What Is an ABCD Pattern
The ABCD pattern is a price action chart pattern that is most often used in intraday trading in the stock market. It can, however, be applied in other financial markets, such as futures, options and forex markets. It also works on a longer time frame if sufficient historical data is available.
The ABCD is a market reversal pattern, signaling trend change, either from an uptrend to a downtrend or from a downtrend to an uptrend.
The ABCD pattern is appealing to new traders because of its simplicity and to experienced traders because of the fact that it’s a price action pattern that occurs often unfolding frequent trading opportunities.
The ABCD price action pattern is a price and time-related technical analysis tool that was originally noted by H.M. Gartley, a technical analyst primarily known for the more complex pattern named after him, the Gartley pattern.
In this article, we’ll cover all the basics of how to identify the ABCD pattern, how to use the pattern in trading, and the primary advantages and disadvantages of making trades based on the ABCD pattern.
How to Identify the ABCD Chart Pattern
The ABCD pattern is relatively easy to identify. It consists of three consecutive price swings connecting four price points (A, B, C, and D).
As with most market reversal trading patterns, there are two versions of the ABCD pattern, bullish and bearish. The bearish version is a price action pattern that signals an impending market reversal from an uptrend to a downtrend. The bullish version provides the opposite trading signal of a likely trend change from a downtrend to an uptrend.
ABCD Trading Pattern, Version One – Bearish Market Reversal
The first version of the ABCD signals an impending market reversal trend change from uptrend to downtrend.
- The initial price swing moves upward from point A, a swing low, to a high intraday price marked as point B.
- The second leg of the pattern represents a downside price correction in the existing uptrend that takes the price from point B down to point C, a swing low that is higher than point A.
- The final price move in the pattern is a move upward from point C to Point D – a new, higher swing or intraday high above point B.
The existing uptrend terminates at point D, the point from which a downtrend begins.
ABCD Version Two – Bullish Market Reversal
The bullish version of the pattern, which signals the end of an existing downtrend, is simply the bearish version flipped upside down.
- Point A is a swing high
- Point B is an intraday low
- The point C is an upward price correction move that doesn’t take price all the way back up to point A
- Finally, point D is new, lower than point B intraday low, the point at which the ABCD pattern predicts that a trend change from downtrend to uptrend will occur.
The Relationships Between the ABCD Price Points
There are several time and distance characteristics that traders use to identify the occurrence of an ABCD price chart pattern more precisely.
The first of these is that each of the three price swings usually occurs over a time frame of between three and 13 candlesticks (or bars, if using a bar chart). Therefore, if any of the legs of the pattern are formed outside of that time frame, then the validity of the pattern is questionable.
The other characteristic elements of an ABCD chart pattern are time and distance relationships between the four price points of the pattern. For example, in one variation of the pattern, both the time and the distance the market takes moving from A to B will be roughly equal to the time and distance covered when the market moves from C to D.
The other possible A-B-C-D relationships that traders look for involve using Fibonacci retracement and extension levels. The existence of any of the following relationships between the patterns price points are usually interpreted as a stronger confirmation of the pattern:
- The price move from point B to point C is approximately 61.8% or 78.4% of the distance from point A to point B
- The distance from C to D is approximately 123.6% or 161.8% of the distance from A to B
- The time required for the price move from point C to point D is roughly 123.6% or 161.8% of the time it took for the price to move from point A to point B
ABCD Pattern Trading
Again, the ABCD pattern is a market reversal pattern. Therefore, traders using the pattern are commonly looking to establish new market positions, long or short, at a price level near the beginning of a new trend.
When the pattern appears in an existing uptrend, signaling a possible bearish market reversal to the downside, traders will look for signs of point D being a reasonable price resistance level. Such signs may be point D coinciding with a trend line or a moving average or simply repeated failed attempts of the market to move higher.
More aggressive traders will initiate a short sell trade very near point D, with an initial stop-loss order placed a bit above point D. More conservative traders will wait for further confirmation of a trend change shown by prices falling below point C before making a short entry into the market.
When a bullish ABCD pattern occurs in a downtrend, signaling a potential market reversal to the upside, traders will look for signs that point D is an actual price support level, again using additional technical indicators such as trend lines, moving averages, or indicators that reflect decreasing market momentum.
More aggressive traders will buy into what they hope is the beginning of an uptrend near point D. More conservative traders will wait to see if the price moves above point C. Both types of traders commonly place an initial stop loss order a little below point D.
The ABCD pattern is sometimes traded as a continuation pattern of an existing trend. For example, if the pattern forms during a prevailing uptrend, a trader may look to buy around point C, with an eye to taking profits around point D.
Traders also use this price move pattern to take profits on existing positions. For example, if a trader is long the market from point A or lower in an uptrend, then traders look to exit their position at or near point D.
A trader who has been short the market and sees the pattern emerge during an existing downtrend may look to exit their short sell trade at or near point D, anticipating that it may be the termination point of the downtrend.
Trading Tip: An additional confirmation of the pattern’s market reversal signal is increasingly high volume when the market begins moving from point D in the opposite direction of the previously existing trend. Another sign to watch for is relatively low volume during the move from C to D.
Advantages and Disadvantages of Using ABCD Patterns
As noted, one advantage of the ABCD chart pattern is that it’s usually relatively easy to spot.
A second advantage that the pattern offers is a trade entry with clearly defined and limited risk. Running an initial stop-loss order just on the opposite side of point D gives traders the chance to take a low risk trade.
It requires a minimal amount of trading capital while providing the possibility of a much larger profit if point D does turn out to signal the beginning of a new primary trend. Thus, the pattern has a favorable risk-reward ratio.
A disadvantage of trading the ABCD pattern is the potential disadvantage common to all technical indicators. The possibility that the pattern may generate a false trading signal is the biggest downside.
For example, the pattern may occur in a continuing uptrend as part of the normal up and down price movement, rather than as a valid signal of a trend change from an uptrend to a downtrend.
Likewise, the bullish version of the ABCD pattern may incorrectly signal the end of a downtrend.
A second disadvantage stems from the fact that stock price moves are rarely as neat and precise as those shown in our images of the ABCD pattern. Therefore, the price movement within the pattern may vary a bit, making it harder to identify.
The varying possible relationships between the price points may also present problems. For example, suppose that, during a downtrend, a price move to the downside from an identified point C occurs that is roughly the same distance as that between points A and B.
Since equal AB and CD distances are one characteristic feature of the pattern, a trader may enter a buy trade, thinking that point D has been located. However, the price may fall substantially lower if the actual ABCD pattern forming is characterized by the C to D distance being approximate 161.% longer than the A to B distance.
The ABCD chart pattern is a good technical pattern for traders to be familiar with because (A) it’s a frequently reoccurring pattern that appears on stock charts, and (B) it offers traders a low-risk market entry with substantial profit potential.
This chart pattern is frequently employed in day trading. You can trade ABCD patterns more effectively by combining them with additional technical indicators of price support and resistance levels.