UNDERSTANDING THE FOREX ABCD PATTERN

In 1935, H.M Gartley wrote a book introducing harmonic patterns in the exchange markets. Scout M, an author on the subject, refined this concept in his book. He gave specific Fibonacci ratios to confirm the formation of these patterns, which we now call the ABCD pattern. This pattern represents a perfect harmony between price and time.

What is the ABCD pattern in forex?

ABCD pattern shows a visual representation of the harmony between time and price. It refers to a geometric chart that shows you the best time to enter or exit a trade in the forex market. 

 Forex traders use this to identify the best time to buy or sell in a trade. On the chart, it looks like a lightning bolt. 

Some important terms to note

  • Timeframe 

The amount of time a trend lasts in the market. Some trends last only a few minutes, some longer than a month. The longer the trends last, the more reliable the trading signal would be. Forex traders identify this trend and use it to their advantage.

Forex traders use any of the 3-different types of timeframe:

1. Swinging trade: Swing trade is the most common form of trading in forex. Traders take a position that can last from a few days to a few weeks.

2. Day trade: The timeframe is shorter in day trading. Traders can hold their position from 15 minutes to a few days. 

3. Positional trade: Positional trading is longterm. Most traders take a trade between 2 – 6 months. It is more common when trading in stocks.

  • Market conditions

As the term suggests, it describes the state of the forex market as it is influenced by different factors. Factors such as the economy, politics, etc. can influence forex market conditions

Market conditions can comprise of 3-main categories: 

  1. bullish, 
  2. bearish, or 
  3. range-bound markets.

In a bullish market condition, traders suspect an “uptrend” in price. Traders see it as a favorable time to ENTER the trade. They believe that prices will continue to rise, and they can sell when the price peaks.

In bearish market conditions, traders foresee a downward trend in price. And they quickly sell the assets. Hoping to buy again, sooner or later at a low price, and make a profit once the price picks up again. 

In a range-bound market condition, the prices remain unstable for a while. 

  • Trading signals

This is a “trigger” that notifies traders to enter or exit a trade position. It is based on some analysis involving price and time.

The abcd pattern can be used in any market condition and on any timeframe. But Forex traders can identify when to sell/buy forex using the 2-types of abcd pattern: 

  • bullish 
  • bearish.
  1. Types of abcd pattern:

1. Bullish abcd pattern

This is shown by a sudden movement in the chart indicating a price change. It starts with a price fall at point A. Then an upward swing follows to point B. Then the price retracts to point C. Slightly lower than point A but higher than B. Then a downward slope to D, which falls below B. Forex traders use this point to determine their actions.

2. Bearish abcd pattern 

This is the opposite of the bullish ABCD pattern. It starts where the previous bullish pattern ends, with point A at the bottom. Then an upward swing in the price, which moves to point B. From point b, there’s a retraction to C, which is called the BC leg. Another move in the price causes a rise from point C to D. This point is usually higher than point B. 

From this point, another ABCD bullish pattern begins. The zigzag pattern continues on and on in the chart. And it helps forex traders identify the best time to enter or exit the trade.

There are 3-price moves in the ABCD pattern. These are called: 

  • AB leg, 
  • the BC leg, 
  • the CD leg. 

Forex traders can enter or exit a trade when the ab leg equals the cd leg.

How do you find the ABCD pattern in forex?

First, find point AB. 

Keep these rules in mind for bullish pattern:

  • point A is significantly higher than point B
  • Point B is significantly lower than point A.
  • No point is higher than A or lower than B.

Then, find BC. 

Keep these points in mind:

  • Point C is lower than point A.
  • There are no lows below point B.

After BC, then plot CD. 

It’s essential to remember that point D must be lower than point B.

There should be no lows below point B. And no highs above point C.

AB leg should be equivalent to CD leg.

The bearish abcd pattern rules are the opposite since it represents a rise in the price. 

For the ab leg, 

  • The A is significantly lower. And the B is significantly higher than A.
  • There are no points higher than B or lower than A.
  • Find the BC retracement by making sure that point C is higher than point A.
  • In the move from B down to C, no points can be higher than B. And no points can be lower than C.

After BC, find CD.

Makes sure point D is higher than point B. As C moves upwards to D, make sure there are no points higher than D or lower than C.

How do you draw ABCD patterns in forex?

As I mentioned, there are specific Fibonacci ratios which traders use to identify the abcd patterns. 

You will need to carefully find point AB leg. Then use your Fibonacci chart tool and ensure BC retracement reaches 0.618 level. After that, measure the CD line and make sure it reaches 1.272 level.

Once you’ve plotted the lines, you can then wait for the pattern to reach point D. 

Remember the rules, AB leg should be equivalent to CD leg. 

Once the pattern completes(reaches point D), you can then take a position, either long(buy) or short(sell).

It is advisable to activate your stop-loss orders when analyzing patterns. It is useful to minimize losses in the event of a sudden price move. Especially when trading in range markets.

Why is the ABCD pattern useful in forex trading?

As I explained, the ABCD pattern is a very important concept in analyzing the market. Regardless of the time frame or market conditions, traders can identify the best time to initiate a trade.

Using this pattern, forex traders can:

  • find trading opportunities in the forex market
  • ascertain the risks and profits in a particular trade
  • In addition, all other patterns are based on the ABCD pattern.

What is a 1234 pattern in forex?

