‘Modern’ Patterns with Catchy Names – Nothing but Price Behavior Models Discovered Long Ago

Sometimes old trading ideas are better than new ones, of course, if you can test them using modern analysis techniques.

The market has been posing more complex challenges to its participants for the past couple of years screening off increasingly more traders. In search of an edge in the market, many ‘survivors’ start studying works of the first masters of technical analysis such as Richard Schabacker, J. Hurst, W.D. Gann and H. Gartley.

In 1935 Gartley wrote a book titled Profits in the Stock Market. After reading this book one is astonished at the understanding that in fact technical analysis has not changed much since then. In most cases ‘modern’ patterns with catchy names are nothing but price behavior models discovered long ago by such pioneers as Gartley.

For example, there is a widespread price pattern called ‘butterfly’ because it visually resembles a butterfly’s wings. However, in his book Gartley calls the pattern ‘Gartley 222’ because it is described on Page 222 of the book.

‘Gartley 222’ can be objectively identified by establishing certain ratios for four price movements or legs (XA, AB, BC and CD) that this pattern is made up of, and by identifying maximum levels for local highs and lows (reversal points) of the pattern – points A, B and C.

It has been already said that the ‘Gartley 222’ pattern is named for the page number it is found on. Since then, multiple books have been written describing the ‘Gartley 222’ pattern and charting software that applies it. Of the almost 500 pages in H.M. Gartley’s book, none are more important than pages 221 and 222. This is where the author described this particular pattern in great detail. Gartley referred to it as one of the best trading opportunities.

The biggest question that came to mind was the discrepancy between the two Gartley’s patterns shown in Figure 2.

The next step in the development of this pattern was the addition of the mathematical relationships of Sacred Geometry (which includes the Fibonacci Summation Series). Adding the Fibonacci Ratios to this pattern offered the tools to more accurately determine price entry, exit points and stop levels. The final step was empirically and statistically testing the validity of these patterns.

Gartley had emphasized in his book that the pattern was correct approximately 70% of the time. Testing weekly, daily and intraday patterns over the past 40 years has proven that Gartley’s original premise was indeed accurate. It was also uncovered that while Gartley describes both buy and sell patterns identically, he had different diagrams for each.

Gartley also used ratios of one third and two thirds with this pattern but did not use ratios from the Fibonacci summation series. The Fibonacci retracement ratios that we apply to the Gartley pattern include: 0.382 (used with strong trends), 0.50, 0.618 and 0.786. The 1.00 is used and is a double top or bottom.

Gartley stated in his book that over a 30 year period he found these patterns to be profitable in 7 out of 10 cases. The statistics validating this are still the same as Gartley suggested over 70 years ago. It is important to know what invalidates the ‘222 pattern in 3 out of 10 cases. There are 3 criteria that should be met to make the pattern valid:

1. The D point cannot be below X in a bullish (BUY) pattern and above X in a bearish (SELL) pattern.

2. The C point cannot be below A in a bullish (BUY) pattern and above X in a bearish (SELL) pattern. A double top or double bottom can be formed.

3. The B point cannot be below X in a bullish (BUY) pattern and above X in a bearish (SELL) pattern, either.

The Gartley pattern can be broken down into four segments. Point X is the starting point of the pattern. The X can be found on longer time frames at major or local highs or lows. After point X is formed and the market begins to move in one direction the XA leg begins to form, at this stage it is impossible to determine where the completion of the XA leg may be. The market may give some clues: if there are gaps and wide range bars this leg may take some time before a correction takes place. Once it has been determined that the XA leg is complete then the next step is to watch the formation of the AB leg. As you understand, this is a correction to the first impulse of this pattern.

It should be added that there are a few key items to watch in this formation:

• the Fibonacci retracement ratio the market corrects to during AB formation

• The number of bars that form the AB correction

For example, if the AB leg takes a considerable amount of time (say, more than 8 to 10 bars), then we would assume that the market is basing for a larger correction, potentially to the 0.618, 0.786 or further. As price begins to form the BC leg it is important to note that the pattern would be invalid if the AB crosses the Point X level. But it is possible for the completion point of AB to be an exact double bottom or top of the X point.

From the Editor's Office: It is important to remember that while many traders will not enter the market at highs or lows in most of the cases, nevertheless, this Gartley’s pattern offers the trader an opportunity to open a trade at a pullback very close to the high or low, thus significantly cutting potential risks of the trade and, accordingly, increasing potential profits. Most importantly, this pattern occurs rather often in financial markets. This means large and ‘smart’ money successfully uses graphical price patterns uncovered over 70 years ago for successful profit taking. If we don’t do the same, who are we, then?