ABCD chart pattern is yet another gift of Fibonacci ratios to the field of technical analysis. It is a blend of time, price and shape. When all three converge at one point, it forms an electric move. Hence, the pattern also goes by the name Lighting bolt (AB=CD) pattern.
What is an ABCD (AB=CD) chart pattern?
The AB=CD pattern consists of two legs. The first leg being the AB and the second leg being the CD. When both these leg of movements have the same length (price), shape and the time duration to complete their move, then it completes the sequence. And the point D becomes a potential reversal zone.
Initially, the pattern was restricted to AB=CD chart formation. Later, Scott Carney in his book, Harmonic Trading, extrapolated the pattern with subtle variations by the application of Fibonacci ratios and found two alternatives.
Spotting the ABCD pattern
There are bullish as well as bearish ABCD chart patterns. The bullish pattern is the one which renders a bullish reversal after a bearish move. And, the bearish pattern incurs a bearish reversal.
The criteria for identifying the bullish ABCD pattern is discussed below. The vice versa applies for the bearish pattern.
- Point A must be a significant high.
- Point B must be a significant low.
- There are to be no highs above point A and no lows below point B.
- Point C is a retracement of the AB move. Hence, the BC rally braces any of the one Fibonacci retracement ratios – 38.1%,50%, 61.8 or 78.6%.
- Point D is a lower low of AB and can extend to 127.2% or 161.8%.
The criteria indicated above are only indicative. In real time, these Fibonacci values are merely zones.
Also, there are multiple variants of ABCD harmonic pattern depending upon which Fibonacci ratio renders support and resistance.
Variant 1: AB=CD pattern
The AB=CD pattern is a simple and basic version. It is easy to spot the formation with the naked eye as it does involve Fibonacci retracement and extension values.
The only criteria being the swing moves of AB and CD have to be equal in length as well as in time.
Although it is not statutory for this pattern to fulfill the Fibonacci criteria, when it does, it adds up to the strength of the formation.
The above chart is the perfect example of an AB=CD pattern. AB equals CD in length and time. The corrective BC wave retraces almost 78.6% of AB as well. And so, on hitting point D, the asset faced resistance that led to a downfall of 50% of the AD rally.
Variant 2: Classic ABCD pattern
In the classic pattern, the BC wave retraces about 61.8-78.6% of the AB swing move.
The CD swing move extends to either 127.2% or 161.8% of the AB wave.
The classic variant is strongest of the lot since it involves both the retracement and extension ratios.
In the above chart, after plummeting 2000+ pips, the currency pair corrected in the form of a BC rally. It retraced to 61.8% of AB wave and then plunged again and found support at 127.2% extension of BC wave. A short term reversal followed subsequently, courtesy ABCD chart pattern.
Variant 3: ABCD Extension
As the name suggests, this pattern takes into account only the extension of the CD wave.
The CD wave extends to either 127.2% or 161.8% of the BC wave.
Further, the CD move is twice the length of the AB move. The time ratio of CD to AB is also twice, usually, although it is not mandatory.
The typical feature of the pattern is that the CD wave will be overstretched and oversold (or overbought).
As you can see in the above chart, the 127.2% and 161.8% extension levels didn’t matter much here. However, when the CD leg hit the mark of twice the length of AB, the price faced resistance initially and then was tossed down.
Remember, as you can see in the above charts, point D can be either a trend reversal zone or a mere profit booking zone. And so, the ability to distinguish the profit booking and reversal can mean life and death, when using this pattern. Because it lets you choose the appropriate profit booking level and avoid any ambush from the market.
So, before moving on to how to trade the pattern, here are three tips to make your life easier.
Tip#1: Cue from the retracement
The ABCD chart formation need not be a reversal pattern every time. More often, it is a profit booking zone. Here is a simple clue to unravel the mystery behind it.
If BC wave retraces only up to 38.2% or 50%, it insinuates that the trend is strong.
In such a case, a target of 23.6% or 38.2% for the AD wave, is the prudent choice.
In the above chart, the BC wave retraced only to 50% of AB. As a result, when it hit the resistance at 161.8%, it retraced just up to 23.6% of AD wave. It was a time consolidation more than the pullback which is a common phenomenon in a robust trend move. After the pitstop, the asset resumed its trend.
