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Harmonic Pattern AB=CD

(The reader should keep in mind that these patterns are only probabilities; they are not certainties, and trying to use

these patterns without a solid understanding of them and a sound money management strategy is equivalent to

trading suicide.)

Prepared By: Aq - Dated: June 8, 2014 of 12

AB=CD

The AB=CD pattern is one of the most basic and simple patterns in technical analysis. If the trader will take the time to learn this pattern and its variations,

it will be time well spent.




trading suicide.)


If C = 38.2 AB Then CD = 2.24 AB

If C = 50 AB Then CD = 2.00 AB

If C = 61.8 AB Then CD = 1.618 AB

If C = 70.0 AB Then CD = 1.41 AB






trading suicide.)


AB=CD PATTERN STRUCTURE

The AB=CD pattern is found in all markets and all time frames. The pattern

is a measured move where the CD leg is similar in length to the AB leg. It

should be noted, though, that the CD leg can extend and will not always be

exactly equal to the AB leg; this is discussed in “Important Characteristics

of the AB=CD Pattern” later in this chapter.

There are three legs that form this pattern. The first leg of the pattern is

labeled AB. After the completion of the first leg, a retracement or correction

occurs that will usually find support or resistance at one of these Fibonacci

levels: .382, .50, .618, or .786. This correction or retracement is labeled BC

and is the second leg of the pattern. (Note: Strongly trending markets will

usually see only a retracement to the .382 level. See the chart in the “Slope

and Time Frames” section later for an example of a shallow retracement at

the .382 level.)

When price resumes in the same direction as the AB leg, the CD leg

then begins to form. Once we identify the CD leg forming, we can project

the potential pattern completion and devise a trading strategy. As the CD

leg forms and completes, we monitor the final leg for any warning signs

that would alert us to a change in market conditions that may signal us to




trading suicide.)


possibly pass on the trade or wait for further confirmation before entering

the trade. Once the price exceeds B, we make an assumption that the price

will reach pattern completion at point D.

When studying this pattern, it is important to know what invalidates

the pattern.

Here are three items that would invalidate the AB=CD pattern: 1. BC cannot exceed the AB leg, meaning the retracement of AB cannot

exceed 1.00. 2. BC can be a 1.00 retracement of the AB leg; this is a rare pattern and a

double top or bottom, but it is a valid pattern. 3. D must exceed B in order for the pattern to complete at point D and be

a valid AB=CD pattern.




trading suicide.)


IMPORTANT CHARACTERISTICS OF THE

AB=CD PATTERN

About 40 percent of the time, the AB=CD pattern will be perfectly symmetrical, meaning AB equals CD. The other 60 percent of the time

variations of the pattern will be present. What this means is that after the AB

leg has formed and the retracement leg, BC, has completed, the CD leg will

be different from the AB leg. The two legs may or may not be perfectly

symmetrical.

Some of the ways the CD leg can vary from the AB leg include:

a. The CD leg is an extension of AB anywhere from 1.27 to 2.00 or greater.

b. The CD leg has a slope or angle steeper or wider than AB.

At first glance this variation might make the trader think the pattern

is not tradable. The key lies in identifying the BC leg. The most important

thing is to watch the price action coming after point C has formed. Many

of the examples that you will see in this chapter will show that the CD leg

determines the relationship to the AB leg.




trading suicide.)


CD LEG VARIATIONS

These CD leg phenomena can be described in four ways:

1. If after point C has occurred a gap exists in the direction of point D,

this usually indicates that the CD leg will be much greater than the AB

leg—1.272, 1.618, or more.

2. A wide range bar (twice normal size) at point C is another indication

that the CD leg could become extended. See Figure 4.8 as an example.

3. Ideally, AB=CD moves are symmetrical in price and time. For example,

if the AB leg is six bars up, then the CD leg will be six bars up.

4. As illustrated in Figure 4.10, the time to form the two legs is symmetrical.

This next sentence is very important: If the CD leg is made in just a few

bars, this strongly indicates that the CD leg is going to be an expansion of

the AB leg.




trading suicide.)


Classic AB=CD pattern on EOG Resources (EOG) daily chart with gap

from point C and sharp sloping down move to point D suggests CD leg will

extend.

