur in a range market. So, let’s take a look at them one by one.
When the pattern is occurring as a pullback in a trending market, it signifies a much deeper correction than was expected. As you know, every price correction starts with profit taking before those with opposite bias see it as an opportunity to hop into the market.
For instance, in an uptrend, profit taking would cause the price to drop. Some retail buyers who have been waiting for a better price level to enter the market would hop in, pushing the price back up. But since these traders don’t have enough buying pressure, more profit taking would kill their little momentum and turn the price back downwards, which invite sellers to the market, thereby dragging the price further down, creating the second leg of the pattern. The result is a deeper pullback which, when completed at the PRZ (point D), would show an oversold market that is ready to rally and continue the uptrend. See the chart below. The exact opposite happens when the pattern occurs as a pullback in a downtrend.
The psychology of the pattern is different when it occurs as an impulse wave extension in a trend. In this situation, it shows buyers exuberance, which often culminates in a buying climax — in the case of an uptrend. For a downtrend, it shows sellers determination and a potential capitulation.
Whatever the case, the completion of the pattern at point D would lead to massive profit booking, which can either lead to a full trend reversal or a significant pullback. Your ability to anticipate what would happen would determine if you can trade the setup and how you manage your trade when you are in one. See the chart below.
Finally, in a ranging market, the ABCD pattern simply implies a 2-legged swing up or down. The good thing is that you know where the D point would be, and it corresponds with existing support (lower boundary) or resistance zone (upper boundary).
How to identify the ABCD harmonic pattern on your chart
Unlike the other harmonic patterns, the ABCD pattern is relatively easier to identify on a price chart because it occurs more commonly than the others. Before we go into how you trace the pattern on the chart, let’s take a look at the tools.
Tools for identifying the ABCD pattern
The ABCD pattern is just a 3-swing zig-zag price movement, which you can draw with the zigzag indicator or simple trend lines. You can use the Fibonacci tool to measure the retracement and extension levels, while you use any of the labeling tools to label the various swing points.
However, there are tools that can be used to trace the price swings, which label the various swing points and displays the Fibonacci retracement and extension levels at the same time. Depending on the platform you are using, you can either have a built-in harmonic tool or need to install a custom harmonic indicator.
In the TradingView platform, there is the ABCD Pattern harmonic tool, which is specifically meant for drawing the ABCD pattern. If you are using the MT4 or MT5 platform, you can get any of the custom harmonic indicators, such as the ABCD Retracement MetaTrader Indicator. Install it on the platform, and you are good.
Tracing the ABCD pattern
Although it is often a part of a larger harmonic pattern, it can also occur on its own. It consists of three swings and four swing points, so you may anticipate a possible ABCD pattern when you have two completed swings and three swing points, with the third swing still emerging.
At this stage, what you do it to pick your harmonic tool — the ABCD Pattern tool in TradingView or a similar indicator in the MetaTrader —and start to trace the price swings. The first swing point you click will take the A label. From there, drag the tool to the next swing high/low as the case may be — this takes the B label. Drag the tool again to the next swing point, which takes the label C, and then, project your tool beyond the B point to the Fibonacci extension level that corresponds with the BC retracement level — this will be the possible D point or the PRZ if the CD wave will be equal to the AB wave.
ABCD pattern rules: the checklist
For a symmetrical pattern, the Fibonacci retracement and extension ratios should be as follows:
- BC is often a 38.2% to 78.6% retracement of the AB wave
- CD should be a 261.8% extension of the BC if the BC is a 38.2% retracement of AB,
- CD should be a 200% extension if the BC is 50% retracement
- CD should be a 161.8% extension if the BC is 61.8% retracement
- CD should be a 127.2% extension if the BC is 78.6% retracement
Note that the pattern may not end up as a symmetrical pattern, meaning that the CD wave may be far longer or shorter than the AB wave, and this can affect your ability to predict the PRZ.
The ABCD harmonic pattern trading system
Now that we have gotten the general idea of the ABCD harmonic pattern, it’s time to take a look at how you can trade it. But before then, let’s discuss some tips and basic rules that can help you refine your analysis and trading.
The trading tips
Here are a few tips to consider when trading this pattern:
Consider the position of the pattern in the overall market structure: Don’t just trade any pattern you see. You need to consider how the pattern fits into the entire price action. An ABCD harmonic pattern that occurs as part of an impulse swing is more likely to cause a pullback than a trend reversal, especially if the BC wave could only retrace about 38.2% to 50%, which implies that the trend is strong.