Tip#2: Clue from the extension
Just like the retracement, the extension also hints at the strength of the trend. But the extension works in a intriguing way.
If the asset stretches up to 161.8% or twice the length of AB, it most likely is an overstretched, exhaustion rally. So, the odds for the trend reversal or a deep pullback is high.
Whereas the extension of 127.2% is a common resistance in technical analysis. After any breakout of a support or resistance level, the market retests the broken level, which most likely is from the 127.2 % extension. So, the 127.2% extension doesn’t offer any cues whereas 161.8% level does.
See the above chart, the asset made a deep pullback of 78.6% in the BC leg. And in the following CD leg, it was overstretched up to 1.618% extension. This is a common phenomenon in corrective waves, especially during the capitulation phase. When the recovery surfaces, it mostly turns the short-term trend on its head towards the long-term trend, as it happened here
Note: Tip#1 and Tip#2 are mutually exclusive. Both interpret different stages of the market — accumulation and exhaustion. Although it favors the odds, they need not be always. Hence, don’t confuse it.
Tip#3: C as the pivot
So far, all the fuss was about point D. The point C has a say in the price action too.
It differentiates the pullback from trend reversal in the market.
When the price retraces from point D: If it takes down point C, then it results in a reversal. Else, it is merely a pullback.
As you can see in the above chart, the CD leg was overstretched. Upon reaching the 161.8% level mark, the buying activity surged crossing the resistance level C in a gallop. Then the broken point acted as support, strengthing the case for buy. As a result, the trend reversed. Point C is the red line in the ABCD chart pattern. Until it holds guard, you can’t expect a trend reversal.
How to trade the ABCD chart pattern?
Point D is the pivotal point of your decision making. So, wait for the pattern to complete. Then observe the price action behavior in the Potential Reversal Zone (point D).
The key word here is potential and not mandatory. So, you should not pounce on to the trade as soon as you see one.
Look for exhaustion signals on the CD wave, like gaps or indicators like RSI indicating an overbought (or oversold) condition or rejection or engulfing candles. When any sign of weakness surfaces, you can enter the trade.
Based on the tips suggested above, you can set the target.
If BC retraces to 61.8% or 78.6% of AB, then expect a retracement of beyond 50% of AD.
Suppose, if BC wave retraces only up to 38.2% or 50% of AB, then set a modest target of 23.2% or 38.2% of AD.
In both cases, keep a stop above the swing high. So, when you are trading with such tight stops, you need to be extra sensitive and enter only after the trend subsidizes and the tension for profit booking creeps in. Never enter hastily.
Always book partial profits at each retracement level. Since you’re going against the trend, the market can ambush you anytime. So be prudent and follow the risk management principles.
In the above chart, the BC wave made a solid retracement of 78.6%. And it extended up to 161.8%.
Note, here the sell-off didn’t attract any support at the 127.2% extension level. Had you tried to be smart and entered as an early bird at that level, the market would have outsmarted you.
However, the 161.8% extension supported the buying activity. A strong bullish candle formed idolizing a higher high setup, which is your entry point.
Your target of 50% and 68.1% would have been rewarded as well.
Since the counter hinted exhaustion (by extending to 161.8%), the market expected a trend reversal. However, the bears were in firm control of the market and didn’t let the bulls pass through. And so, the bearish momentum continued.
Advantages of the Harmonic ABCD pattern
The ups and downs of the long-term wave usually sync with the pattern.
The pattern works on all kinds of markets — stock, forex and commodity.
Also, it works perfectly in the short-term as well as long-term charts.
It is the basic harmonic pattern and all other patterns, say Gartley or butterfly, are its derivatives.
Most of all, it’s a leading indicator as it renders advance reversal signals.
A word of caution: Anticipating trend reversal in advance can often lead you to lose (fair) perspective of the market and let you be biased towards one side. There are, in fact, #13 biases that kill your trading. Get to know the counter-intuitive approaches to take it down here.
There are many harmonic patterns and the ABCD chart pattern is just a tip of the iceberg. Understanding the psychology of this pattern and mastering its application can undoubtedly help your endeavor in the application of other patterns too.