If you’re serious about forex trading, you need to understand how charts and chart analysis tools can help you identify trades that maximize your potential earnings while minimizing risk.
Standard chart patterns are easy to identify just by glancing at a chart and spotting certain movements, but advanced patterns, also known as harmonic patterns, require additional tools and information to identify trade opportunities and monitor price movements.
These harmonic patterns offer incredible value to traders who use them to inform their trading plan, and all of the tools you need to spot and track these patterns are available in online platforms such as MetaTrader 5. In general, the key characteristic of any harmonic pattern is the way the chart movement corresponds to the famous Fibonacci levels.
The Importance of Fibonacci Levels
Harmonic patterns are named after measurements known as Fibonacci levels, which are mathematical markers, expressed as ratios, that are used to indicate potential lines of support and resistance with a given asset. Fibonacci ratios are seen both in nature and in art, and their “harmonious” nature isn’t just appealing to the eye—they have also proved over time to be reliable metrics for forecasting future price movements.
Harmonic patterns develop when an asset’s price movements reach certain Fibonacci markers, moving both up and down in retracements and extensions that can foreshadow price breakouts. Although there are exceptions, most harmonic patterns feature four price movements from a starting point, X.
By studying these retracement levels and using them to time your trades in forex, you can reduce your risk by opening a position when the math suggests your risk is minimized. The graphic below shows the lines of retracement and range of risk associated with an asset that has fallen into a harmonic pattern:
The pattern that has developed indicates a future price breakout. An overeager trader might try to open a position quickly after the fifth point is established, for fear of missing out on the breakout if they wait too long. But the guidance provided by Fibonacci patterns, and the prevailing strategy used when analyzing harmonic patterns, suggests that traders are better off waiting until the price moves closer to the 61.8 percent retracement level.
This patience minimizes the potential risk if your prediction is wrong and the price dips to the stop area, and it increases your range of potential profit if your prediction is right.
Understanding the Gartley Pattern
One of the most famous patterns in history, and the most important harmonic pattern to understand in forex trading, is the Gartley pattern. This pattern has been modified over time since it was first conceived by H.M. Gartley in 1932, and many other harmonic patterns—including butterfly, bat, crab, and cypher patterns—all exist as variations of the Gartley pattern, with different Fibonacci ratios used to define their shape. If you understand the Gartley pattern, it’s much easier to apply these other harmonic patterns to your forex evaluations.
To identify a Gartley pattern, you first need a plain chart with no indicators present other than the Fibonacci lines. Any chart being analyzed for harmonic patterns needs to have four price movements that switch directions each time, with points X, A, B, C, and D. In this sequence, point C needs to have a 61.8 or 78.6 percent retracement from point B. At the same time, the movement of AB and CD must match, and point D should be a 78.6 percent retracement of X.
If these parameters are all met, you’ve got a Gartley pattern. Points A and C will tell you whether the price setup suggests a positive or negative breakout: If A and C are the highest points on the chart, you can likely expect a price decline. If A and C are lower than X, B, and D, plan for a price breakout.
Taking a Profit
Because you’re using Fibonacci lines to identify patterns and time your trades, you can also use them to decide when to take a profit. Consider two profit goals, depending on your own evaluation of a forex asset’s potential price movement. One profit goal comes at 38.2 percent retracement, at which point you can safely close your position and claim a profit. Or, if you’re feeling confident in the price, you can consider waiting until 61.8 percent retracement, capturing a nice return from your harmonic pattern analysis.
Harmonic patterns may be more complicated to analyze than standard patterns, but they offer clear rules when making trades. Incorporate this analysis strategy into your trading plan to improve your risk management and your ability to time your trades.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.