The 1234 chart pattern was created by Jeffery Cooper in 1996. In his book, “hit and run: the short-term traders manual,” he explained some valuable strategies to help traders identify when to take a position in the market. Although, he was more concerned about “dynamic” stocks. According to Jeff Cooper, “strong stocks only see weaknesses for a short period.”

This pattern is popular among traders. It is especially used for swing trade. 

Forex traders have adopted the 1234 reversal strategy and are profiting from using it. 

How to identify the 1234 chart pattern?

1234 chart pattern occurs when there are 3-consecutive lower lows and 3-consecutive lower highs in the price. Traders buy a position when the market price rises above the last “candlestick” in the pattern.

Advantages of 1234?

  • This pattern was introduced by a famous and successful trader.
  • Traders have confirmed the merits of this pattern.
  • Although Jeffery Cooper designed this pattern for stocks, it can be used for other financial instruments.
  • The pattern is easily understood
  • The pattern provides “buy signals”

How can forex traders profit from the 1234 pattern?

Below I will explain how forex traders can profit from the 1234 chart pattern. But first, let’s understand these terms:

Downtrend

It occurs when prices move lower in the chart. It is created by “lower lows” and “lower highs”

Uptrend 

As the term suggests, it describes an upward movement of the price of assets in the chart. And it is brought about by “higher lows” and “higher highs” in the trend.

Pips 

Pips is short for “price interest points” or “percentage in point.” It is the smallest unit of measurement in asset trading. In forex, it represents the amount of change in a currency pair. Generally, the value of a pip depends on the currency pair and the exchange rate. Your broker will confirm the value depending on the currency pair you choose.

Short trade

In foreign exchange trading(forex), short trade means making a profit when the price drops. 

“Go short” is a famous expression in the trading industry. It means “to sell” to buy again when the price drops.

Long trade

Long trade is the opposite. You make a profit when the price rises. When traders say “go long”, they mean “to buy” to make a profit when the price rises soon. 

Let’s look at how traders make a profit using the 1234 reversal chart pattern. 

As the pattern shows, there are 4 points in the chart; that’s points 1, 2, 3, and 4.

The best time to trade is right after a “strong currency” pairs up with another. Or when there’s a downtrend in the chart.

The basic rules for short trade are as follows:

Find point 1. It begins at the peak/high in an uptrend currency market.

There’s a downward retracement/correction.

Point 2 sits at the lowest point in the “downward correction” before the price picks up again.

The price moves up but stops before it reaches the same level as the previous high(point 1). This is point 3.

Then another move occurs, 1 pip below point 2. At this point, forex traders “go short”.

For Long trade, the rules are the other way round.

Point 1 is low in a downtrending currency market.

The price then moves upward. The highest point before the price drops again is point 2.

From point 2, there’s a downward movement to point 3. But not as low as point 1.

The price picks up again and goes 1 pip above point 2. This is point 4. Traders “go long” at this point.

Forex traders confirm this reversal strategy through the use of technical indicators like DMI и MACD.

The DMI indicator, which stands for “directional movement index,” is a technical indicator that measures price movements. 

It comes with 2 pointers:

+DMI (positive DMI) 

-DMI.(negative DMI)

+DMI measures how strongly the price rises in the market. While the -DMI measures how strongly price falls. This indicator is useful for reducing false signals.

How to use DMI indicator for trading

Most traders combine dmi with other indicators. With it, they can confirm the strength of the trade signal generated. It is common for traders to wait till +dmi and -dmi crosses over before making a trade. However, most traders do not think it wise to depend solely on this indicator. It’s essential to consider other influences and trend indicators before making a trade. 

1234 reversal pattern using dmi

The dmi indicator can be used in the 1234 reversal pattern when trading forex.

This strategy is only suitable for a strong uptrend.

First, identify points 1, 2, 3, and 4 on your chart as described above. 

Then “go short” 1 pip below point 2.

After this, confirm your trade using the dmi indicator. Make sure that the dmi is on “SELL mode”. 

Check your target level by calculating the distance between points 2 and 3.

Put a STOP LOSS 1 pip above point 3.

MACD indicator

Moving average convergence divergence. This indicator tracks the trend in the market and shows the relationship between the 2 “moving averages” of the price.

There are 2 lines in a MACD chart, moving at a different speed. 

1. the MACD line

2. the signal line

The macd line shows you the distance between the 2 moving averages. On the chart, it moves faster than the signal line.

The signal line shows you the moving average of the macd line. 

A new trend in the market will cause the macd line to “move away” from the signal line. 

1234 reversal pattern using macd?

This strategy is only suitable for a strong downtrend.

After identifying points 1, 2, 3, and 4 in a bearish/downtrend …,

Go long 1-pip above point 2.

Confirm your trade using the macd indicator. Make sure the indicator is on “BUY MODE.”

Check your target level by calculating the distance between points 2 and 3.

Authorize STOP LOSS 1-pip below point 3.

Вывод

Traders use these strategies trading forex. It is important to check all the factors and influences, and trends before making a trade.

There are different strategies and patterns. But the ABCD and 1234 patterns are common among forex traders. Find what works best for you, according to the instruments you’re working with.

Take advantage of all the educational resources available with your broker. And gain in-depth knowledge on how to use the indicators to find trends. Though, “experience is the best teacher” most times.

Even the experts of traders still lose money trading forex or other instruments sometimes. Taking small reasonable risks is helpful to fully understand how it all works.

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