If you are new to trading, it can be confusing to know when to buy, sell, or hold a specific security. The common-sense approach to turning a profit in any market is to buy low and sell high. However, high and low points can be challenging to detect, so investors look to chart patterns to get an idea of a stock’s future performance; one of these harmonic patterns is known as a crab pattern.
What is the harmonic crab pattern in trading? The harmonic crab pattern is an M or W-shaped model on a line graph that uses Fibonacci sequences to help technical investors predict the future performance of an investment.
While the advanced math behind identifying and measuring crab patterns can become quite complex for those with limited experience, investors can first focus on locating M or W-shaped sequences in a security’s line graph history to see if it qualifies as a crab pattern, which may be useful for predicting future performance of an investment.
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Table of Contents
Types of Crab Patterns
Crab patterns are classic reversal patterns, meaning that once identified, traders can expect to see a sharp trend in the opposite direction from how the security is currently moving.
There are two types of crab patterns: bullish crab pattern and bearish crab pattern. Both patterns work in fundamentally the same way, with the main difference being that a bullish crab pattern indicates a forthcoming market gain. In contrast, a bearish crab pattern indicates an impending market loss.
Bullish Crab Pattern
A bullish crab pattern is shaped like an “M” and is a likely indicator that the market is going to start an upswing (bull market). Remember, crab patterns are reversal patterns, so even though there is a sharp downward trend on the final leg of the “M,” the trader can feel confident that a reversal is imminent.
Bearish Crab Pattern
A bearish crab pattern is shaped like a “W” and is a likely indicator that the market is going to start a downswing (bear market). For the same reasons that a bullish crab pattern reverses a downswing, a bearish crab pattern will see the market come off its highs set in the last leg of the “W.”
How to Identify Crab Patterns?
There are a couple of ways that a crab pattern can be identified, alerting the trader to a potential reversal of market fortunes:
- Construction of the pattern within the security’s overall history
- Indicators that can help determine if the “M” or “W” present on the graph is an actual crab pattern
Construction of Crab Pattern
The classic crab pattern, either bullish or bearish, will consist of several legs and have swing points comprising these legs that are labeled XABCD. The following breakdown explains how the crab pattern is constructed:
- The XA segment will comprise the initial leg of the “M” or “W” and be a sharp gain in a bullish crab pattern or an abrupt loss in a bearish crab pattern.
- The AB segment will then see between 38.2% and 61.8% retracement, countering the trend of the XA leg.
- The BC segment will then start moving back in the direction of the original XA leg, recouping 38.2% and 88.6% of the initial gains or losses—but never getting as high or low as point A.
- The final leg, CD, shows a dramatic reversal. It is the longest leg of the pattern and will be at least 161.8% of the initial XA leg.
Tools/Indicators to Identify/Draw the Crab Pattern
While it can be challenging to memorize the Fibonacci retracement and extension patterns listed above, even the most novice traders can recognize a crab pattern by looking at an instrument’s price on a line graph and going through this checklist with points XABCD:
- The BC leg is parallel to the XA leg and could be considered a smaller segment of XA.
- Compared to A, C is a higher lower in a bearish crab pattern and a lower high in a bullish crab pattern.
- Compared to X, B is a lower high in a bearish crab pattern and a higher low in a bullish crab pattern.
- Extending beyond X, D is the extreme point, the highest high in a bearish crab pattern and the lowest low in a bullish crab pattern.
How to Improve the Reliability of the Crab Pattern in Trading?
While the harmonic crab pattern is in and of itself useful in helping predict the reversal of a market trend, it can be combined with some other technical analysis tools and concepts to help assure its reliability.
The butterfly pattern is another similar harmonic pattern that can be useful in predicting market reversals. In addition, technical analysis indicators such as Elliott waves, moving averages, and stochastics oscillators can be used to help ensure a crab pattern’s predictive reliability.
How to Trade with the Crab Pattern?
Now that you understand what a crab pattern is and how to identify one, it is essential that you know how to use this knowledge to make profitable trades. The following are a couple of examples of how to make successful trades using the crab pattern.
Strategy 1: Buy a Bullish Crab Pattern
When you recognize a bullish crab pattern forming, you are going to want to buy at point D (the point at which we think the price has bottomed) so you can capitalize on the potential reversal zone (PRZ). Use the following guide to help you successfully buy a bullish crab pattern:
- Tradeable leg: This will be the final leg of the M-shaped crab pattern (CD). You have successfully identified the crab pattern through the initial legs and want to purchase point D to capitalize on the forthcoming PRZ.
- Trade entry: Again, point D should be the entry point for buying a bullish crab pattern, precisely the point at which D reaches 161.8% of the low hit at point X, the initial starting point for the model.
- Stop-loss target: You want to have a stop loss in place just below 161.8% of point X. If the losses continue past this point, it may not be a true crab pattern, as the Fibonacci rules are broken, and you will want to cut your losses and locate another trade.
- Setting take-profit target: This is generally up to personal taste and depends on how aggressive you are as a trader. Most traders take their profits when the PRZ has rebounded to at least the B point of the original crab pattern for conservative gains and the A point for the original crab pattern for aggressive profit targets.
Strategy 2: Sell a Bearish Crab Pattern
As bullish and bearish crab patterns are essentially the same, only the reverse of each other, many of the same tenets for successfully buying a bullish crab pattern can be used to sell a bearish crab pattern successfully:
- Tradeable leg: The final leg of the W-shaped crab pattern (CD) is when you want to make your sell to avoid the forthcoming PRZ.
- Trade entry: Like in a bullish crab pattern, point D of the final leg should be the entry point. When point D hits 161.8% of the original XA leg, it is time to sell.
- Stop-loss target: This target should be just above point D, as you will want to capitalize on all potential gains and avoid short-selling.
- Setting take-profit strategy: Like a bullish crab pattern, an aggressive profit point is point A of the original crab pattern, while a conservative profit point would be point B.
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Conclusion
The harmonic crab pattern allows you to enter or exit a market at extreme highs or lows. For the best results, enter the market with a long (buy) or short (sell) trade at point D on the final leg of the crab pattern, as the market is likely in for a sharp reversal of fortunes.
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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