What Is an ABCD Trading Pattern?
Are you looking to improve your trading strategy and technical analysis skills? The ABCD trading pattern may be just what you need. This tool may help you identify potential reversals and decide when to enter a trade. Keep reading to learn more about the ABCD pattern and how to apply it to your own trading strategy.
What Is an ABCD Pattern?
The ABCD pattern is one of the most basic yet effective harmonic patterns out there. It gives traders an idea of where the market might reverse and, when combined with other forms of technical analysis, it may be a great addition to your trading arsenal.
The ABCD pattern comprises two legs, AB and CD, and one retracement, BC, with D as an entry point. More specifically, an ABCD can be identified by:
- AB Leg: A trend starts at A and makes a high or low at B.
- BC Retracement: The price retraces from B to C.
- CD Leg: The trend continues from C to D.
- D Entry Point: Once another high or low forms and traders enter at D.
These price movements create the “zig-zag” or “lightning bolt” shapes.
In fact, ABCD patterns are present across every market and every timeframe. The up-down movements seen in financial assets represent opportunities to identify and trade ABCD patterns.
Why Use the ABCD Pattern in Your Trading Strategy?
Before we move on to identifying and trading the ABCD pattern, it’s worth explaining why you might want to consider using it. Here are a few reasons traders favour the ABCD pattern:
- It’s one of the easiest harmonic patterns to identify, suitable for traders of all levels.
- It’s versatile and works for stocks, commodities, and cryptocurrencies*, not just Forex trading.
- Traders use ABCD patterns to make an informed decision about potential turning points in the market.
- It can form the basis of a working trading strategy if used correctly alongside other forms of technical analysis.
- It provides an effective risk/reward ratio if reversals are successfully caught.
How to Identify an ABCD Trading Pattern
The first step in finding ABCDs is to look for that classic zig-zag shape. Once you’ve found one, it’s time to apply Fibonacci ratios to confirm the pattern. If you’re struggling, you can consider using pre-made ABCD pattern indicators or scanners to help your eyes get used to spotting them.
The ABCD pattern requires that the BC leg is between a 38.2% to 78.6% retracement of AB, ideally between 61.8% and 78.6%. This means that if you put a Fibonacci retracement tool at A and B, then C should be between 0.382 and 0.786.
The second CD leg should be a 127.2% to 161.8% extension of the BC retracement. For extra confirmation, consider specifying that AB is equal to the same length as CD and that the number of candles between A-B and C-D is the same. In other words, AB = CD.
While it can be tempting to start trading based on these conditions, you’ll find that, in practice, identifying point D can be trickier than it seems. That’s why traders typically use Fibonacci ratios, key levels, candlestick patterns, and higher timeframe convergence to confirm their entries, which we will touch on shortly.
Trading the ABCD Pattern
Now that we understand how to identify the ABCD stock and Forex pattern, we can start applying it to real price action. If you want to follow along, you may consider using the FXOpen TickTrader platform. There you’ll be able to use the built-in ABCD drawing tool that automatically calculates the Fibonacci ratios between points.
Note that the ratios won’t always be perfect, so allowing for slight variability above or below the defined ratios is acceptable.
The Bullish ABCD
For a bullish ABCD stock or Forex pattern, the following must be present:
- The AB leg should be between the high A and low B.
- The BC bullish retracement should be between the low B and high C, which is below the high A.
- The CD leg should be between the high C and low D.
- BC is a 38.2% to 78.6% retracement of AB, preferably between 61.8% and 78.6%.
- CD is a 127.2% to 161.8% extension of BC.
Additionally, you may look for AB to be an identical or similar length to CD and for the number of candles between A-B and C-D to be equal.
Entry: Traders set a buy order at D.
Stop Loss: The theory suggests traders place a stop below a nearby support level or use a set number of pips.
Take profit: Traders take profits at the 38.2%, 50%, or 61.8% retracement of CD or hold for higher prices if they believe there’s the potential for further bullishness.
The Bearish ABCD
The bearish ABCD stock or forex chart pattern is essentially the same, just with the reversed highs and lows. As such:
- The AB leg should be between the low A and high B.
- The BC bullish retracement should be between the high B and low C.
- The CD leg should be between the low C and high D.
- BC is a 38.2% to 78.6% retracement of AB, preferably between 61.8% and 78.6%.
- CD is a 127.2% to 161.8% extension of BC
You can choose to apply the same AB = CD rules if desired.
Entry: Traders typically place a sell order at D.
Stop Loss: A stop may be placed above a nearby resistance level or at a set number of pips.
Take profit: Traders often take profits at the 38.2%, 50%, or 61.8% retracement of CD or hold for lower prices if there’s a bearish trend on a higher timeframe.
Looking for Additional Confluence
Given that trading the ABCDs usually relies on setting orders at predicted reversal points, consider looking for extra confirmation to filter potential losing trades. Below, you’ll find three factors of confluence you can use to confirm your entries.
Key Levels
If your analysis shows that D is projected to be in an area of significant support or resistance, there’s a greater chance that the area will hold and reverse in the way you expect.
ABCD Timeframe Convergence
This is a slightly advanced technique, but it should be easy once you’re used to spotting ABCD chart patterns. If you see the pattern forming on a particular timeframe, you may check if there’s another on a higher timeframe.
For example, if you think EUR/USD will reverse at D on the 5-minute timeframe, check the 30-minute chart to see if there is a higher timeframe ABCD pattern projected to reverse in the same area. If there is, then your analysis is more likely to be correct.
Candlestick Patterns
Some traders look for particular candlestick patterns to appear. The hammer and shooting star patterns are commonly used by ABCD traders for extra confirmation, as are tweezer tops/bottoms and engulfing candles. You could choose to wait for one of these candlesticks to form before entering with a market order.
Common Mistakes to Avoid When Identifying an ABCD Chart Pattern
Of course, ABCD patterns aren’t a silver bullet when it comes to successful trading. There are several common mistakes made by inexperienced traders when trading these types of patterns, such as:
- Confusing the ABCD with other harmonic patterns, like the Gartley or three-drive pattern.
- Trading every potential ABCD formation they see. It’s preferable to be selective with your entries and look for confirmation.
- Not being patient. ABCDs on higher timeframes can take days, even weeks, to play out. Experienced traders wait for the pattern to develop before making a trading decision.
- Ignoring key levels. Instead, you could allow them to guide your trades and look for the ABCD pattern in these areas.
How to Start Using the ABCD Pattern in Forex Trading
By now, you may have a solid foundation to start building your ABCD trading strategy. But if you’re not sure what steps to take next, you may:
- Try a free demo account if you want to get your bearings first.
- Practice identifying the ABCD pattern with the TickTrader terminal and the built-in ABCD drawing tool.
- Create some rules around how you would like to trade ABCD patterns, and test them on historical and live charts.
- Continue to record, analyse, and refine your strategy.
- Consider opening an FXOpen account and incorporating ABCD entries into your live trades once you feel comfortable.
*At FXOpen UK, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules. They are not available for trading by Retail clients.
Read more: https://fxopen.com/blog/en/what-is-an-abcd-trading-pattern/
Text source: Forex Trading Blog
