The AB=CD Pattern

111 Pages·2013·1.89 MB·English

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C H A P T E R 4
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The AB CD
Pattern
Ithasbeensaidmanytimesintradingtostudy,learn,andtrademethods
thataresimpleinnature.TheAB=CDpatternisoneofthemostbasic
andsimplepatternsintechnicalanalysis.Ifthetraderwilltakethetime
tolearnthispatternanditsvariations,itwillbetimewellspent.
We teach you this pattern here both in structure and from a trading
standpoint using real chart examples. In coming chapters we show you
how this simple pattern is also formed within other patterns such as the
Gartley“222”pattern,Butterflypattern,ThreeDrivespattern,andsomeof
theclassictechnicalanalysispatterns.
HISTORY OF THE AB=CD PATTERN
In 1935 a book was published for sale to investors at an incredible price
of $1,500. Thatbook was Profits in the Stock Market byH.M.Gartley.On
page 249, under “Practical Use of Trend Lines,” Gartley describes a chart
patternthatwenowcalltheAB=CDpattern.(SeeFigure4.1.)
39
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Figure 4.1 Illustration of the Parallel Trend Lines chart found in H.M. Gartley’s
book,ProfitsintheStockMarket (1935).
Courtesy of Lambert Gann Publishing. P.O. Box 0, Pomeroy, WA 99347. www.
wdgann.com.
Thispatternhasappearedinanotherwork,onebyFrankTubbs.Tubbs
offered a correspondence course in the 1950s called The Frank Tubbs
Stock Market Course. This course was based on the pattern that Gartley
hadexplainedinhis1935book.
Tubbs used many charts from the 1920s and 1930s in his description
ofthepatternandbroughttheworkforwardintothe1950s,validatingthis
classicpattern.CharlesLindsayalsousedthispatterninhisbookTrident:
A Trading Strategy written in 1976. Lindsay identified trends as micro,
minor,intermediate,andmajor.Heillustratedthattheparallelpriceswings
were apparent on all charts and in all time frames. The system described
wasidenticaltoGartley’spattern.LindsaylabeledhispatternwithP1,P2,
P3,andP4,whichwerenothingmorethanA,B,C,andD.
LindsaytooktheAB=CDpatternandmadeitintoaformulathatwould
givethepatternacompletiontargetatD(P4),sotheformulawouldbe:
P2+P3
P4=
P1
Thisisequivalentto:
B+C
D=
A
HethencameupwithaformulathatsaidP3shouldbearatioof.625
ofP1toP2.Thisisequivalenttoa.618retracementbytheBClegfromthe
ABswing.(SeeFigure4.2.)Hetook25percentoftheP1orthefirstlegas
ariskfactor.
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TheAB=CDPattern 41
Figure 4.2 Merck (MRK) daily chart showing AB=CD pattern with .618 retrace-
ment of the AB leg. This is similar to Lindsay’s .625 retracement of the P1 to P2
leg.
AB=CD PATTERN DESCRIPTION
Gartley’s description of the AB=CD pattern illustrated how the market
would rallyinanuptrend and thenretrace. Itwould then rallytoanother
uptrend then make another retracement, forming an upsloping parallel
channel.ItwasfromthisdescriptionthattheAB=CDpatternachievedits
nickname,thelightningbolt.(SeeFigure4.1.)
Gartley spent several pages referring to these trend lines and parallel
lines as excellent signals when used in conjunction with other working
tools.Healsoappliedtheselinestopriceratios.Heusedmainlyratiosof
one-thirdandone-halfforretracements.
AB=CD PATTERN STRUCTURE
The AB=CD pattern isfound inall markets and all timeframes. This pat-
tern is the foundation for the Gartley buy and sell patterns (discussed in
Chapter 5). It is also an integral part of the Butterfly pattern (Chapter 6)
andalsoformsapartoftheThreeDrivespattern(Chapter7).Thepattern
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isameasuredmovewheretheCDlegissimilarinlengthtotheABleg.It
shouldbenoted,though,thattheCDlegcanextendandwillnotalwaysbe
exactlyequaltotheABleg;thisisdiscussedin“ImportantCharacteristics
oftheAB=CDPattern”laterinthischapter.Figure4.3showstheshapeof
thebasicAB=CDbuyandsellpatterns.
There are three legs that form this pattern. (See Figure 4.4.) The first
legofthepatternislabeledAB.Afterthecompletionofthefirstleg,are-
tracementorcorrectionoccursthatwillusuallyfindsupportorresistance
at one of these Fibonacci levels: .382, .50, .618, or .786. This correction
or retracement is labeled BC and is the second leg of the pattern. (Note:
Strongly trending markets will usually see only a retracement to the .382
level. See the chart in the “Slope and Time Frames” section later in the
chapterforanexampleofashallowretracementatthe.382level.)
Figure 4.3a BasicstructureoftheAB=CDpattern,illustratingthe“lightningbolt”
shapeofthebuyandsellpatterns.
Figure 4.3b AB=CDbuyandsellpatternswithS&PE-minichartprice.
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TheAB=CDPattern 43
Figure 4.4 Merck(MRK)dailychartshowingcompletedAB=CDpattern.Thispat-
tern completion leads to retracements of the AD swing of almost all the main Fi-
bonaccilevelsweuse.
