ABCD Pattern Trading: All you need to know

A quick but informative article explaining ABCD patterns and how you can use them in your investments.

Whereas other investors simply rely on pure luck to guide their investment decisions, more experienced investors rely on charts and graphs -- reports of historic and projected prices of stocks. After a while, an experienced investor will learn how to identify chart patterns. There are repeating patterns in stock movements that, more often than not, can tell an investor whether a stock is about to increase or decrease in value.

Now, of all the very technical terms and mechanics that go into learning the different chart patterns and their meaning, ABCD chart patterns are probably the easiest to identify. Once you get the hang of it, being able to identify ABCD patterns can tell you when to buy and sell a stock, walking out with as many returns as possible while avoiding loss.

Here in this article, we'll go over the basics of ABCD patterns, how to identify them, how to capitalize on them, and what not to do -- all to give you the information that other successful investors took years to learn:

What's an ABCD Chart Pattern?

Officially published by Larry Pesavento and Scott Carney, but originally discovered by H. M. Gartley in his 1935 book "Profits in the Stock Market", ABCD patterns, also written as AB=CD, is a frequently occurring pattern that's probably one of the easiest to spot. It is essentially a four-step sequential pattern that resembles a lightning bolt.

Simply put, they consist of 3 consecutive price swings (A, B, C) and a buy or sell action (D). To be more specific:

• The stock goes through a sharp price increase, then falls.
• It then goes through a new low. It seems like it's on a decline but, low and behold, it begins to rebound.
• It then reaches a new support level. Meaning it's beginning to inch higher and higher until it reaches the point that letter A was at.
• The stock surpasses point A in value.

This can happen at any point and in any kind of market. It might seem chaotic at first, but establishing each of the high, low, and support levels can allow you to determine an entry and exit strategy.

ABCD is also the easiest of the harmonic patterns to understand and is also one of the most versatile. Being intimately familiar with this pattern, so much that one can easily identify, can make it much easier for one to identify and utilize other chart patterns.

Three Main Types of ABCD Patterns:

• AB=CD
• Classic ABCD
• ABCD Extension

There are respective rules to each of the types by which the guiding principle remains the same: identifying a fluctuation of the price in an easy-to-predict quantifiable consistency. The only thing that changes with each type time they occur and how quickly they reach each point on the sequence. These types also work in bullish and bearish markets as well.

Fibonacci Sequence

The ABCD chart pattern and Fibonacci Sequence are inextricably linked -- the former being deeply rooted in the principles of the latter. 

• Under the guiding rules, investors ideally want point C of the pattern to be around 61.8% of AB. 
• Another rule, known as the Fibonacci extension, states that CD is 127.2% of BC.

These rules allow an investor to work out a buy and sale strategy -- letting on know when to enter and when to exit.

In Bear and Bull Markets

When engaging in trading this pattern, it is usually in either one of two settings: Bearish markets or bullish markets.

When trying to use the AB=CD pattern trading in a bullish market, the pattern will usually begin with a decrease in price for the points of A to B. After this, the price should rebound and begin to rise, starting from B to C. 

The BC move then reverses into a new bearish move from C to D, which goes below the bottom made at point B.

The ideal scenario is that a reversal of fortunes occurs once again and the price begins to increase, eventually creating a new high.

For bearish markets, this trajectory is simply revered and the lightning bolt pattern should appear upside down.

Benefits of the ABCD Pattern?

There are several perks to being able to identify ABCD patterns in the market. Below are just some of the important ways investors benefit from ABCD chart patterns:

• It is one of the most versatile chart patterns an investor can work with. Traders who see this pattern to predict certain developments in various markets, no matter the market condition or time-frame
• It can be used to determine the risks versus returns before making a trade decision -- something essential in the high-stakes world of trading.
• It serves as the framework for other patterns. It is quite easy to build a larger strategy based on the ABCD pattern as it serves as the basis for other chart patterns and predictions. Being familiar with it is also a good springboard towards learning other, more complex patterns.
• It offers potential for much higher returns compared to other, slower-moving forms of investment.
• Recurrences in one or more ABCD patterns, patterns are seen across different or the same timeframe provides you with a powerful trade signal. Though there are no certainties in the market, such recurring patterns are strong indicators of a future outcome with a stock.
• It offers some predictability in day trading -- an infamously unpredictable practice.

Common Mistakes Made By Investors

Though it is a simple enough principle that anyone with a knowledge of the basics of trading can understand, it still takes some practice to be able to perfect. Some investors still make mistakes and see patterns when there aren't -- often very expensive mistakes.

To help you avoid losing money to bad decisions, below are some of the most common mistakes investors make with ABCD patterns:

Misinterpreting a chart to have an ABCD Pattern

The most common mistake traders make is thinking a chart is reflecting an ABCD pattern when it is not. Some stocks never reach the point where they increase in price but end up on a totally different trajectory -- leaving investors who already took up positions in anticipation very disappointed.

Stocks that are considered highly active are subject to large swings over a short time period. Though they may show indicators of an ABCD pattern, they can be very difficult to accurately establish support levels.

Failing to observe the volume

It's essential that you also observe the volume. Volumes of the ABCD patterns have a tendency to be high as the pattern is forming and more compact as the trend culminates. If there's low volume when you begin to see the pattern forming, that's a major red flag. In cases like this, it might not be due to regular trading action but might actually be the result of external factors unknown to the market.

Things like this mean that the stocks are more volatile than what would be desired.

Lack of experience with Technical Analysis

ABCD patterns might be simple to understand, but trading is a practice that requires a lot of knowledge about technical analysis and being able to read complex data. Many investors make mistakes because they simply read the situation wrong.

Some Tips for Trading with ABCD Pattern

• Know your entry point. It is always ideal to know when to enter and when to leave. For example, let's say you want to set up a position with bearish formation, you'll need to wait for the stock to rise from point A and hit a new high point on that day -- this will be your point B. Wait and see if the next support goes about point A. If it does, you can confidently call this new level your point C. Wait for the price to consolidates. If support occurs at C, then wait for a new high point which will serve as your point. Your position should ideally be set up between point C and point D. The opposite of the aforementioned is what you would do in a bullish ABCD formation.
• Know your exit point. To be safe, you'll want an ideal 2:1 reward/risk ratio. This, of course, can differ depending on market conditions at that particular time and how much you're willing to invest.
• Pair it with other charts. As an investor, you'll want the best information possible, and that only comes with wide access to as many charts and intel as possible. Create a full-proof strategy and diversify your portfolio with more stable and predictable investments to come out on top.

Bottom Line

And that was all you needed to know about ABCD chart patterns and more. Certainly, this article is helpful to you in your education on more complex forms of trading and investment.

The market can be a big, scary, and often confusing place. Technical analysis helps us make sense of all the craziness and offers investors the best chance possible to walk away with more than what they started with.

That being said, we always ask investors to proceed with caution and invest their money wisely.

ABCD patterns are by no means guaranteed to return, it is a simple but powerful tool that when used correctly, can be the nearest thing to certainty as one can get in the market.