Day trading is all about spotting patterns on stock charts, and ABCD pattern trading is the most crucial idea for beginner traders to grasp. This pattern can be found regularly on stock charts and is simple to recognize once you know what to look for. More importantly, it can assist you in better timing your purchases and sales, and it can also help you feel more confident about your trading judgments.
In day trading, there are no guarantees. However, because it is the result of market fundamentals in action, ABCD pattern trading is one of the most reliable indications for decision-making.
What is the ABCD Buying and Selling Pattern?
The ABCD pattern is a simple chart pattern that consists of two price legs that are equal in length. It is a harmonic pattern that aids traders in predicting when a stock's price is going to shift direction.
Depending on the angle, the pattern can be utilized to forecast a bullish or bearish reversal. It is especially significant because it appears regularly on stock charts.
The bearish pattern starts with a powerful upward surge – initial spike (A) – during which purchasers buy vigorously, driving the stock price to its high-of-day high. Buyers will inevitably begin to sell their shares to benefit. As a result, we witness a surge, followed by a healthy pullback.
When buyers outnumber sellers, the pattern creates an intraday low (C) as the price falls. You should not enter the trade at this moment because you do not know where the pullback's dip will be.
When stocks reach a new high (D), you should seek resistance as a potential short entry point.
A stock is up and down movement may appear chaotic to rookie traders. Establishing the high, low, and support levels, on the other hand, gives traders a notion of how the stock will perform in the future. Before the stock swings up or down again, it is an excellent indicator of when to initiate or quit a position.
AB=CD, Classic ABCD, and ABCD Extension are three forms of ABCD patterns that apply to both bullish and bearish trajectories. Each pattern has its own set of laws, but they all have one thing in common: a predictable price volatility. The time period, or how quickly a stock reaches the critical levels in an ABCD pattern, is what changes.
What Is the ABCD Pattern, and Why Is It Important?
ABCD pattern trading is the most basic of all market patterns, and it serves as the foundation for all others. This is because it is based on the Fibonacci sequence, which entails dividing one number by another in a pattern.
Traders looking for the essential Fibonacci ratio of 61.8 percent in ABCD pattern trading are looking for the Fibonacci ratio of 61.8 percent. The optimal value for point C is 61.8 percent of AB. If this is the case, traders can use the Fibonacci sequence to determine when to enter and exit trades by monitoring the value of D.
The first step in detecting other patterns, such as a flag pattern or a rising/falling wedge, is to recognize an ABCD pattern. A critical clue that the stock behaves predictably is the convergence of patterns atop the ABCD pattern. Traders might be more confident when entering or abandoning a position at higher levels because of this.
Common ABCD Pattern Trading Mistakes
The most common mistake made by ABCD pattern traders is assuming there is an ABCD pattern when there isn't one. Active equities that see huge swings in price over a short period of time may exhibit ABCD pattern indicators. However, establishing support levels in these equities might be challenging despite a trending tendency.
When looking for ABCD patterns, it's also vital to pay attention to volume. Volume is typically strong when a pattern is formed (thus the action) and then settles as the trend progresses. It's a red flag if there's low volume when the pattern is forming. It's possible that the pattern isn't the result of normal trade activity, and external variables may be causing the setup to be more volatile than planned.
Three-Drive
The three-drive pattern resembles the ABCD pattern, but it has three legs (now called drives) and two corrections or retracements.
It's as simple as pie! This three-drive pattern is, in reality, the forerunner of the Elliott Wave pattern.
For this one, you'll need your hawk eyes, the Fibonacci tool, and some patience, as usual.
The 61.8 percent retracement of drive one should be point A, as shown in the charts above. Similarly, the 0.618 retracements of drive two should be point B.
The 1.272 extensions of correction A should be driven 2, and the 1.272 extensions of correction B should be driven 3.
When the entire three-drive pattern is complete, you can enter your long or short trade.
You may generally put your short or long orders at the 1.272 extensions when the price hits point B to prevent missing out!
But first, see if the following rules also apply:
The pricing should take the same amount of time to complete drive two as it does to complete drive 3.
Retracements A and B should also take the same amount of time.
Trading Tips for the ABCD Pattern
There are bullish and bearish versions of each ABCD trading pattern. An ascending ABCD pattern is bearish, while a descending ABCD pattern is bullish, as shown in the diagram above.
The lines AB and CD are referred to as the legs in both versions, whereas BC is referred to as the retracement or correction.
While there are many other ways to apply stock entry and exit techniques, traders should keep a few things in mind while using the ABCD pattern.
Watch your scanner as the stock climbs from A and sets a new day high to find a potential short entry point with the bearish formation (B). Then, if the price makes a new support level that is higher than point A, designate it C.
Wait and see how the price settles at this stage. Look for a new high, which will be D, if support is established at C. With a stop above highs; your short entry will be when prices start to come off that new high.
With the bullish ABCD formation, you'd do the exact opposite.
Point of departure
A reward-to-risk ratio of two to one is ideal. So, if your stop-loss is 10 cents from your entry, you'll want to gain at least 20 cents in profit.
Depending on the time span and the amount of money at stake, this can vary for each setup. In the case of the bearish formation, you want it to go to C or lower, while in the case of the bullish pattern, you want it to reach C or higher.
Consolidation volume is low.
The ABCD pattern, like most types of technical analysis, works best when combined with other chart patterns or technical indicators. Because stocks tend to consolidate fast following a trend, you may want to monitor volume when utilizing this pattern to validate a reversal after the pattern makes a prediction.