When price resumes in the same direction as the AB leg, the CD leg
thenbeginstoform.OnceweidentifytheCDlegforming,wecanproject
the potential pattern completion and devise a trading strategy. As the CD
leg forms and completes, we monitor the final leg for any warning signs
thatwouldalertustoachangeinmarketconditionsthatmaysignalusto
possibly pass on the trade or wait for further confirmation before enter-
ingthetrade.Chapter11,“TradeManagement,”coversthisinmoredetail.
OncethepriceexceedsB,wemakeanassumptionthatthepricewillreach
patterncompletionatpointD.
When studying this pattern, it is important to know what invalidates
the pattern. Here are three items that would invalidate the AB=CD pat-
tern:
1. BCcannotexceedtheABleg,meaningtheretracementofABcannot
exceed1.00.
2. BCcanbea1.00retracementoftheABleg;thisisararepatternanda
doubletoporbottom,butitisavalidpattern.
3. DmustexceedBinorderforthepatterntocompleteatpointDandbe
avalidAB=CDpattern.SeeFigure4.5asanexample.
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Figure 4.5 Euro daily chart. Once price exceeds B, we assume the pattern will
completeatpointD.
IMPORTANT CHARACTERISTICS OF THE
AB=CD PATTERN
About40percentofthetime,theAB=CDpatternwillbeperfectlysymmet-
rical, meaning AB equals CD. The other 60 percent of the time variations
of the pattern will be present. What this means is that after the AB leg
has formed and the retracement leg, BC, has completed, the CD leg will
be different from the AB leg. The two legs may or may not be perfectly
symmetrical.
SomeofthewaystheCDlegcanvaryfromtheABleginclude:
Ĺ The CD leg is an extension of AB anywhere from 1.27 to 2.00 (or
greater).SeeFigure4.6asanexample.
Ĺ TheCDleghasaslopeoranglesteeperorwiderthanAB.
At first glance this variation might make the trader think the pattern
isnottradable.ThekeyliesinidentifyingtheBCleg.Themostimportant
thing is to watch the price action coming after point C has formed. Many
oftheexamplesthatyouwillseeinthischapterwillshowthattheCDleg
determinestherelationshiptotheABleg.
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TheAB=CDPattern 45
Figure 4.6 Dailychartof30-yearbondsshowingAB=CDpatternwiththeCDleg
extendingto1.27oftheABleg.
CD LEG VARIATIONS
TheseCDlegphenomenacanbedescribedinfourways:
1. If after point C has occurred a gap exists in the direction of point D,
thisusuallyindicatesthattheCDlegwillbemuchgreaterthantheAB
leg—1.272,1.618,ormore.SeeFigure4.7asanexample.
2. A wide range bar (twice normal size) at point C is another indication
thattheCDlegcouldbecomeextended.SeeFigure4.8asanexample.
3. Ideally, AB=CD moves are symmetrical in price and time. For exam-
ple,iftheABlegissixbarsup,thentheCDlegwillbesixbarsup.See
Figure4.9asanexample.
4. AsillustratedinFigure4.10,thetimetoformthetwolegsissymmetri-
cal.
Thisnextsentenceisveryimportant:IftheCDlegismadeinjustafew
bars,thisstronglyindicatesthattheCDlegisgoingtobeanexpansionof
theABleg.SeeFigure4.11foranexampleofthis.
Asanexampleofthisthrustprinciple,imaginehavingtwoFerrariauto-
mobilesontheracetrack,onewithdieselfuelandtheotherwithhigh-tech
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Figure 4.7 ClassicAB=CDpatternonEOGResources(EOG)dailychartwithgap
frompointCandsharpslopingdownmovetopointDsuggestsCDlegwillextend.
Figure 4.8 Allthewarningsignsarepresentinthis120-minutechartoftheNAS-
DAQfutures.(WarningsignsarediscussedinChapter11.)Noticethelongbarsas
theCDlegisjustbeginningdown.ThisgivesthetraderanalertthattheCDlegmay
beanextensionto1.272,1.618,orgreateroftheABleg.
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TheAB=CDPattern 47
Figure 4.9 EurocurrencydailychartshowingAB=CDpatternwithverysymmet-
ricalsixbarsupintheABlegandsixbarsupintheCDleg.
Figure 4.10 Google(GOOG)5-minutechartshowingtimeisalsoanelementin
thesymmetryofthepatterns.
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Figure 4.11 A very long bar from the C turning point in this Intel (INTC) daily
chartindicatesthattheCDlegwillbeanexpansionoftheABleg.
gasoline. It would be easy to understand the Ferrari powered with high-
techgasolinegettingtothefinishlinefirst.WatchtheCDleg,becauseifit
startsfast,thatisthefasterFerrarigoingfurtherfaster.
SLOPE AND TIME FRAMES
The slope or time frame of the BC move can also be helpful in determin-
ing the pattern. BC legs generally correct to one of the Fibonacci ratios:
.382, .50, .618, or .786. The slope of this BC leg is usually a good indica-
tionofwhatthenextCDlegwillbe.Forexample,assumethattheABleg
took15tradingbarstoreachpointB,andnowtheBCleghastaken8bars
buthasretracedonly.382percentoftheABleg.Thisisasignofthemar-
ket absorbing a lot of selling at a high price; it is a shallow retracement,
andthepricehasnotbeenabletoretraceto.50,.618,or.786percent.We
wouldassumethatpriceswouldgomuchhigherandpossiblyquiterapidly
once the selling slows. However, if the market retraces to a .618 or .786
retracement, the CD leg will most probably be a normal move equaling
AB=CD.