In technical analysis there is a methodology known as Harmonic trading, first described by H.M. Gartley in his 1935 book Profits in the Stock Market. The original pattern (displayed to the left) is known as the “Gartley” and revolves on the ratio of lengths in four price movements: X-A, A-B, B-C and C-D. A position is then established near point D which varies on the suggested directional bias. The “Gartley” has since inspired many variations bearing the names Butterfly, Bat and Crab which can sound like nonsense when one starts hearing of the “Bearish Crab” or “Bullish Butterfly”.
Harmonic patterns utilise the Fibonacci ratios to determine likely turning points in the markets. The core to finding successful signals lie in the precision of moves and retracements to key resistance levels (0.618, 0.382 etc). In practice, these patterns intend to set up high probability entries with very favourable risk to reward ratios. In my experience of the foreign exchange market, it can occasionally capture some moderately sized, short-term trends.
The above image is detail from a “Bearish Bat” on a 15-minute EUR/USD chart (the triangle displays the right half of the pattern). The entire pattern developed over the course of nine days cumulating in a short signal on the 22nd of June in the 1.4421-35 range with 30 pip stop. Buy-limit orders can be placed at potential resistance areas such as 1.4195 (June 20 low) or 1.4120 (June 17 low) for a gain of 240 and 315 pips respectively. The risk to reward for this trade is in the 1:8 to 1:10 range which is significantly higher than most other technical patterns.
The Bullish and Bearish Bat:
The Bullish and Bearish Crab:
The Bullish and Bearish Butterfly:
As you can see, the variations are all very similar yet they have different risk to reward potential and varying expectations of success. With slight differences in the ratios differentiating the patterns it is evident as to why precision is essential. You may also imagine that it is rather cumbersome to manually calculate all of this on the fly which is where trading software comes in handy.
There are several proprietary charting packages which are dedicated to trading harmonic patterns however the cost of these can be high ($4,000+). Anybody who trades foreign exchange on the MetaTrader platform is able to find free indicators like “ZUP” and “KorHarmonics” which will identify and display these patterns but won’t automatically enter and manage positions.