Harmonic Trading: Patterns, Rules and Examples

Do you know who Scott M. Carney is?

If you have come across harmonic trading before, you probably do.

Harmonic patterns theory for trading was introduced by Scott Carney^[1], in his book “The Harmonic Trader” in the 90s ( “Harmonic trading – profiting from the natural order of financial markets”^[2] – 2010 edition).

Harmonic patterns are purely based on Fibonacci retracements and extensions. The Fibonacci sequence is at the core of this trading approach.

This is why Scott subtitled his book “profiting from the natural order of financial markets”. The Fibonacci sequence is evident in nature all around us, thus giving context to the above phrase.

Now you know why the patterns are mostly named after animals.

All things aside, ultimately it comes down to 1 – usability and 2 – profitability of the method. But these attributes are subjective. So it’s completely up to you to decide on the usability and the profitability factors.

In this guide, you will also find some example forecasts of harmonic patterns.

If you are already an experienced patterns trader, then feel free to jump ahead to any preferred section below:

• Definition
• Overview
• Price patterns
• AB=CD
• Potential reversal zone
• Gartley pattern
• Bat pattern
• Crab pattern
• Butterfly pattern
• Secret technique
• Conclusion

Definition

The harmonic trading method identifies key reversal zones using price patterns, which forecast possible trade entry or exit levels.

The price reversal zone is labeled as the “Potential Reversal Zone” (PRZ) which defines the area where the pattern completes and the Fib ratios converge.

PRZ is the zone to look for possible trade opportunities in the opposite direction of the last leg that completes the pattern.

Harmonic price patterns are defined by a sequence of retracements and projections using Fibonacci ratios, thus providing specific price points to look for trade opportunities.

Fibonacci retracement levels have been used in trading for a long time. Except for the Elliott wave theory, no other trading method provided an organized and objective usage of the Fib ratios.

However, the term harmonics in trading is not new.

One of the earliest references to harmonic trading appeared in W. D. Gann’s book – The Tunnel Thru the Air^[3]:

"But mathematical science, which is the only real science that the entire civilized world has agreed upon, furnishes unmistakable proof of history repeating itself and shows that the cycle theory, or harmonic analysis, is the only thing that we can rely upon to ascertain the future."
W. D. Gann

So the concepts such as “order within chaos” and “financial markets too are governed by the same mathematical science as nature” have been around for some time.

Overview

Harmonic trading is based on price patterns. When speaking of price patterns, the Elliott wave theory has a prominent place.

Because the Elliott wave principle is one of the earliest pattern trading methods which is still widely in use, even today.

The concept of impulse and the corrective wave is a major similarity between Elliott waves and harmonics. Because the impulse-correction-impulse structure is the fundamental component of both pattern-trading methods.

In harmonic trading, this is the AB=CD pattern and in the Elliott wave principle, it is the ABC ZigZag ( corrective structure of a higher degree). Although the rules are not the same, the pattern itself is quite identical.

The real power of harmonic patterns is when multiple Fib ratios align to form a confluence zone. “The Harmonic Trader” introduced this potential reversal zone (PRZ) concept.

The patterns that comprise 5 price points are labeled as XABCD and they consist of 4 price waves – XA, AB, BC, and CD.

The Bat pattern is a precise, high R:R pattern. It distinguishes from the famous Gartley pattern with a slight difference in the retracement ratio for the mid-point B.

Bat and the Gartley patterns are the most popular of them all because they both revolve around the “golden ratio” for the sequence of retracements.

As opposed to the Bat and Gartkey, the final leg projection of the Crab pattern extends beyond the starting point – X of the pattern.

In addition to the Crab, the Butterfly pattern is another that the final D point extends beyond the starting X point.

Since the inception of the original harmonic patterns, many additional patterns have emerged within the trading community. Among those, the Cypher pattern is quite popular.

Price patterns of harmonic trading

Harmonic trading is precise and rule-based. There’s no middle ground, no ambiguity, it’s either black or white.

Extreme precision in trading can be a double-edged sword!

While precision does provide an objective approach to trading with the possibility of set-and-forget trades, it can also lead to a completely mechanical mindset. Which of course, can work against you, thus this particular sword would cut both ways.

Not all pattern trading strategies are made equal.

There are several similarities between the Elliott wave principle and harmonic trading.
To mention a few, both methods:

1. use price patterns as the basis to forecast the price
2. forecasts reversals
3. utilizes the concept of impulse and corrective wave

However the last point above – “the concept of impulse and corrective wave” drives it home. This is the key to mastering and executing any trading strategy that involves price patterns.