All the warning signs are present in this 120-minute chart of the NASDAQ

futures. Notice the long bars as the CD leg is just beginning down. This gives the

trader an alert that the CD leg may be an extension to 1.272, 1.618, or greater of

the AB leg.




trading suicide.)


Euro currency daily chart showing AB=CD pattern with very symmetrical

six bars up in the AB leg and six bars up in the CD leg.

5-minute chart showing time is also an element in the symmetry of the patterns.

A very long bar from the C turning point in this Intel (INTC) daily chart indicates

that the CD leg will be an expansion of the AB leg.




trading suicide.)


SLOPE AND TIME FRAMES

The slope or time frame of the BC move can also be helpful in determining

the pattern. BC legs generally correct to one of the Fibonacci ratios:

.382, .50, .618, or .786. The slope of this BC leg is usually a good indication

of what the next CD leg will be. For example, assume that the AB leg

took 15 trading bars to reach point B, and now the BC leg has taken 8 bars

but has retraced only .382 percent of the AB leg. This is a sign of the market

absorbing a lot of selling at a high price; it is a shallow retracement,

and the price has not been able to retrace to .50, .618, or .786 percent. We

would assume that prices would go much higher and possibly quite rapidly

once the selling slows. However, if the market retraces to a .618 or .786

retracement, the CD leg will most probably be a normal move equaling AB=CD. To figure the extension of the CD leg, take the difference between A

and B and multiply it by 1.272 or 1.618; then add the resulting figure to the

low (or subtract it from the high) of C. The steps in Figure 4.12 to find the

1.618 projection would be calculated like this:

B = 1274 − A = 1256 = 18 points 18 points × 1.618 = 29.12

Add this to the low of C: 1266.25 + 29.12 = 1295.37 (If figuring 1.272 or any other extension number, simply use that number

in place of 1.618.)

The number of time bars in the AB=CD pattern will usually range from five to eight bars. When the CD leg is extending beyond eight bars in an up

or down move, the probability is for a price extension where CD will be

1.272, 1.618, or greater of the AB swing.




trading suicide.)


In this S&P E-mini 30-minute chart, the 1.618 extension can be figured

by taking the difference between the high and low of AB, multiplying it by 1.618, and adding it to the low (or subtracting it from the high) of C.

TRADING THE AB=CD PATTERN

Trade Setup #1: AB=CD Sell Pattern Market: S&P 500 E-mini

In the trade shown below , the S&P E-mini market completes

a picture-perfect AB=CD sell pattern. A limit order would be used on this entry at approximately 1286 to go short, just below the completion point at

D. Once the order is filled, a stop-loss buy order is placed 5 points above

the entry. In this case the stop-loss buy order would be placed at 1291.

The first exit is at the .618 retracement of the AD swing. We shade

the exit order, meaning we place orders just above or below the actual

exit, just as we do the entry orders, about .50 to 1 point away to try to




trading suicide.)


ensure a fill. The exit order would be placed at 1279.50, just above the .618

retracement. Occasionally the market may trade just at but not through the

price, and it will be up to the individual trader’s discretion how to handle

these situations. We prefer to exit if the price is traded at, even if it means

slightly less profit. We don’t want a winning trade to turn into a losing trade.

Risk-Free Trade Once a profit is realized on the first part, the stop-loss

order is then moved to the breakeven point. This accomplishes two very

important things:

1. Reduces the risk in the trade.

2. Books a profit.

At this point in the trade we have a 6.5-point profit and our stop has

been moved to the breakeven point. Our second profit objective is at the

.786 retracement level from the A–D swing. We place a limit order to exit

the second contract at 1277.25, just above the .786 retracement level. Once




trading suicide.)


This is a picture-perfect S&P E-mini day trade of the AB=CD sell pattern.

The market turns down almost exactly at the completion of D (15-minute chart).

the second profit objective is filled, we then remove our stop-loss order.

The second contract profit nets 8.75 points for a total profit of 15.25 points.

Examples:

S&P E-mini 15-minute chart showing an AB=CD buy pattern trade where shading

the order just above the actual completion point definitely helped us to get into

the trade.

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