ABCD pattern captures the typical rhythmic pattern of the market, which traders use to identify trading opportunities. Since ABCD patterns work on different timeframes, they are widely used and form in both market uptrend and downtrend. ABCD patterns belong to the category of harmonic pattern that consists of two equivalent price legs.
ABCD patterns are easy to identify in a price chart, indicating high probability opportunities. They are used in predicting bullish and bearish reversals.
Hence, acquainting yourself with this pattern is crucial whether you want to day trade, swing trade, or enter into a significant investment bid. Let’s explain the ABCD pattern, but before delving deep into the topic, let’s touch upon Fibonacci retracement, which lays the foundation of ABCD pattern.
Fibonacci ratios are referred to many times in trading and investment strategies. Traders believe these ratios influence the financial market and can help determine a possible outcome of a trade set-up.
Introduction to ABCD Pattern
The pattern begins with identifying point A, the initial spike, which is a significant high. It indicates the market is in control of the bull, who is aggressively buying and pushing the market sentiment up. However, once the asset price reach day’s high and traders start to sell, we see a healthy pullback. Once the selling force takes over, we get the intraday low at point B.
After the first dip, traders wait for the price to confirm the pattern by attaining a higher low at point C above point B. when price forms point C, traders plans, keeping a risk level close to point B and would book profit at point D when price breaks above point A.
The pattern depicts a change in market direction in harmony with price and time, which suggests selling when the price goes high and buying when it is down.
Between the four points, the ABCD pattern creates three pattern legs AB, BC, and CD, each depicting three consecutive price swings or trends, calculated using the Fibonacci ratio.
Traders use the Fibonacci ratio to calculate proportion between the legs to predict where the pattern will complete both in terms of time and price, which is usually between 3-13 bars or candles in any given timeframe. If the pattern doesn’t form within 13 bars, traders consider an extended timeframe where the formation would fit within the range.
Now let’s consider how to plan a trade using the ABCD pattern. Since the pattern can form in both bullish or bearish trend, we will consider both aspects.
A Bullish ABCD pattern is denoted by AB=CD, that the length of both the legs is equal to confirm a trend reversal. Along with that, in a classic ABCD pattern, BC is either 61.8 or 78.6 percent of AB, and CD is 127.2 or 161.8 percent of BC.
There is also an exception, where CD is 127.2 or 161.8 percent of AB. This formation is called the ABCD extension. However, in both cases of classic and extension, a trade is planned at point D.
Here are the rules to trade in a bullish ABCD pattern.
Find the pattern in the chart, where A is significantly high, and B is extremly low. There is no point higher than A or below than B in the range between A and B. Then, point C forms above point B and below A. Ideally, the length of BC is 61.8 or 78.6 percent of AB.
Point D is a point lower than B, and the length of CD equals AB.
To generate trading signals, the pattern must conform with price, time, and Fibonacci ratio. When the confluence of the three occurs, traders take a position to go long in the market.
Bearish ABCD pattern
In a bearish trend, point A is significantly low when point B is considerably high. There is no other point higher or lower between A and B. Point C then forms above A, and the distance between BC is 61.8 or 78.6 percent of AB. To complete the pattern, a point D forms above point B, and it is the highest data point between C and D. CD is ideally 127.2 or 161.8 percent of AB or 127.2 or 161.8 percent of BC. Traders wait for symmetry between Fibonacci ratio, time, and price to plan a trade, that is, to go short.
Significance of ABCD pattern
ABCD is a strong pattern with significant risk/reward opportunities.
- ABCD pattern forms the basis of all the other patterns
- It accurately predicts market reversal and helps traders plan excellent high risk-reward trades with a high winning percentage
- Traders use it to identify trading opportunities in different market conditions and timeframe
- The convergence of several ABCD patterns signifies a strong trading signal
How to trade in ABCD pattern
Traders consider an ascending ABCD pattern as a bearish and descending pattern as a bullish trend pattern. AB and CD lines form legs of the pattern, whereas BC indicates retracement or correction.
Traders wait till the pattern confirms after the formation of point B after the stock hits a new low at A. When a new support line is formed at point C, traders enter a trade expecting asset price to grow beyond point D, placing a stop-loss close to point C. So, if the price falls below point C, the trader would exit the trade.
The ABCD pattern forms the basis of all other chart patterns. However, like technical trading tools, the ABCD formation works best when used in combination. The formation combines times, price, and shapes, and when the three come together, it creates a strong trading signal, which traders use to predict the subsequent reversal in trend.