AB=CD

AB=CD pattern has 3 phases – AB, BC, and CD. Many a time AB and CD legs comprise impulse waves.

Right off the bat, there’s a warning sign that is screaming out loud! If the CD leg is an impulse, then any reversal trade must be handled with great caution.

An important rule in trading is “never try to catch a falling knife!”.

Scott himself rejected the notion of treating the AB=CD as an “end-all-be-all” structure. In fact, no pattern or strategy should be treated as such.

"The idea of trading every AB=CD that completes is absurd" - Scott M. Carney

Confluence in trading is key to maximizing the profitability of any trading strategy.

The key takeaway here is that variations of AB=CD are the basic component of every other harmonic pattern.

AB=CD rules

1. AB and CD legs are equal
2. C retracement between 0.382 and 0.886 (0.618 is ideal)
3. BC projection (D point) between 1.13 and 3.618

Although AB=CD is tradable as a pattern of its own, it is introduced as the main building block for other patterns.

Potential Reversal Zone (PRZ)

The concept of PRZ is used with harmonic patterns that consist of 5 price points (XABCD). As they contain 4 price legs, retracements and projections of the first 3 legs (XA, AB, and BC) provide 3 Fib levels to define the zone where the D point would complete the last leg – CD.

These Fib levels off XA retracement, AB projection, and the BC projection would not align up to the pip. But instead, they form a nice price confluence zone for the pattern completion.

Having a confluence zone to look for trading opportunities is the real advantage of trading with harmonic patterns rather than with standalone Fib retracement levels off isolated single waves.

Furthermore, the price boundaries of the zone clearly define where a pattern is still valid. Thus providing a clear level for the stop-loss placement.

Usually, the stop-loss is placed beyond the edge of PRZ with a cushion of a few pips depending on the timeframe.

Gartley pattern

H. M. Gartley presented the basic outline of this pattern in his book “Profits in the stock market”^[4]. In fact, in the context of visual structure, there is very little difference from the Gartley pattern as we know it today.

However, H. M. Gartley never attributed Fibonacci ratios to the pattern, nor did he name it the “Gartley”.

Although many technical analysts have assigned a variety of Fib ratios to the Grtley framework over the years, there was no set standard of Fib ratios until the publication of “The Harmonic Trader”^[5].

The Gartley harmonic pattern has a B-point retracement of 0.618 and the D-point retracement of 0.786. They are the current standard Fib ratios for the Gartley.

Gartley rules

1. XA leg retracement of 0.618 to mark the B point
2. AB leg retracement between 0.382 and 0.886 to mark the C point
3. Maximum BC projection of 1.618.
4. AB=CD is the most common, although other alternate ratios can exist
5. D point at the 0.786 retracements of the XA leg

Bullish Gartley pattern

If the starting XA leg is upwards, then the trade call would be bullish. Such patterns confirming the Gartkey rules would be bullish Gartley patterns.

Bearish Gartley pattern

The same Gartley ratios and the pattern in the opposite direction, in which the trade calls would be to short the market, are bearish Gartley patterns.

Perfect Gartley pattern

There is a special Gartley pattern defined with precise ratio confluence. This particular pattern is called the perfect Gartley pattern, simply because of the perfect and precise Fibonacci ratio alignment.

The perfect Gartley rules differ from the conventional Gartley rules only at the C point (AB retracement) and the BC projection. In the perfect version,
1. AB retracement to mark the C point must be 0.618 instead of the range.
2. BC projection must have a mandatory 1.618

In the perfect Gartley pattern PRZ is defined by a narrow zone between 1.441 and the 1.618 BC projection.

Bat pattern

The Bat pattern commonly appears at significant price levels of support and resistance. As such, Bat structures represent corrective signals.

The bat pattern provides the best risk-to-reward ratio because the PRZ limit is defined by an 88.6% retracement of the XA leg. The minimum BC projection is 1.618, so the price has room for a deep retracement of the XA leg.

That gives a narrow gap between the X and D price levels. Even for those traders who use a very safe stop-loss beyond the X point, the Bat pattern provides a tight stop-loss for trades.

So the R:R of trades of the Bat harmonic pattern is lucrative indeed.

Bat pattern rules

1. B retracement of the XA leg must be less than 0.618 (ideally 0.50 or 0.382)
2. PRZ limit is defined by the precise D point retracement of 0.886 of the XA leg
3. The minimum BC projection is 1.618 with possible extensions of 2.0–2.618
4. The minimum CD projection of AB is 1:1 (AB=CD). But a 1.27 alternate AB=CD is ideal
5. C point retracement between 0.382 and 0.886 of AB leg

Bullish Bat pattern

Bearish Bat pattern

Rules for the bearish Bat pattern are the same as the bullish pattern, only in the vertically inverted formation.

