Harmonic patterns, however, take this to the next level. Essentially, the Fibonacci numbers are used to help determine the point at which the market will turn. It is very different from other forms of trading because it aims to predict the future.
This is seen particularly often in the foreign exchange (Forex) market.
How to Combine Fibonacci and Geometry
With these harmonic patterns forex traders know that it is all down to combining mathematics and patterns into a precise trading method. The idea is that that, in order for something to be called a pattern, it must repeat itself.
It requires the identification of a primary ratio, which is usually 0.618 or 1.618. Additionally, it requires complementing ratios, which are all part of the Fibonacci sequence.
Fibonacci patterns are found everywhere in nature and man has noticed these in all levels of society. Currencies are affected by both natural events and by society, which means that the logical conclusion is that the pattern can be applied to currencies as well.
Different patterns have different magnitudes and lengths, however, and a trader must be able to identify those before they can apply the Fibonacci ratio to them.
It is believed that the father of applying Fibonacci to trading was Scott Carney, but many others have improved and expanded on his original ideas.
The Problem with Harmonic Patterns Forex Traders Must Realize
If there is to be a true pattern, it must be precise. This means movements have to meet a certain magnitude if a pattern is to unfold at an accurate point. Sometimes, patterns appear to be harmonic, causing a trader to make a move.
However, upon closer inspection, it often appears that there is no Fibonacci alignment, which means the harmonic approach was not suitable. Sometimes, this helps the traders, because it means they just need to wait a little longer to make a bigger profit.
With harmonic patterns forex traders can determine how long a certain move will last. At the same time, they can be used to determine when a reversal point will happen.
The problem is that it is possible for a trader to bank on reversal, only to find the pattern didn’t materialize. At that point, the trader would lose a lot of money. Of course, all trades are risky and only those who are able to handle that risk should venture into the market.
It is also quite common to see a pattern within a pattern. Some of them aren’t harmonic either. By being able to identify harmonic patterns forex traders will have the opportunity to take better entry and exit points.
Additionally, one harmonic wave may be home to several individual price waves. This is why it is so important to be able to see the bigger picture. Markets are fractal in nature, which means the theory can be applied on all time frames, from smallest to largest.