Learning how to spot chart patterns in the trading market is a skill most traders aim to develop. The patterns help traders determine the risks and identify opportunities to turn a profit in any market. They also provide an insight into whether the price is about to change directions. The ABCD pattern is considered one of the most reliable designs, and traders often use it.
What is ABCD Pattern in technical analysis? It is a geometric and time pattern that looks like a zig-zag line on the stock chart. It is usually based on 3 consecutive price swings, and it’s a helpful tool that helps determine when someone should enter or exit a trade.
Identifying the ABCD pattern can be challenging for beginners. That’s why it’s good to know the basics. It can help you get ahead in the trading business. Here’s some information to get you started.
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Table of Contents
What Is ABCD Pattern and Why Is It Important?
The ABCD pattern is a mathematical pattern that’s based on the following:
- Time
- Price
- Shape
When all three components merge at points on the chart, it creates a pattern. The pattern illustrates the electric move of the stock so that traders can predict the price trajectory. Many traders refer to it as a “lightning bolt” on a chart.
The ABCD pattern is important because it helps provide a consistent insight on potential reversal zones, so traders can determine if they should buy or sell. It applies to all types of trades, whether it’s stocks or cryptocurrency. It can also be used to determine if the risks outweigh the reward.
Types of ABCD Patterns
As you learn about the patterns, you’ll see that there are two types of ABCD patterns:
- Bullish
- Bearish
Bullish ABCD Pattern
The goal is to find AB, with the A point being high and point B being low. Then, find BC. Point C has to be lower than point A. Once you have BC, you should be able to “draw” CD. Keep in mind that point D needs to be lower than point B.
You should be able to predict where D may end up on the chart, and it should be lower than point B in the bullish pattern. These patterns are typically used to identify opportunities to “go long,” which means to buy.
Bearish ABCD Pattern
The goal is to find AB, with the A point being low and point B being high. Then, find BC. Point C has to be higher than point A. Once you have BC, you should be able to “draw” CD. Point C should be 61.8% or 78.6% of AB.
Like with the bullish pattern, you should be able to predict where D may end up. Point D should be higher than point B in the bearish pattern. These patterns can be used to identify opportunities to “short,” which means to sell.
How To Identify The ABCD Pattern?
If you’re trying to identify the ABCD pattern, it helps to illustrate the pattern’s construction on the chart and see if it aligns with an ABCD pattern. There are several ways to do this, including using chart tools.
Construction of ABCD Pattern
Each point (A, B, C, D) is either a high or low point on a price chart. The lines between AB and CD are the price legs. With the classical ABCD pattern, it starts by moving upwards in a line from point A towards point B.
This is where you’ll see people buying the stock, which increases the price. As the price goes up, the buyers will shift gears and start selling their shares to make a profit.
Eventually, there will be more sellers than buyers, and the pattern will go downwards to point C as the price decreases. Then, the cycle repeats itself with more people buying the stock, which moves the line up again towards point D.
If the pattern shows a higher low after the next spike and fall, to the point where it is above point A, then it would be ideal to lock in the profits at point D.
The ABCD pattern should have:
- Equal lengths of the lines between points AB and points CD
- Equal time it takes to move between points AB and points CD
Tools to Identify The Pattern
The Fibonacci chart tool is a popular mathematical approach that works well, and traders use it to find proportions between AB and CD. That way, they can develop an estimate of the ABCD pattern trajectory (in time and price). This will help identify the ideal entry and exit points.
When you apply the Fibonacci tool on the price legs, it measures the retracement between the points. There should be a retracement of the line between points B and C at 0.618 or 0.786. And the line between points C and D should be the Fibonacci extension of the BC leg, which is 1.272 or 1.618.
Thanks to innovative technology, you can also use smart ABCD pattern drawing tool apps to illustrate a chart’s pattern.
How to Improve Reliability of ABCD Pattern in Trading?
Most traders use a wide variety of chart indicators to look at price history or the trading volume. Some of the indicators are momentum-based.
There are two types of indicators.
- Overlays– These indicators use scales to plot prices on a stock chart. You can use it to see if the market may be overbought or oversold. A good example would be Bollinger Bands, it’s an overlay that shows the high and low limits of a price.
- Oscillators- These indicators are momentum-based and consist of using a particular mathematical formula to compare a closing price to its range of prices over a specific time period. A good example would be a Chaikin Oscillator, it’s an indicator that shows how much money may be flowing by combining price and volume.
Now let’s look at popular indicator’s traders use:
- On-Balance Volume– Measures the positive and negative flow of volume.
- Accumulation/Distribution Line– Determines the money flow in and out of a particular trend. It can be used to confirm an uptrend.
- Average Directional Index– Used to illustrate the strength and momentum of a trend. This will help show the direction of the pattern.
- Aroon Indicator– Used to identify when a trend is about to begin, and if the price is hitting new highs and lows.
- Moving Average Convergence Divergence (MACD)– Provides trade signals and helps illustrate the trend’s direction and momentum.
You can try out several indicators to develop new trading strategies, or you can combine them with chart tools to increase the pattern reliability.
How to Trade ABCD Pattern?
ABCD pattern traders typically develop strategies to help look for an opportunity to buy stocks in a market while it’s falling, intending to sell when the demand is rising again. Let’s go over one of the strategies.
The Pullback Strategy
This strategy is based on the ABCD pattern. The goal is to enter a profitable trade during a pullback when the price is still close to point C.
- Tradable Leg– For the bullish version of the ABCD, a bear trend bar can be the first tradable leg of a pullback.
- Trade Entry– Pullbacks are considered a great entry point for strong trends. Watch as the stock zig-zags along the chart to see if point C is higher than point A. If it is, then enter the trade while the price is still close to point C. It’s best to avoid entering the trade until the ABC pattern has been established.
- Stop Loss Target– If the price starts to decrease below point C, you’ll need to stop out and exit. If the price moves up in your favor, you can move the stop loss point to a break-even point.
- Setting Take-Profit Targets- This is an essential part of trading, it’s where you set a profit target on a chart where you will exit and turn a profit. In most cases, it’s ideal to set a profit target close to point D.
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Conclusion
The ABCD pattern shows the relationship between time and price by illustrating the distance and time it takes for a trend price to go from point A to B and C to D. It can be handy if you’re considering entering the trading business. Keep in mind that it works best when it’s used with other chart indicators and tools.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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