In the bearish setup, the XA leg is downwards, hence the trade call is for a short trade. Fib ratio alignments are the same.

Example Bat pattern (bullish) in the making – AUDUSD weekly chart.

Crab pattern

Crab is one of the few structures in that the D point that expands beyond the initial starting X point of the pattern.

This usually occurs due to price retesting the support or resistance price levels with momentum and force. Crab patterns mostly appear in corrective channels regressing against the direction of the predominant main trend.

Crab rules

1. Maximum retracement of 0.618 of the XA leg to form the B point
2. D point completion at the 1.618 projection of the XA leg
3. BC projection is typically above 2.618 (can be 3.14 or 3.618)
4. AB projection of 1.27 or 1.618 for the D point (alternate AB=CD)
5. C point between 0.382 and 0.886 retracement of the AB leg

Butterfly pattern

Ironically the Butterfly pattern too has the D point expand beyond the starting X point of the structure.

Out of all harmonic patterns, the Butterfly structure has the deepest B midpoint retracement of the XA leg.

Butterfly pattern rules

1. B point at a deep and precise 0.786 retracement of the XA leg.
2. C point retracement of AB between 0.382 and 0.886
3. The minimum BC projection for the D point is between 1.618 and 2.24
4. Minimum equal AB=CD is required (alternate 1.27 AB=CD is the most common)
5. 1.27 XA projection most critical number in the Potential Reversal Zone (PRZ)
6. D point must be at the 1.27 XA projection. !.618 XA projection invalidates the pattern

Bearish Butterfly pattern

When the pattern forms with X and D points above the A, B, and C points (starting XA leg is downwards), then it is a bearish butterfly pattern.

The trade signal of this pattern is (correct!) bearish.

Bullish Butterfly pattern

If the X and D points are below the A, B, and C points of the butterfly structure, it is called a bullish butterfly harmonic pattern.

Because the trade signal is for a long trade.

Perfect Butterfly pattern

The Perfect butterfly pattern differs from the regular structure only at the BC projection.

The usual butterfly structure must have a BC projection between 1.618 and 2.24. But in the perfect structure, the PRZ limit would be defined by a precise 1.618 BC projection.

The defining limits of the PRZ in this case are:
1. precise 1.27 XA projection
2. precise 1.618 BC projection.

Secret technique

The price movement of any market alternates between impulsive and corrective phases. Impulse movements are usually followed by corrections.

This knowledge of alternating phases of the market becomes very useful in pattern trading, especially when the pattern is utilized for reversal trades.

The technique is to work with 2 contexts of time (within the same timeframe and chart, of course).

Think of the time contexts in terms of moving averages – e.g. 100-period ma and 20-period ma. The idea is to have the reversal trade in the direction of the longer-term predominant wave.

For the reversal trade to be in the right direction, the CD leg of any pattern must be against the predominant impulsive direction. This means the CD leg must show some weakness compared to the XA leg.

Having said that, if you have studied the Elliott wave theory, then you know that the XA leg too can be impulsive. ABC ZigZag correction in the Elliott wave principle is the closest counterpart to the AB=CD portion of all harmonic patterns.

In this case, both the AB and CD legs would be sharp. However, all three waves of AB=CD combined, are still a corrective structure.

The secret technique to maximize the success rate is to only look for patterns with A to D overall steepness less than the XA leg. If you come across harmonic patterns with the AB=CD phase much sharper compared to the XA leg, then it probably needs another review.

Conclusion

When it comes to harmonic patterns, PRZ is the most important concept.

The Fibonacci retracements and projections of various legs of a harmonic pattern never align up to the pip.

This misalignment is the real beauty of it because that provides the gorgeous PRZ zone to confirm the pattern and then enter or exit a trade.

1. Scott M. Carney “The Harmonic Trader“
2. Scott M. Carney “Harmonic trading – profiting from the natural order of financial markets” United Kingdom, Pearson Education, 2010.
3. William D. Gann “The Tunnel Thru the Air: …or Looking Back From 1940” N.p., Pantianos Classics, 1927.
4. H. M. Gartley “Profits in the Stock Market” United States, Lambert Gann Pub, 1935.
5. Scott M. Carney “The Harmonic Trader” United Kingdom, unknown binding, 1999.