Learning and spotting chart patterns in the stock market is a popular hobby amongst day traders of all skill levels.
Patterns are an important aspect of trading and traders love and naturally count on them when placing small and big trades.
Not only are they the connection between trends, but they are also at the origin of all major price moves.
That brings us to our main topic: the ABCD trading pattern, which is undoubtedly one of the most consistent and powerful patterns in the stock market.
What is the ABCD Trading Pattern
The ABCD pattern is an easy-to-identify chart pattern that consists of two equivalent price legs. It is a harmonic pattern that helps traders predict when the price of a stock is about to change direction.
The pattern can be used to predict either a bullish or bearish reversal depending on the orientation. It is particularly important as it appears very frequently in stock charts.
This pattern begins with a strong upward move – initial spike (A), during which buyers are aggressively buying thus pushing the stock price to it high-of-day. Inevitably, buyers start to sell their shares in order to take profits. Therefore, we end up seeing the spike, followed by a healthy pullback.
Once sellers are overpowered by buyers, the pattern establishes an intraday low (B) as the price falls. At this point, you should not enter the trade since you aren’t sure where the dip of the pullback is going to be.
Instead, you ought to wait for the price to show strength by hitting a higher low (above point B) on the next bottom. After the pattern has established this higher low at (C), you can start planning your trade with your risk at point B.
Simply put, we are waiting for the price to break above point A, and we consider locking in profits at point D.
Importance of ABCD trading pattern
The ABCD pattern is important to traders for a number of reasons:
- Traders can use it to identify trading opportunities in various markets, in any market condition, and on any timeframe
- It is the basis of all other patterns
- It can be used to weigh the risks versus rewards before making a trade
- It offers an excellent risk-reward and a high winning percentage
- The convergence of several ABCD patterns (across multiple timeframes or within the same timeframe) provides a powerful trade signal
Tips for trading the ABCD Pattern
Each ABCD trading pattern has both a bullish and bearish version. As you can see from the diagram above, an ascending ABCD pattern is bearish, while a descending ABCD pattern is considered bullish. For both versions, the lines AB and CD are called the legs while BC is known as the retracement or correction.
While there are many various ways to implement stock entry and exit strategies, there are a number of things that traders ought to consider when using the ABCD pattern.
To identify a potential entry point, watch your scanner as the stock rises from A and hits a new high of day (B). Then wait to see if the price makes a support level higher than point A, and if it does, call this new support level C.
At this point, wait and watch as the price consolidates. If support is established at C, enter the trade as close to the price of C as possible while hoping that the stock will go or even rise beyond point D.
If the price falls below point C, you need to stop out and exit the trade. When the price reaches D, it would be best to sell half of your position and bring your stop higher. Once you hit your target or sense momentum is dwindling, it would be great to sell your remaining position.
Low volume on consolidation
Like most types of technical analysis, the ABCD pattern works best when used together with other chart patterns or technical indicators. Assuming you already know that stocks tend to consolidate quickly after a trend, you may also want to check volume when using this pattern in order to confirm a reversal after the pattern makes a prediction.
Volume is the total number of shares of stock traded over a given period (e.g., daily, weekly, monthly). It reflects the strength of a stock and also provides an indication of the quality of a price trend and the liquidity of the stock.
Generally, volume tends to be low while a stock is consolidating and you ought to consider this a red flag when using this pattern.
High volume on breakout
Once you have identified a very clear buy signal on your chart, the only thing left to do is to watch for a breakout. If volume breaks out at the same time the price does, that is a much stronger signal than a price breakout with low volume.
Traders know that the market is likely to reverse direction after a pronounced trend.
ABCD pattern traders try to identify the second time when a trend loses steam and may reverse. In short, they are looking for an opportunity to buy in a market that is falling and looking for a short sell opportunity in a market that is rising.
The ABCD pattern is a blend of time, price, and shape. When all three merge at one point, the pattern forms an electric move that traders can rely on to spot potential reversal zones so they can jump back in the direction of the overall trend.