Cypher Pattern Trading Strategy — What Is It? (Backtest and Trading Example)

Although it is not one of the patterns described by H.M. Gartley or Scott Carney, the Cypher pattern is considered one of the harmonic patterns since it has a similar structure — with four swings and five swing points. But what is it?

The Cypher pattern is a chart formation that indicates a potential price reversal. It is a five-point harmonic pattern with the XABCD labeling, just like other Gartley-discovered patterns, though it wasn’t discovered by him. This advanced harmonic pattern can give a truly outstanding strike rate, as well as a pretty good average reward-to-risk ratio, if traded correctly.

Want to know how to trade this pattern? Read along! At the end of the article we make a backtest of the Cypher pattern.

What is the Cypher pattern?

The Cypher pattern is a chart formation that indicates a potential price reversal. It is an advanced harmonic pattern that can give a truly outstanding strike rate, as well as a pretty good average reward-to-risk ratio, if traded correctly.

Discovered by Darren Oglesbee, the Cypher formation is a five-point harmonic pattern with the XABCD labeling, just like other Gartley-discovered patterns.

It is a relatively advanced pattern formation, and due to its unique Fibonacci ratios, it is not a very common chart pattern. Just like many other harmonic patterns, the Cypher pattern is made of five points (labeled X, A, B, C, and D) with four swings — labeled XA, AB, BC, and CD.

As with any other harmonic pattern, the Cypher chart pattern is a reversal pattern, and the theory behind it is that there is a strong correlation between Fibonacci ratios and price movements. The pattern makes four market swing wave movements — from point X to A, A to B, B to C, and C to D. The B point retracement of the primary XA leg lies between 0.382 and 0.618, the C point should be a 1.272 to 1.414 projection of the primary XA leg, and the D point should be a 0.786 retracement of XC. Eventually, the market is expected to reverse from point D.

How do you get a Cypher pattern?

You identify the Cypher pattern by observing the price waves. The pattern starts with a normal impulse price swing (XA), followed by a correctional wave (AB). Then, the price attempts another impulse wave (BC) but is stopped just after making a new high or low — depending on the orientation of the pattern. The price then reverses significantly to the D point, but without getting to the starting point (X). The D point is where the pattern is completed and is regarded as the potential reversal zone (PRZ), which is where traders look to place a trade to ride the next price wave. See a bullish Cypher pattern below:

Although the pattern has four swings, you may begin to suspect a Cypher harmonic formation when the third swing has completed at point C, and the fourth swing is emerging.

But at that point, you don’t know whether it would be a Cypher pattern or a Shark pattern. What you do at that is to take your harmonic pattern tool and trace the various swings with their Fibonacci ratios and project the possible D point for a Cypher pattern. Then, you wait and watch how the price reacts when it gets there.

What is Cypher pattern harmonic?

The Cypher pattern is in a way similar to the Gartley harmonic pattern, but with an extended BC swing. Its formation is also similar to the Shark pattern but the last swing is not hyperextended beyond the origin of the formation.

It is a reversal chart pattern. It can be a bullish pattern or a bearish pattern, depending on how the pattern is formed. See a bearish Cypher pattern below:

It is a reversal pattern and can lead to a trend reversal if it occurs against a trend. However, the pattern often occurs as a deeper pullback within a trend after an impulse wave fails early.

Cypher pattern trading rules (common rules)

The rules for the Cypher pattern are as follows:

• The AB wave is about 38.2% to 61.8 % retracement of the XA swing.
• The BC wave extends beyond point A and could be up to 113% – 141.4% of the AB swing.
• The CD wave is 78.2% retracement of the distance between the X and C swing points.

How do you trade Cypher patterns?

You trade the Cypher pattern by identifying it early enough, waiting for it to complete, and placing the right trade. Here are the steps to take if you want to trade this chart pattern:

1. Identify a potential Cypher pattern: When you see three price swings (drives) that look like a possible Cypher pattern but you are not sure if it will eventually end up as one, take note of it. Then, use the Cypher pattern tool in your trading platform to trace and label the price swings and project the D (PRZ) point. If your trading platform does not have the Cypher tool, use the Fibonacci retracement and extension tool to measure the various price swings.
2. Wait for the pattern to complete: Watch what happens when the price gets to your projected D point. Look for a reversal candlestick pattern, such as the engulfing pattern, pin bar, or an inside bar, which shows that the price may be about to reverse. It may also help if that point corresponds with a known support or resistance level.
3. Place the right order: With the formation of a reversal candlestick pattern after the Cypher has completed, you place a market order. Go long if it is a bullish Cypher and short if it is a bearish Cypher.
4. Place your stop loss: Your stop loss should be below the D point in the case of a bullish setup and above it in the case of a bearish setup. You may even go beyond the next structure support/resistance level at the X-point.
5. Put your profit targets: The best way to take profit with harmonic patterns is to take partial profits at multiple levels: the first target would be the 38.2% retracement of CD and the second target at the 61.8% retracement of CD. You may put a third profit target at the level of the C point.

See the chart of a bearish Cypher below for the positions of the stop loss and profit targets.

Cypher pattern trading strategy (backtest and example)

Unfortunately, we are not able to make a meaningful backtest of the Cypher pattern strategy. Any backtest requires strict trading rules and some additional settings, but because this is a somewhat subjective pattern, we are not able to jot down what is needed. It’s simply too many rules that are needed for a historical test.

Because of the lack of objectivity, we believe traders are better off NOT trading on classical chart patterns. Why spend time on something that is mostly based on subjectivity and not any objective standards based on historical data? How do you know a pattern is profitable if you have not backtested it and found any statistical advantage and edge?

Backtesting and a data driven trading approach is no sure thing, but at least you have an idea that something has worked in the past – you have historical performance and performance statistics. If it has not worked in the past, you can skip it immediately. If you know how to backtest with historical data you can develop a portfolio of trading strategies pretty fast. There is no best trading strategy because you need many to smooth returns.

(If you are new to backtesting and statistical testing and it looks like a daunting task, you might be interested in our backtesting course.)

FAQ:

– What are the key characteristics of the Cypher pattern?

The Cypher pattern has four swings and five swing points, labeled X, A, B, C, and D. The key Fibonacci ratios include a B point retracement of 0.382 to 0.618 of the XA leg, a BC wave extending beyond point A by 113% to 141.4% of the AB swing, and a CD wave with a 78.2% retracement of the X to C distance.

– How is the Cypher pattern identified?

The Cypher pattern is identified by observing three price swings that resemble the pattern. Traders use the Cypher pattern tool or Fibonacci retracement and extension tools to trace and label price swings, projecting the D (Potential Reversal Zone) point.

– How is the Cypher pattern different from other harmonic patterns?

The Cypher pattern shares similarities with Gartley harmonic patterns but features an extended BC swing. While it is also similar to the Shark pattern, the last swing of the Cypher is not hyperextended beyond the origin of the formation. It can be either a bullish or bearish reversal pattern.