The ABCD pattern is a commonly recurring chart formation that helps traders understand the relationship between prices and time. Due to its overwhelming simplicity and ease of use, it is a popular way to identify potential trading opportunities and determine the correct timing to go ahead and establish bullish or bearish positions. In keeping with the name of the indicator, A, B, C, D and used to refer to highs and lows in the price action during a trend. The result is three legs, AB, BC, and CD. These three legs help to understand turning points in momentum and the idea entry point for taking advantage of momentum reversals.
The ABCD Basics
One of the first steps towards assessing an ABCD pattern emergence is by assigned each letter to a portion of a directional trend. Of the three legs, AB and CD are considered part of the trend while BC is a correctionary move or technical pullback. In the case of a bullish trend, A would refer to the first valley, B would refer to the first peak, C would be in reference to the second valley, and D would be indicative of the second peak. In a bearish situation, the opposite would be true, with peaks being replaced by valleys and vice versa.
Once established, it will become helpful to overlay the Fibonacci levels on the trend being examined in order to get a better feel for where the price action in the asset may land and where it may be helpful to initiate bullish or bearish positions depending on the nature of the setup. The main idea behind ABCD is early identification of potential reversals based on how the trend is behaving.
Once the A and B points have been established on a chart with the Fibonacci line connecting both points as well, it is critical to see that the resulting pullback from this move is between a 38.2-78.6% retracement. A move that exceeds a 78.6% retracement means that the price action is on the verge of a reversal from the trend between points A and B. However, if the retracement lands between the proper levels, the peak or valley is labeled as C, with the resulting CD leg expected to be parallel to AB.
Point D is anticipated to be an extension towards the 127.2-161.8% Fibonacci levels resulting from the distance measured between points B and C. Once point D can be projected and is confirmed, this is the opportunity to establish a bullish or bearish positions that is anticipating a reversal of the prevailing trend displayed by all the points of ABCD. Should D extend past the Fibonacci levels discussed earlier, it indicates a continuation of the trend and no reversal in the price action.
The Three Strategies
There are three commonly employed strategies based on the ABCD points including price & time, the classic ABCD pattern, and the ABCD extension.
For the price & time pattern, the general principle is that the time and distance between point A and point B will be exactly mirrored by the move between points C and D.
For the classic ABCD pattern, the BC retracement must follow the conditions listed above based on the Fibonacci retracement levels.
Finally, the ABCD extension basically implies that the CD leg extends past the Fibonacci levels determined by the AB leg, moving as far as 127.2-161.8% retracement levels that are determined by the move between points A and B.
Unlike many other technical setups and patterns that might be viewed as less exact and scientific and more subjective, the ABCD pattern is rooted in mathematics, so identifying potential setups should conform very closely with the rules and ideas established above.