The AB=CD pattern structure
The AB=CD pattern is one of the most simple patterns from price action methods that a beginner trader can use for trading. The AB=CD pattern can be found in all timeframes and all trading instruments. It is also part of Gartley buy and sell and Butterfly pattern.
AB=CD is a simple chart pattern where the CD move is equal in measure with AB move. Keep in mind that CD leg can extend and there will be cases when CD leg will not have exactly the same length as AB. So, we can have a CD extension at this Fibonacci Expansion levels: 127.2 / 161.8 and 200.
This pattern is formed of three legs: AB, BC and CD. The firs leg AB is basically the first move of this pattern, BC is the retracement of AB which usually is supported at these Fibonacci Retracement levels: 38.2 / 50.0 / 61.8 / 78.6 For stronger trends we will see only shallow retracements at 23.6 or 38.2 levels. The CD leg is the second thrust (impulse) of the initial move AB and it appears after de BC retracement takes over.
This is a classic AB=CD buy pattern on SP500 15 minutes chart where AB leg equals CD leg. We can easily see how a buy opportunity appears after the CD leg is finished.
How to spot AB=CD pattern on the chart
The easiest way to find an AB=CD pattern on the chart is to search for an initial move (impulse, AB leg) into one direction (either up or down) with a retracement (BC leg). When we see that the initial move (AB leg) resumes we can assume that the price will reach the D point only after the price exceeds the B point. There is only one case when the AB=CD pattern is valid and D point is at the same level with B, and this is the double bottom / top pattern.
Here are some rules which invalidate AB=CD pattern:
- BC can’t be higher / lower (depeding if there is an uptrend or downtrend) than AB, this means that BC correction (retracement) can’t exceed the AB impulse (100.0 level of Fibonacci Retracement);
- The maximum BC length can be at 100.0 level of Fibonacci Retracement of AB leg. This happens only in a double bottom / top pattern;
- D point must exceed B point in order to have a valid AB=CD pattern (except double bottom / top pattern).
Characteristic of AB=CD pattern
In 40 – 45% of the cases the AB leg equals CD leg. In the other cases we will see variations of CD leg at 127.2 / 161.8 and 200. Those are the clues for the trader to look for an extended CD leg:
- If there will be a gap into the CD leg the trader must expect an extension of CD leg at 161.8 or 200 levels of Fibonacci Expansion;
- Strong candle/s into the CD leg (twice as normal size) can offer a clue that the trader might see an extension of CD leg;
- The classic AB=CD pattern is symmetric in price and time, which means if the AB leg is formed of 10 candles the CD leg might have also 10 (maybe 12) candles too. It’s very important to know that if the CD leg is formed of a smaller number of candles than AB, or the slope of CD leg is steeper than AB then this is an important clue for the trader that there will be an extension of CD leg;
- If the BC leg retraces at 61.8 or 78.6 there is a good chance that CD leg will be equal with AB.
Here is an AB=CD sell pattern on FTSE 1H chart with an 127.2 extension of CD leg. Note the strong bars contained in the CD leg and how the price reacts at the exactly 127.2 level:
How to trade the AB=CD pattern
After the trader identified an AB=CD pattern and decided that he will trade that pattern, the trader needs to find some signs of reversals at the completion of D point (wicks, engulfing patterns, etc.). The trader needs to keep in his mind all the characteristics that can validate / invalidate this pattern or may suggest an expansion of CD leg.
For instance, in the FTSE example, the market offers an 1:1 risk / reward opportunity to the trader. An early (agressive) entry is made at the retest of the 127.2 zone (the first bear candle of Fibonacci Expansion level after the bull candle with a big wick which indicates a strong bear pressure) and the Stop Loss is placed few pips above 161.8 level of the same Fibonacci Expansion (7497.40 price level). A conservative entry can be made after the first bear candle close. The trader would want to secure some profits when the price is traded with few pips above 23.6 and / or 38.2 Fibonacci Retracement level. Tha main target is the 61.8 Fibonacci Retracement, but in this case the uptrend is a very strong one and the AD swing only retraces until 38.2 Fibonacci Retracement level. After the trader secured his profits he can move the Stop Loss (SL) to the entry point so he can enjoy a “free ride” trade with 0 risk. After the price reaches next levels of Fibonacci Retracement the trader can place the SL few pips above each level so he can secure more profits.
Before starting to trade, it is indicated for the trader to practice on demo account first until he aquires this method and the results are good. It is also good to find 1 – 2 instruments for testing because each instrument has it’s own “secrets”.
It is also important to use a proper risk and money management and check for every trade opportunity the SL size and if there is an acceptable loss. If there is an unacceptable loss the trader will simply skip the trade and move to the next one. It is recommended to use a risk of maximum 2% to 5% of equity.