In the world of speculative trading—particularly, in the world of forex—successfully identifying turning points will be absolutely crucial. Without knowing whether current price trends are in the process of reversing or are likely to continue, your daily trading strategy will carry an unnecessary degree of risk.
A turning point, as you might assume, is a point on a price chart where a trend turns and begins moving in the opposite direction. Generally speaking, turning points provide excellent opportunities for you to either close or open a new trading position.
There are quite a few different ways that traders will attempt to identify turning points. Developing a robust collection of technical trading indicators is certainly an excellent place for you to begin. Additionally, once you have effectively studied price trends for long enough, you will realize that certain patterns tend to emerge. When understood correctly, these patterns can be effectively exploited and will enable you to stay ahead of the slow-moving market.
Geometric trading patterns can be found in many different forms. Some of the best geometric trading patterns will utilize Fibonacci numbers and their related ratios. Fibonacci numbers can be found throughout the natural world, but their ongoing presence in the world of trading is something that is truly remarkable.
In this article, we will discuss the most important things for you to know about identifying harmonic price patterns. Harmonic patterns can be identified using Fibonacci numbers, which many traders believe to be an advanced form of geometric trading strategies. While these strategies are certainly not without their fair share of risks, they offer a unique market perspective that is frequently overlooked.
What is harmonic pattern trading?
Fibonacci (also known as Leonardo Bonacci) was an Italian mathematician who lived from around 1170 to 1250 CE. He is well-known for many of his extensive works in mathematics, but there is no doubt that his most famous contribution was the identification of the Fibonacci Sequence. Using natural patterns, this sequence can help “decode” geometric phenomena in nature and within human systems (such as trading markets).
Fibonacci’s theories have been applied to many different fields over time. The use of Fibonacci numbers in the world of trading has become increasingly popular in the digital era. Using the primary ratio—which relies on the “magic” number 0.618 and 1.618—multiple other “complementary” numbers can be easily derived. Complementing numbers include 0.382, 0.5, 1.41, 2.0, 2.618, 3.618, and several others.
Harmonic pattern trading strategies will triangulate recent price movements and attempt to identify if any of these ratios are currently present. If they are, based on historical data, future price movements will become much more predicted. In more recent years, Scott Carney and other trading theorists have helped apply these ratios to various different markets.
How can I identify harmonic trading patterns? What are some of the most common harmonic trading patterns?
In order to determine whether or not these ratios are present, the first thing you will need to do is identify the five most recent turning points. Turning points occur when a price changes its direction (positive or negative). Once you have identified these turning points, you will want to label them—moving from left to right—X, A, B, C, and D.
Using these five points, you should then be able to derive a quadrilateral. Accordingly, Point B will represent a relative “middle” while points X, A, C, and D will represent each of the quadrilateral’s corners. Once you calculate the ratios between each line within the quadrilateral (which itself will contain four distinct quadrants), you can then determine if any corresponding trading patterns are actually present.
In calculating these ratios seems confusing to you, you are certainly not alone. Fortunately, there are many different brands of trading software available that can help you identify these patterns and open (or close) trading positions in response. There are several different patterns that you should actively be looking for.
· Gartley Patterns (0.382, 0.618, 0.786, 0.886, 1.13, and 1.618)
· Butterfly Patterns (0.382, 0.786, 0.886, 1.27, 1.618, and 2.24)
· Crab Patterns and Shark Patterns (0.382, 0.618, 0.886, 1.618, 2.618, and 3.618)
· Cypher Patterns (0.382, 0.618, 0.786, 1.272, and 1.414)
Obviously, these ratios cannot easily be calculated by hand. The best trading software will be able to identify all five turning points for you. Then, keeping in mind that point “D” represents the price in the status quo, you can guess whether prices are likely to increase or decrease in the immediate future. Once you are familiar with Fibonacci trading, you will be able to forecast future movements with an even greater sense of precision.
Which markets are ideal for using harmonic pattern trading strategies?
As stated, Fibonacci ratios can be found in almost all natural and manmade structures in the world. The universal usefulness of these ratios is truly astounding. Because the principles underlying these trading patterns are universal, they can be applied to seemingly any speculative trading market.
However, there are quite a few reasons why Fibonacci trading is particularly useful in the world of forex.
·High trading volumes result in “cleaner” price movements
·24 hour trading periods eliminate gaps and jumps found in other markets (such as the stock market)
·High levels of liquidity help reduce associated trading complications
· Large amounts of historical data make it easier to “test” the predictive value of harmonic trading patterns
In order to make sure you understand the use and application of harmonic trading patterns, trading on paper in advance will generally be a good idea.
What are the pros and cons of using harmonic trading strategies?
As is the case with any technical indicator or derived trading strategy, using harmonic trading patterns will have both pros and cons associated with it.
The pros of harmonic trading patterns include:
·Mathematically consistent: these patterns are entirely objective, removing the need for subjective speculation
·Historically reliable: retroactively applying harmonic trading strategies yields a remarkably high ROI
·Automatic: with the right trading software, you can avoid the tedious mathematics and simply identify whether or not a harmonic trading pattern is present
The cons of harmonic trading patterns include:
·Need for precision: these ratios are all very precise; because there are very few perfect instances of harmonic trading patterns, there will always be a certain degree of speculation involved
·Limited Windows: harmonic trading patterns will only exist for a limited amount of time; because of this, they are mostly used by day traders
·Overlapping waves: because many of the ratios can be found in multiple different shapes (Crabs and Sharks, for example), it can be difficult to determine which harmonic trading pattern is actually present
Many of these apparent “cons” can be effectively managed. Using other technical indicators, such as the Elliott Wave, can help confirm the validity of a prospective position. Additionally, it will also be helpful to “zoom out” in order to avoid price complications caused by the continuous gyrating of the market.
Conclusion
Harmonic trading patterns represent some of the most useful tools for identifying possible price turning points. By learning how to use, interpret, and apply these patterns to your trading strategy, you can outsmart the market and identify profitable trading opportunities before they’ve gone away.