Cypher pattern is an important concept to learn and use that falls within the group of harmonic pattern trading. The concept, thankfully, is simple enough for an average trader to use in various types of trading.
What is a cypher pattern? Cypher trading is a rare and advanced pattern formation which was founded by Darren Oglesbee. Since cypher patterns use a tighter Fibonacci ratio, the overall visual appearance is steeper while still consisting of the common 4-legs of harmonic patterns.
Cypher pattern is a unique strategy founded by Oglesbee and is known to be one of the rare harmonic patterns. Continue reading to find out what the types of cypher patterns are and how to identify them.
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Table of Contents
What is Cypher Pattern?
Within the harmonic trading strategies are common geometric patterns. Out of the well-known harmonic patterns, such as the Gartley, Butterfly, Crab, and Bat, the Shark and Cypher patterns were not included in Scott M.Carney’s original book, Harmonic Trading. Nonetheless, a cypher pattern is a useful tool in harmonic trading.
In general terms, a cypher pattern is easy to spot because of its wave-like characteristics (rising peaks and falling valleys). All harmonic patterns share the five parts of the pattern, resulting in a 4-leg pattern.
Review:
- X – Start of the trend
- A – End of the trend
- B – First pullback of the trend
- C – Pullback of the pullback
- D – The target of letter C, pattern completion
Types of Cypher Patterns
In a book called, Profits in the Stock market, by H.M. Gartley, the use of AB=CD pattern is introduced. When the AB=CD pattern was modified with Fibonacci ratios, the resulting patterns were used as tools to forecast key market turning points and profit targets for traders.
Cypher trading consists of 4 legs and can be either bullish or bearish. The orientation may be different depending on whether the cypher pattern is bullish or bearish, but you will be performing it the same way. The bullish cyphers will have both lows and highs trending upwards, and in bearish patterns, the lows and highs will be doing the opposite.
Bullish Cypher Pattern
A bullish pattern is like the letter “M.” In a bullish pattern, the following conditions are keys to look for:
- C is higher than A
- D must be less than B
- D must be greater than X
- Higher high (C > A), Higher Low (D > X)
Bearish Cypher Pattern
A bearish pattern is an upside-down orientation of the bullish pattern and will create a “W.” In a bearish pattern, the “opposite” conditions are found:
- C is lower than A
- D must be more than B
- D must be lower than X
- Lower high, (D < X), Lower low (C < A).
How to Identify the Cypher Pattern?
The cypher pattern consists of five points – X, A, B, C, and D. The XABCD will go in the left to right direction forming legs of XA, AB, BC, and CD.
Construction of the Cypher Pattern
- Point B is between 0.382 – 0.618
- Point C is between 1.272 – 1.414
- Point D is at 0.786
Considering the above specifications, the construction of the Cypher pattern is as follows:
- Cypher patterns are spotted when there are sharp reversals in the wave.
- The start of the pattern will be with the X point, which leads to the first XA leg.
- Generally, you will find a B point that is at the end of the AB leg, which is a retracement of the initial XA leg.
- The AB leg follows the XA leg, often called an anchor leg.
- This point B must lie between 0.382 and 0.618 retracement.
- It is followed by the BC leg; point C must lie at the end of the BC leg landing between the 1.272 and 1.414 projection of the XA leg.
Watch this video to see an overview of identifying a cypher pattern. It will walk you through the steps above with a few examples to help you understand what you’re looking for.
Tools and Indicators
To identify these, you will be using the Fibonacci retracement and extension tool. The following are the major components of the cypher pattern.
Leg XA
The first four legs, as mentioned above, start with the first impulse leg, X to A, often referred to as the anchor leg. This impulse leg can be up or down, which is a hint of bullish or bearish, respectively.
First Guide: Find Point B (0.382-0.618)
Then, using a Fibonacci retracement from X to A, find the B point. The turning point to the next leg from XA makes point B. Then, the next leg is the BC leg.
The first clue of cypher pattern: Point B must retrace between 0.382-0.618 Fibonacci level of leg XA. The retracement from X to A has to come down to 0.382, the wick itself has to touch 0.382 but not close below 0.618.
If you were to use a candle, the body of the candle still has to be within the ranges of the 0.382 and 0.618. The wick can pass below 0.618, but not the body of the candle. (Candle 1)
Second Guide: Find Point C (1.272 – 1.414)
Fibonacci extension of X to A and back down to X comes up to 1.272 but not close to 1.414. It follows the same rule as before. The candle body has to remain within the range and must not exceed past the 1.414. (Candle 2)
Point C is at least 1.272, but usually, the candle can go as far as 1.13 to 1.414 projection of the primary XA leg. Again, the pattern is invalid if it moves past 1.414.
Point D (0.786)
Using the Fibonacci retracement from the X to the C and up to the wick of the second candle, point D will be at the 0.786 retracement of the XC.
Additional Note
Listed below are few additional things to note here –
- Candles and Wicks. Wicks can always exceed the ranges mentioned previously, but the body of the candle must not. As long as the candles don’t close beyond them, it is still within range. As for closed candles, this would mean the entirety of the candle.
- Point B also cannot come below the 0.786. This includes the wick and candle and will only be a concern when there are deep extensions of the XA leg.
How to Improve the Reliability of Cypher Pattern in Trading?
Although this is a high-risk ratio pattern, the general success rate is 40%. It is crucial to make the best of the pattern by using the tools.
Use the tools and indicators to identify the entry position, stop loss, and profit levels. Keep in mind that the risk of the trade is the distance between the entry point and stop loss. The reward is the area between the entry point and the take-profit.
How to Trade Cypher Patterns?
In the following section, we will discuss one of the best and well-known strategies for trading with cypher patterns. Knowing your buying entry and stop-loss will be your key to getting the most profit with minimal risk.
Strategy 1: Buy Once CD-Swing Leg Reaches 0.786
This strategy lowers the risk by waiting until the completion of the D point at the 0.786 Fibonacci retracement.
Tradable Leg
In this strategy, the tradable leg cannot be determined until the CD leg completes at the 0.786 Fibonacci retracement.
Trade Entry
- To ensure that a cypher pattern is complete and valid, you will want to see that the Fibonacci retracement of X to C leads the CD leg to 0.786.
Stop Loss
- Stop-loss should be placed below the X point at ten or more pips on your intraday charts.
- Bullish cypher pattern: stop loss at least ten pips below the (low of) X
- Bearish cypher pattern: stop loss at least ten pips above the (high of) X
- This may vary for daily charts. Consider 20-30 pips or more instead of ten.
Taking Profit
- First profit level is by using the B point at the 0.382 retracement of the CD.
- Second take profit is at 0.618 within the CD line.
- Close half of the position at the first take-profit, 0.382, then close the rest of the position at the second take profit, 0.618, to exit.
Risk Management
Move the stop losses after your position goes into profit if you want to lower the risk of wiping out your previous gain. For example, if you move the stop loss to the entry point after hitting the first take profit, you will prevent a market reversal back across D, taking advantage of the high strike-rate.
This is why paying attention to the candle and wick is essential. When the candle bodies pass the given ranges, the pattern is too steep.
For example, if you wanted to improve the risk to reward ratio, you would wait for the CD leg to retrace below the 0.786 level of the D point. After it is below the line, you would trade there.
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Conclusion
Keep in mind that cypher patterns may seem choppy at times but pay attention to the Fibonacci retracement and extensions to validate the pattern.
Overall, the cypher pattern has become advanced and appreciated for its advanced price action pattern. It has a high strike at 80% in specific markets make it worth implementing.
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