Explaining harmonic price patterns for beginners
When trading Forex, stocks, or other trading assets, many people tend to use practices that help them speculate the future prices of their assets. While it’s not guaranteed that every prediction will work out in the end, traders still use technical/fundamental analysis, technical indicators, or pattern analysis in their trades.
When it comes to the pattern analysis, there is a prediction method called harmonic price patterns that gets the most attention from traders. The core idea behind this method is that everything around us has some sort of pattern that repeats itself.
As for harmonic patterns themselves, they’re called harmonic because they derive from the Fibonacci sequence - the famous mathematical formula that goes like this: 0, 1, 1, 2, 3, 5, 8, 13, 21… In short, every next number is a sum of the previous two numbers.
From those numbers, the harmonic pattern ratios can be derived. The most integral ratios are 0.681, 0.382, 0.236, etc. There are also those ratios that are derived from the integral ones, including 1.681, 2.236, 3.14, etc. Harmonic price patterns use exactly those ratios for predicting future price movements.
Harmonic price patterns usually consist of four consecutive price movements on the chart. In order to identify them as harmonic patterns, they have to conform with the ratios derived from the Fibonacci sequence. For this reason, traders can basically analyze harmonic price patterns using the Fibonacci Retracement indicator and some additional tools.
If and when the harmonic pattern is detected, then a trader can make a certain prediction about where the next price will go. Depending on which types of harmonic price patterns they use, the future price movement will go in different directions.
There are lots of different harmonic patterns in Forex and other markets. Among the most popular ones are:
- Gartley pattern
- Bat pattern
- Butterfly pattern
Let’s take a look at each of these patterns more closely.
The Gartley pattern
The first harmonic pattern was introduced by H.M Gartley in his book, Profits in the Stock Market, that’s why it is called the Gartley pattern. Additionally, all the other harmonic patterns use this pattern as a foundation for their specific use-case.
So, here’s the brief explanation of the Gartley harmonic pattern ratios and how they work:
- The first price move on the chart can be anything as there are no specific requirements for it to be recognized as a harmonic pattern;
- The next move should be the opposite of the first one and be about 61.8% (0.618) of it;
- The third price move should also be the opposite of its previous move. This one has two possible ratios: either 38.2% or 88.6% of the second move;
- The fourth and final move should, again, be opposite of the third movement and it should either be 127.2% (if the third move is 38.2%) or 161.8% (if the third move is 88.6%);
- From the first to the last movements, the overall move should be 78.6% of the original price.
Now, if the above-mentioned “zigzag” patterns can be detected on the chart, traders can use other Fibonacci ratios to predict future price moves of their assets.
The Bat pattern
The Bat pattern, as we have already mentioned, derives from the Gartley pattern and takes a similar zigzag complexion. However, unlike its predecessor, the Bat pattern lines are a little bit more symmetric to one another, while the 88.6% Fibonacci retracement appears in several places. So, here’s how the pattern works:
- Just like in the Gartley pattern, the first move in the Bat pattern can be any random one and there are no particular prerequisites for it to be considered the harmonic pattern;
- The second move should be opposite to the first one with a difference of either 38.2% or 50% from the initial move;
- The third move is also supposed to be the opposite of the second move. As for the difference, it should either be 38.2% or 88.6% of the second move;
- The final move, also opposite to the previous one, should either be 161.8% (if the previous move is 38.2%) or 261.8% (if the previous move is 88.6%);
- The total price move from the first to the last move should be 88.6%.
The two harmonious patterns - Gartley and Bat - are similar in another aspect: both of them end in a point that doesn’t go beyond the first price move. For this reason, they are called internal patterns.
The Butterfly pattern
The Butterfly pattern is similar to the previous patterns in some ways, yet in other ways, it differs from them. The similarity between the three patterns is that they all have four legs, all of them are the opposites of one another, and they come from the original Gartley Pattern.
However, unlike the previous patterns, the Butterfly pattern’s end price is beyond the initial leg. This means that the price has changed much more drastically than in the previous FX harmonic price patterns. Here’s how this pattern works:
- The first movement, as always, is random and can be anything;
- The second move should be the opposite of the first one and the difference must be about 78.6%;
- The third move is also opposite to the second move. It can either be 38.2% or 88.6% of the second move;
- The final move, being the opposite of the third one, should be 161.8% (if the third move is 38.2%) or 261.8% (if the third move is 88.6%);
- In all of these possible scenarios, the total price change from the first to the last moves will be more than 100% (extending the internal leg) - either 127% or 161.8% of the initial price.
Now, there are other harmonic patterns Forex traders can use, including the Crab pattern, Cypher pattern, and many more, however, for the sake of this guide, the three patterns are also enough to explain the mechanism behind harmonic price patterns.