The total number of shares of stock exchanged in a given period is referred to as volume (e.g., daily, weekly, monthly). It reflects a stock's strength and indicates the quality of a price trend and the stock's liquidity.
When a company is consolidating, volume is typically low, and you should consider this a red flag when using this pattern.
On the breakout, there is a lot of traffic.
The only thing left to do now is wait for a breakout once you've discovered a clear buy signal on your chart. When volume and price both break out simultaneously, it's a far stronger signal than a price breakout with low volume.
Trading Strategies for the ABCD Pattern
Although the ABCD pattern is simple, mastering it can be tough. When compared to other patterns, there are a lot of variables to consider.
Always remember to trade only the finest situations. You can achieve this by being extremely selective. Ignore the chart if it isn't perfect enough to print and hang on your wall.
Knowing when to trade is one thing; knowing when not to trade is quite another. Before you trade a stock, make sure you've checked all of the boxes on your trading checklist.
Point of Entry
At the breakthrough over morning highs, traders frequently initiate an ABCD pattern, and it's usually after 1 p.m. or such.
But keep in mind that your risk is set at the bottom of the B leg. If the breakout is too far from the bottom of the B leg, it's probably advisable to avoid the trade altogether.
In extremely rare circumstances, such as when a stock grinds up and closes forcefully on massive volume, you might purchase the C leg before the breakout.
Consolidation with Low Volume
Low volume consolidation and a slow grind-up are recommended. This indicates that buying was gradual and steady throughout the day.
It's preferable to avoid a stock that's really choppy or putting in more volume than the A leg during this time. It could indicate that there are a lot of short-sellers vs. buying.
If that's the case, the stock may be packed shortly after it breaks out.
Breakout with a lot of volumes
The larger the volume on the breakout, the more likely it is to succeed.
A low volume breakout indicates that the stock isn't receiving much attention. Instead of a strong D leg, it can easily fake out and form a double top.
Point of Exit
Many variables influence your decision to leave.
You might wish to aim for a 3:1 risk/reward ratio if the bottom of the B leg is near to the morning top of the A leg.
In some circumstances, you might choose to go with a 2:1 ratio. It all relies on what you consider to be an acceptable price goal for that particular stock.
Some traders attempt to swing a stock in a single day. However, keep in mind that this can sometimes lead to unanticipated consequences. There might be an overnight offering or a vicious sell-off.
However, if the chart is excellent and the hot market, you might want to consider it. Simply take some profits before the end of the day!
Getting Into a Negative Risk/Reward Situation
You may wish to purchase every ABCD breakout, but keep in mind that the risk/reward at the breakout level will be low if the midday pullback is big.
The objective is to make two to three times as much money. Consider whether or not it is a reasonable goal for each ABCD setup. Don't exchange it if you don't want to.
Arriving Too Early
It's tempting to enter the C leg's consolidation level before the 2 p.m. opportunity when witnessing an ABCD pattern play out.
This, however, sets traders up for failure, and they don't meet the basic requirements for trading ABCD patterns.
Set price alerts and physically step away till the correct time of day if you can't stop yourself.
What's the Best Way to Find an ABCD Pattern?
You'll need a stock scanner first, and I use StocksToTrade to look for ABCD patterns. It comes with over 40 built-in scanners, or you can create your own scans.
Step 1: In the morning, run StocksToTrade's 'Top Percent Gainers' scan. This should result in a small number of stocks.
Step 2: After that, pick only the best stocks to keep an eye on. Consider a hot sector, breaking news, and large volume.
Set price alerts right below each candidate's morning highs, and this will aid you in spotting any potential afternoon outbreaks.
Step 3: Now is a good time to take a rest. Take a walk, make a cup of coffee, and study video tutorials.
Step 4: Return after 1 p.m. to prepare for the 2 p.m. opportunity I mentioned earlier.
Step 5: You've discovered an ABCD pattern if one of the stocks on your watchlist breaks the morning high of the day!
Conclusion
A review of the lessons that have been discussed thus far.
The AB=CD pattern aids in determining price and direction changes.
When prices are low, this pattern can be used to buy, and when prices are high, it can be used to sell.
The pattern is made up of three legs, two of which are called AB and CD.
The name "Lightning Bolt" comes from the development of a zig-zag pattern with AB = CD.
This strategy can be applied to any financial market and time range.
The first leg (A-B) of an uptrend is established as the price increases from point A to point B.
At point B, the price reverses direction and forms the B-C leg, which is ideally a 61.8 percent or 78.6 percent retracement of the price increase from point A to point B.
The price then resumes its original upward trajectory, establishing a C-D leg of equal length as the A-B leg.
Place a sell order at the pattern's completion (point D) and wait for a price reversal to profit.
Your stop loss should be a few pips over point D.
Draw a fresh Fibonacci retracement from point A to point D of the completed pattern.
Profit should be taken when the price has retraced 61.8 percent of the distance between A and D.
In a down-trending market with a bullish buy trade, we reverse the pattern and trade orders in the same way as before.
Traders are aware that the market is likely to change direction after a strong trend.
Traders that use the ABCD pattern aim to spot the second time a trend loses steam and may reverse. In other words, they're looking for a buying chance in a falling market and a short selling opportunity in a rising market.
The ABCD pattern comprises three elements: time, price, and shape. When all three come together simultaneously, the pattern creates an electric movement that traders may use to predict probable reversal zones and return to the broader trend.
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