There are two basic types of ABCD structure. The perfect ABCD is no more than a symmetrical zig zag pattern. The alternate ABCD structure, which is the more common, is not symmetrical but has one side lonbger than the other.
Both types can forecast a bullish or bearish breakout. To be successful in trading the ABCD you need to predict when the pattern will complete and recognize how it fits into the bigger picture of the chart.
AB=CD Chart Patterns
A perfect ABCD, or AB=CD structure is recognized by the fact that it has symmetry in the price and time axis. This means the price change from A to B equals the price change from C to D. And the time between A and B is the same as the time between C and D.
D is the last point and where to expect the breakout to occur. In an ideal ABCD case, from point D the price retraces back on itself towards C again.
For a bullish ABCD the point D should break a new recent low. In a bearish ABCD, check that point D breaks a new recent high.
With any ABCD the outline of the pattern should be obvious. Make sure that the points A, B, C and D are well defined.
If the pattern is a perfect AB=CD this allows you to predict precisely where D will be, and therefore where the market should begin its reversal.
As an example, if C retraces 50% of AB, then for a symmetrical pattern, CD would expect to retrace 200% of BC. Or if C retraces 38% of AB, CD would expect to retrace 262% of BC. And so on.
The easiest way to measure retracement ratios on a chart is by using a Fibonacci extension tool.
The most common ratios for a perfect AB=CD pattern are
- BC retraces 38% AB and CD retraces 262% BC
- BC retraces 62% AB and CD retraces 162% BC
- BC retraces 78% AB and CD retraces 127% BC
Calculating the reversal
Success in trading ABCD patterns depends on predicting the final point D. In a bullish pattern, expect the market to break upwards. In a bearish pattern, expect the market to break downwards. Though in real trading the exact timing of the break is often difficult to pin down.
There may be some signs on the chart as to whether to expect a symmetrical pattern or not. If an ABCD looks like it is part of something bigger such as a crab, butterfly or bat, there’s some reason to expect the CD leg to make an extended move.
As well, it is essential to look for other confirmations like divergence signals to help time the potential reversal point.
Alternate ABCD Patterns
Many times ABCD patterns are not perfectly symmetrical or even close to. These are alternate ABCD patterns. The CD leg can be shorter or longer than the AB leg. But usually the CD leg is longer – these are called ABCD extensions.
In an ABCD extension the retracement at D extends further than anticipated. The extension can be in time or price, but usually it’s both.
The common ABCD extension ratios are:
- CD = 127% x AB
- CD = 162% x AB
- CD = 262% x AB
When there’s an ABCD extension a bullish market makes higher highs than anticipated by the ideal pattern. In a bearish trend it’s the opposite, and the trend makes lower lows than otherwise predicted.
When checking an ABCD extension, anticipate higher volatility around point D.
What do ABCD Patterns Mean?
Financial markets rarely move in straight lines. More often they zig zag along in fits and starts. ABCD patterns are the result of these dynamics. The corrective waves happen as the price trends in a given direction and pulls back again with a short retracement.
As with other harmonic patterns, the size of the structure and ratios between each leg will help you to predict when the next retracement will happen. It also provides a price target to expect once the pattern completes and the market breaks in the new direction.
Trading Rules for the ABCD
To trade a bullish ABCD:
- Calculate the expected completion area (PRZ) for the ABCD using above rules
- Confirm the point D and check it is breaking a new recent low
- Look for other technical signs of reversal such as a bullish oscillator divergence
- Place pending buy orders above point D in anticipation of a bullish reversal
Find the Fibonacci levels in the expected break direction to set a price target, the stop loss and take profit. The position is then accumulated if the bullish break develops as expected.
To trade the bearish ABCD you can simply use the above rules in reverse, placing pending sell orders to anticipate a bearish breakout.