Harmonic Pattern Trading Strategy Explained (Backtest And Example)

In the world of price action trading, there are different kinds of chart patterns, ranging from simple ones like triangles to the more advanced ones like the harmonic patterns. Are you wondering what the harmonic pattern is?

In chart analysis, harmonics refer to the pulse and rhythm of the market. So, harmonic patterns are chart patterns that arise from price waves and cycles. They typically consist of four or five price waves with five swing points that represent unique Fibonacci ratios.

In this post, we take a look at the harmonic pattern trading strategy and make a backtest at the end of the article.

What is the harmonic pattern?

In financial markets, harmonics refer to the pulse and rhythm of the market. So, harmonic patterns are chart patterns that arise from price waves and cycles. They typically consist of four price waves with five swing points that represent unique Fibonacci ratios.

Generally, harmonic patterns are some sort of reversal patterns that can either indicate a trend reversal or the reversal of a multi-legged pullback. They show when a price movement is potentially getting exhausted so that traders can prepare to move in with the reversal.

The key swing point is known as the potential reversal zone (PRZ), which is where a harmonic pattern is completed, and traders anticipate a price reversal. Traders look for trade setups at the PRZ, using reversal candlestick patterns, such as a pin bar, an engulfing bar, or an inside bar.

There are many variations of the harmonic price patterns, but the common ones are the AB = CD pattern, Gartley, Bat, Crab, Butterfly, Shark, and the Cypher pattern. By identifying and analyzing these patterns, one can predict how the price might move in the near future. In order to exploit the trading opportunities that come with the patterns, you must be able to spot one before it completes forming.

Do harmonic trading patterns work?

Some traders believe the harmonic patterns work, which is why they are always eager to spot and trade them. They believe that since the patterns follow Fibonacci ratios and show when the price is extended in a particular direction and probably ready to reverse, they provide some sort of trading opportunity.

However, it is not clear whether the patterns work just as a self-fulfilling prophecy because traders are following them. As with other chart patterns, the harmonic patterns do not work all the time. The only way to know whether the harmonic patterns have any tradable edge in the market is by backtesting them. And any backtests are far in between because of the subjectivity of the pattern.

Which timeframe is best for harmonic patterns?

Traders use the harmonic pattern strategy on different timeframes. While some like to trade it on the H-1 or H-4 timeframe, others prefer to trade them on the daily timeframe. But which timeframe is the best?

Well, the only way to find out is to backtest the patterns to know if they ever make money, and on which timeframe they work best. Note that different harmonic patterns may work best on different timeframes. So, it is best to test the patterns one after another.

Harmonic Pattern Trading Strategy backtest

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

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? How do you know a pattern is profitable if you have not backtested it?

Backtesting is no sure thing, but at least you have an idea that something has worked in the past. If it has not worked in the past, you can skip it immediately. If you know how to backtest 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 it looks like a daunting task, you might be interested in our backtesting course.)

We believe you can get many trading ideas to form a trading strategy by looking at what we have to offer. We have hundreds of different trading strategies on this website – all of them backtested with strict trading rules. You find all our products in our shop.

FAQ:

What is the potential reversal zone (PRZ) in harmonic patterns?

The potential reversal zone (PRZ) is a key swing point in harmonic patterns where the pattern is completed, and traders anticipate a potential price reversal. Traders often look for trade setups at the PRZ, utilizing reversal candlestick patterns like pin bars, engulfing bars, or inside bars.

What are the common harmonic patterns in financial markets?

Common harmonic patterns include the AB = CD pattern, Gartley, Bat, Crab, Butterfly, Shark, and the Cypher pattern. These patterns vary in their structure and Fibonacci ratios, offering traders different tools for identifying potential reversals.

Do harmonic trading patterns work consistently?

The effectiveness of harmonic patterns is debated among traders. While some believe in their validity, others view them as a form of self-fulfilling prophecy. Harmonic patterns, like other chart patterns, do not work all the time. To assess their tradable edge, backtesting is essential, although the subjectivity of the pattern makes this challenging.