How Do You Trade ABCD Patterns? - ABCD Chart Patterns

Imagine a trader who is watching the earnings accumulate from a successful “buy” deal he made on a particular stock. Prices just keep on rising and, with it, his account balance just keeps on swelling. At a certain point, though, he’ll start to second-guess himself. “Perhaps”, he’ll reason, “prices are growing too inflated for their own good and are setting themselves up for a fall.” Since no bull run goes on forever, he knows he will have to, sooner or later, close his position and walk away with what he has earned until now.

Here's an interesting question: Is there any way of knowing when this moment will occur? When will his instinct of self-preservation get the better of his desire for an ever-fatter account balance? And let’s add another question: When enough bullish traders close their positions and prices indeed start to drop, when will they second-guess themselves once again, considering: “Perhaps there is, in fact, more room for a bullish run and our pullback was premature”?

It might seem to you that these second and third thoughts in traders’ minds emerge entirely at random, but many people believe they do not. More importantly, there is a substantial body of evidence to support their position. The research doesn’t just show that there’s some kind of regularity in traders’ waves of decision-making. It puts precise numbers on the waves. If you push one of these researchers for an answer, he’ll identify the exact moment at which the retreating bulls will slow down and poise for another upward push: when prices retrace the original bullish thrust by 61.8%.

The Fibonacci Sequence

Perhaps it surprises you that we’re so confident and exact about this? Nevertheless, thousands of charts support the notion that price movements tend, more often than not, to reverse at this point. This percentage is familiar to us because it derives from the Fibonacci ratio, otherwise known as the Golden Ratio. This ratio repeatedly emerges when you take a sequence of numbers made up by adding up the two last digits (like this: 0,1,1,2,3,5,8,13,21,34…), and divide each number by its predecessor. It seems “golden” to us, not only because it is a mathematical peculiarity, but also because it appears persistently in nature.

If you take a close look at a pinecone, you’ll notice that it’s made up of a series of eight spirals, countered by a series of 13 going in the opposite direction. 13 and 8 are neighbours in the Fibonacci sequence. The structure of the sunflower, which is designed to optimize the plant’s use of sunlight, is also built through two opposing groups of spirals: 34 against 55. These two numbers know each other from their adjacent positions in the Fibonacci sequence. Without claiming any special knowledge of the Divine scheme in the world, it does seem that this ratio signifies the point at which Nature finds its happy medium: its ideal strategy of adapting and flourishing.

And, yes, we are suggesting that human beings involved in trading on the financial markets find themselves guided in their decision-making by that same universal ratio. After all, they are one of the marvelous creations in this world, no less than a pinecone or a sunflower! Once you accept this, the foundation is there from which to understand ABCD pattern trading.

What are ABCD Chart Patterns?

Take a look at this chart pattern, which might describe the price movements of a stock, a commodity, or a forex pair:

Prices started off by surging up the line marked as XA, where they met resistance and fell back to point B. This is that same point we mentioned above, where the retreating bulls begin to hesitate and consider trying for another upward push. And, as we explained, this point will mark a 61.8% retracement of the ground covered by XA. When prices have settled down to this extent (which means they lost close to two-thirds of the original progress made through XA), they shoot up again into bullish territory with line BC.

There they stall again, as the bulls start to question how much momentum they really can gather. BC is a 38.2% retracement of AB, which means that 38.2% of the bearish fall in prices signified by AB has been made up. Then, at point C, the bulls lose confidence once again: “How much more bullish momentum can we really muster?”, they wonder despondently.

After this second bout of self-doubt, the bulls are depressed enough to let prices drop even more than they rose in BC. To be exact, they fall 1.272 of the length of BC, and then they pause at D. How much have prices now lost with respect to their original bullish surge of XA? The answer is 0.786. In other words, all that remains of XA is a remnant of 21.4%.  

Now, if you find yourself holding at point D, and your ABCD chart pattern looks like what we have above, you may have a unique opportunity, so pay attention.

ABCD Pattern Trading

D is a potential reversal zone. This means we are anticipating a major bullish revival to show itself. It’s at this point that traders will open a “buy” deal on the security because the bulls are expected to come back with force. Although they’ve been tormented by self-doubt, we know their spirit is not yet broken. A common price target is as much as 161.8% over and above the level of A. (It’s there that you may want to put your take profits order because prices could meet a wall.) Having an inkling that prices are due for such a pronounced surge can be invaluable to you, so say thank you to Harold Gartley who laboured to discover this reversal point back in the 1930’s! The pattern we used above is called a bullish Gartley, and its opposite would be a bearish Gartley, which looks like the inverse of this shape and tells us when to expect a bearish downtrend. Traders interested in opening a “sell” deal on a security keep an eye out for these when perusing their charts.

Spotting a bullish Gartley takes practice but, for a start, try looking out for a large M-shaped price movement on your price charts (or W-shaped for the bearish Gartley). Before going ahead and acting on the pattern, you’ll have to check that its dimensions really do fit all the criteria for an official Gartley. Close to perfect won’t be good enough here. With a little bit of practice, you can get used to giving your chart patterns the once over to ensure they really are what you believe them to be. You wouldn’t want to find yourself opening a large buy deal at point D, only to find yourself left in the lurch when prices keep on dropping! Even if you do check your pattern out thoroughly, it’s wise to set a stop-loss order in case things don’t go according to plan.

Gartleys are not the only indicators of price reversals, but they certainly are special. They tell us, not only when to expect a trend reversal, but also how much of a reversal to expect. This kind of precision is highly prized by financial traders. The next ABCD pattern we’ll look at is based on the same Fibonacci ratios, and it’s considered at least as reliable as the Gartley.

The Crab

More recently, in 2000, Scott Carney produced his own version of the Gartley, and it resembles the shape of a crab. The crab, like the Gartley above, is a signal to buy and tends to precede a strong bullish thrust. Take note of the altered dimensions: After the bull run represented by XA, prices drop by 38.2%, so forming line AB. Prices then rebound in BC, making up (once again) 38.2% of the loss made through AB. With CD, prices go into an extended fall that amounts to over twice the length of BC (2.24 times, to be exact). Now, check that CD has erased all the progress made through XA and extended a little below X (CD is 1.618 the length of XA). If everything looks good so far, you have a potentially powerful buy signal at D!

Wrapping Things Up

It’s a good idea to read up about the various other ABCD patterns, examining closely both their bullish and bearish incarnations. Practice searching them out and testing them, but also practice ABCD pattern trading with iFOREX’s free demo account. When you do so, incorporate other technical indicators to confirm your analysis as much as you can. This is the way the experts do it.

Mastering ABCD chart patterns is a significant step forward in your journey into the financial markets. They offer powerful and precise reversal signals, which can potentially compound your earnings many times over. Remember, though, to study patiently and diligently so your understanding of these patterns is thorough and not superficial.