- Wait for the pattern to complete: If you are dealing with the symmetrical ABCD pattern, you can project the D point before the price gets there. But you can’t know at the beginning whether the pattern would end up a classical symmetrical one or an extended pattern, which makes it difficult to trade. One thing to note is that the extended pattern is more likely to be a part of another harmonic pattern like the Gartley, Bat, Crab, or Butterfly pattern. Whatever the case, it is better to wait for the pattern to complete to know what you are dealing with.
- Consider the extension of the CD wave: For the extended ABCD pattern, you can take a cue from the ratio of the CD wave to the AB wave. If the CD wave is 1.61 times or more of the AB wave, the price is probably overstretched and exhausted in that direction, so a reversal is more likely.
- Make use of a trade trigger: The PRZ tells you where the price is likely to reverse from, but it cannot tell you the right moment to enter a trade — hence, the need for a trade trigger, which can tell you when the price is about to reverse. Examples of triggers to use are oscillator divergence, counter-trend line breakouts, and reversal candlestick patterns, like the pin bars, morning or evening stars, inside bars, and engulfing patterns.
- Plan your risk and trade management beforehand: You should know where you want to place your stop loss orders, as well as when to move it to breakeven, before entering a trade. Also, consider how you want to take profit — single profit target, multiple partial profits, or trailing.
- Breaking the C point is a good sign: The C point is a critical level in assessing the price movement. When the price takes out the C level after reversing at point D, there is a great chance that the price would move further.
Trading the bullish ABCD setup: a step-by-step guide
These are steps to follow when trading a bullish ABCD harmonic pattern:
Identify an emerging bullish ABCD pattern and consider the market structure
As a component of most harmonic patterns, you can either identify it as a part of another pattern or on its own. With two completed swings, three established swing points, and an emerging third swing, you may start thinking of a potential classical or extended ABCD pattern. More importantly, note the position of the pattern in the broad market perspective. It is better to trade it when it is occurring in a range market with already-established support and resistance zones or as a pullback in a trend, as you can see in the chart below.
Draw the pattern and identify the possible D point
With the help of your harmonic tool, trace the price swings, and estimate the potential D point. But this only works for a symmetrical pattern, and there is no way to know how the pattern would end up.
Wait for the pattern to complete
Since there is no way to tell whether the pattern would be symmetrical or not, it is better to wait for the pattern to complete first. One clue to guess whether the pattern would be extended is if it is part of another pattern, such as the Crab, Bat, or Butterfly pattern.
Look for a bullish trigger
One of the signs that the D point has formed is if the price is stalling and showing signs of reversal after reaching your estimated level. At this point, look for a bullish reversal signal, such as the hammer, morning star, a bullish inside bar, or a bullish engulfing candlestick pattern. Alternatively, you may use a bullish oscillator divergence or a breakout of a counter-trend line placed on the CD wave, as you can see in the chart below.
Enter a long position at the close of the candlestick that completes the trigger
Once the candlestick that generates or completes the trigger closes, you can enter a long position with a buy market order or place a buy stop order above the high of that candlestick.
Place a safe stop loss
A safe place to place your stop loss is below the lowest point of the CD swing low. Ensure you use a hard stop loss order rather than a mental stop because of violent adverse price movements.
Book your profits at the right levels
You can use multiple profit targets at the levels of swing point C, point A, and 161.8% extension of the CD wave. You can scale out of your position at these levels.
Trading the bearish ABCD setup: a step-by-step guide
These are steps to follow when trading the ABCD harmonic pattern:
Spot an emerging bullish ABCD pattern in the right place
Look for the patterns that occur in a range market with already-established support and resistance zones or as a pullback in a trend. If you have two completed swings, three established swing points, and an emerging third swing, a potential classical or extended ABCD pattern may be forming.
Draw the pattern and identify the possible D point
Pick your harmonic tool and trace the price swings and estimate the potential D point. Beware that the pattern may not end up symmetrical.
Ensure that the pattern is complete
It is best to wait for the price to reach the estimated D point or beyond it and stall so that you avoid any ambush from the market.
Check for a bearish trigger
Once the D point is established, look for a bearish reversal signal, such as a break below a counter-trend line placed along the CD wave, a bearish oscillator divergence, or a bearish reversal candlestick pattern, such as the shooting star, evening star, a bearish inside bar or engulfing bar.
Go short at the close of the candlestick that completes the trigger
Enter a short position with a market order at the close of the candlestick that formed the trigger. Alternatively, place a sell stop order below the low of that candlestick.
Place a safe stop loss
Put your stop loss above the highest point of the CD swing high. It is better to use a hard stop loss order than a mental stop to avoid violent adverse price movements.
Book your profits at the right levels
Swing point C, point A, and 161.8% extension of the CD wave are good levels to take partial profits as the price drops.