ABCD or AB=CD is the most basic of all harmonic patterns. Harmonic patterns are defined by fibonacci retracement and extension ratios. Yes, in order to understand harmonics, its imperative that you have a deep understanding of fib ratios. If you are totally new to harmonic trading or trading in general for that matter please read this article first – An Introduction to Harmonic Trading.
There is one important thing to note when trading harmonics – confluence and price-reversal-zone or PRZ as popularly called. A pattern formed might as well become a failed pattern and continue to form a different pattern at another PRZ. The reason is confluence.
So, rule no. 1 – Don’t fall in love with any pattern, however perfect they might appear.
By experience we know that price follows a certain Zig Zag pattern. ABCD or AB=CD is in fact a method to define these random zigzag patterns using Fibonacci ratios.
The theory is simple. There is a starting impulse wave, then there is a correction. The 3rd wave length should be a similar length that of the 1st impulse wave. PRZ must include the end of the 3rd wave. In order to determine the PRZ and narrow it down to a smaller range, other price levels and confluence factors must be used.
AB = Impulse wave
C Point must retrace to either 0.618 or 0.786
CD price leg should be equal to AB leg
D Point will be at the 1.618 Fib extension off the BC leg if there is 0.618 retracement at the C point
D Point will be at the 1.27 Fib extension off the BC leg if there is 0.786 retracement at the C point
It all looks nice and clean on the above images. But its not so often on real life charts. Lets have a look at some real life examples too.
Above is the current AUDUSD H4 chart. As of right now, it is actually forming an ABCD pattern. Markets have been just opened and there seems to be a gap at this weeks open. Downside to this pattern is that C point has been just shy of the 0.618. It is still a valid pattern (according to my rules of engagement) since the candle that created the C point actually closed above the 0.50 retracement. Had the wick touched the 0.618 it would have been perfect.
Another negative point with regard to this particular ABCD is that the CD leg has more bearish momentum than that of the AB leg. Since we are looking for a reversal at the D point, we would have liked to see lesser bearish momentum in the CD leg compared to the AB leg.
Having mentioned those points to the contrary, we still might see price reverse sharply to the upside. How would I trade this though? This is a no-trade pattern for me. Unless I see strong reversal signals in price action in lower timeframes, there is no reason to enter any trade. Remember a pattern in itself offers only a slight probability of a reversal happening. Finding confluence and other reasons to support the idea of a reversal is totally up to the trader. This is the reason why some traders say harmonics do not work. They simply dont understand the concept behind harmonic trading.
Here is another example – a perfect ABCD pattern that worked out up to the pip…
Its also easy to spot completed patterns in older charts. Although its a challenge to spot currently forming patterns, by training your trading-eye to spot patterns in older charts and a bit of an understanding of order flow; you will feel more comfortable in spotting, expecting and trading AB=CD patterns on live charts.