If you ever look at the inside of a flower—or various other natural phenomena, for that matter—you will quickly realize that the arrangement of its petals is not “random”, rather it contains a very specific pattern. In fact, the interior of a rose is one of the most commonly cited naturally occurring instances of a Fibonacci sequence.

The number of natural instances where geometric patterns occur is something that is truly astounding. However, it’s not just nature where these patterns can be frequently found—many different components of human behavior tend to create a natural sequence as well.

As time has gone on, the behaviors and actions of traders has continued to represent a wide variety of different patterns. By carefully monitoring these patterns, the future behavior of entire markets (such as the foreign exchange market) can be predicted with a much greater sense of mathematical precision.

Navigating the world of geometric trading patterns may sound quite difficult, or even impossible. However, by simply paying attention to the finer details and keeping the proper principles in mind, these patterns can actually be easily detected. This will make it much easier for you to know when to enter into and out of various different trading positions.

In this article, we will discuss the most important things for you to know about a practice referred to as harmonic pattern trading. Though this practice, like every other trading theory, will not guarantee an immediate return on your investment, the mathematical principles that validate it have caused its use to become increasingly appealing in several different markets.

What is harmonic pattern trading?

Harmonic pattern trading strategies involve looking for geometric patterns in asset price changes over time. This will be especially crucial for short-term traders who are hoping to move into and out of multiple positions in a single trading hour.

When graphing the price changes of a given asset over time, there will often be several “triangular” movements that correspond with the primary ratio. Examples of the primary ratio include 0.618 and 1.618. This seemingly “magic” ratio can be found in nearly every natural structure in nature, all structures made by humankind, and—perhaps most importantly of all—various different financial markets.

You should also actively monitor for complementing ratios such as 0.382 (which is simply 1- 0.618), 0.50, 2, 2.618, 3.618, and several. Once you have begun to identify these patterns, you will find that you are in a position to predict the way that prices will change in the future. Though, in theory, harmonic trading patterns could be identified manually, this is something that will almost always be unnecessarily difficult. There are many different computer programs you can use in order to automate the pattern detection process.

What are these patterns used for? What are some of the issues with harmonic pattern trading?

While the relationship between these ratios is something that always remains consistent, their ability to accurately appear in markets is something that is a bit less clear. There are plenty of instances where a trading pattern may appear to be harmonic, but instead will ultimately fall flat. The risk of this unique strategy is that if the pattern fails to materialize, then the markets may not be moving in the direction you had originally hoped.

Essentially, these patterns are used for traders to help identify a specific “reversal” point. Any asset that is increasing in value will likely begin decreasing in value at some future point in time. Similarly, any asset that is decreasing in value will (almost always) reverse this trend and begin moving in a positive direction. By monitoring these naturally occurring patterns, traders can attempt to be “ahead” of the curve and open a new position before the general market has been able to respond.

It’s also important to note that many of these patterns may be existing simultaneously. No asset exists in a vacuum, meaning that you may need to be accounting for multiple different geometric “waves” whenever you are entering into or out of a given position.

What are some of the most common harmonic trading patterns to look for?

There are several different harmonic trading patterns that could potentially occur. Two of the earliest thinkers regarding this technique were H.M. Gartley and Scott Carney—these revolutionaries recognized that the timeless principles of mathematics would likely be much more secure than the simple “instinct” used by many of the traders in years past.

These are just a few of the geometrically sound patterns that traders can be actively monitoring for:

• The Gartley—as markets continue to move over time, they will inevitably move up and down. After connecting the “dots” to make a theoretical trapezoid, a “bullish” Gartley pattern will produce a trapezoid that is wider at the bottom (0.786) than it is at the top (0.382), and the price will be generally moving upward. A “bearish” Gartley, on the other hand will be generally moving downward, with a wide top and narrower bottom.
• The Butterfly—this pattern will be similar to the one mentioned above, but will have different ratios and different turning points. For example, a bullish butterfly will have a bottom ratio of 1.27 and a top ratio of 0.382; this suggests that, when all else is equal, these patterns may take slightly longer to fully materialize.
• The Bat—this is yet another pattern that resembles that Gartley, though its measurements will be quite different. When successfully executing a bat trade, it will be important to wait until the initial price rise has actually occurred.
• The Crab—this graph resembles the butterfly in the sense that it has relatively more dramatic “turning points.” Carney claims (and has proved using math) that the Crab may be the pattern that is able to most closely embody the Fibonacci sequence.

If you are a bit confused by these graphs and theories, you are certainly not alone. In order to be able to put them into material use, it will be important to recognize the material situations where they have actually unfolded.

What markets can benefit from the use of harmonic pattern trading?

In theory, harmonic pattern trading can be applied to seemingly any industry where assets are regularly traded. For example, these patterns may unfold in the stock markets, bond markets, and various others.

However, due to the fact that these markets have so many asset-specific variables (such as company news, etc.), this strategy can often be considered an afterthought. The market where harmonic pattern trading is implemented on the widest scale is the forex market. Naturally, this will also be the market where you can find the widest range of real-world examples.

How can I effectively implement a harmonic pattern trading strategy?

As stated, there are still some risks involved in using this strategy, namely, that the patterns will not actually unfold. However, in order to protect yourself from this happening, there are still several things you can do.

• Use stop losses and stop orders—this will protect you from instances where turning points occur unexpectedly or too late.
• Diversify—applying these principles to many different assets (specifically, currencies) will help minimize the exposure to single-instant outliers.
• Use other strategies as well—this technique is by no means mutually exclusive. By developing a more comprehensive trading strategy, you will find yourself in a much better position.

Conclusion

Harmonic volume trading is a technique usually employed by more experienced forex traders. However, by familiarizing yourself with these principles and learning to identify where a harmonic pattern may be unfolding, you may find yourself in a position where you can predict value changes with a greater degree of precision.