Many traders rely on chart patterns to help them identify trading opportunities. In some cases, chart patterns are combined with technical indicators to produce greater insights.
Harmonic chart patterns were developed by H.M. Gartley in 1932 and popularized in his book, Profits in the Stock Market. Since then, market technicians have improved upon these concepts by incorporating Fibonacci ratios and specific rules. The AB=CD pattern is one of the most popular harmonic chart patterns.
In this article, we will take a look at how to identify the AB=CD chart pattern and use it to identify profitable trades.
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What is the ABCD Pattern?
The AB=CD chart pattern is a reversal pattern that helps you predict when the price is about to change direction. Depending on the orientation, the pattern can be used to predict either a bullish or bearish reversal. It also appears relatively frequently in stock charts, making it particularly useful.
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Let’s take a look at a diagram of the pattern:
The AB=CD chart pattern consists of three legs:
- A-to-B: The A-to-B leg is the initial move higher or lower.
- B-to-C: The B- to-C leg is a 61.8% Fibonacci retracement of the A-to-B leg.
- C-to-D: The C-to-D leg is a 127.2% Fibonacci extension of the A-to-B move that should equal to the A-to-B leg in distance.
In some cases, traders may permit the A-to-B leg to be different in length than the C-to-D leg, as long as the retracement and extension fall on Fibonacci levels.
How to Use the Pattern
Buy and sell signals are generated after the final C-to-D leg, when a reversal is expected to occur. If the pattern is trending higher, you can look to sell or enter a short position at Point D. If the pattern is trending lower, you can look to buy the security at Point D in anticipation of a turnaround.
Stop-loss points are best placed just above or below Point D, depending on the direction of the trade. If the move extends beyond that point, the chart pattern is invalidated and the reversal is less likely to occur.
Take-profit points are typically placed using Fibonacci levels. For example, you might look for a move back to the original Point A and move a trailing stop-loss to 28.2%, 50% and 61.8% Fibonacci levels along the way.
As with most forms of technical analysis, the AB=CD chart pattern works best when combined with other technical indicators or chart patterns, such as the relative strength index (RSI) or pivot points. You may also want to use volume as a confirmation of a reversal once the AB=CD chart pattern makes a prediction.
Example of the AB=CD Pattern
Let’s take a look at the AB=CD chart pattern in the widely popular EUR/USD currency pair.
In this example, you can see an initial A-to-B leg, followed by a 61.8% retracement between Points B and C. There was a brief period of consolidation before a move lower reached the 127.2% extension level. The stock again consolidated for a period of time before the start of the anticipated bullish reversal.
There was also some technical confirmation from trend line support a few days ago prior to the original move higher leading up to Point A. The only red flag in this pattern is that there was limited volume following the reversal, but the strong trend line support could be enough technical justification for a buy signal.
The Bottom Line
The AB=CD chart pattern is one of the most popular harmonic patterns developed by H.M. Gartley. Since it appears frequently in practice, traders can use it in conjunction with other forms of technical analysis to improve their odds of success. The key is matching up Fibonacci levels and setting the right stop-loss and take-profit points to manage the trade.