Module 4 - AB=CD Pattern

Module 4: Understanding the AB=CD Patterns

What is the AB=CD Pattern?

The AB=CD pattern is one of the simplest and most foundational patterns in technical analysis. If you dedicate time to learning this pattern and its variations, you will find it a valuable tool for your trading strategy. We will cover both its structure and trading applications, using real chart examples. Additionally, you will see how this pattern appears within other, more complex structures such as the Gartley, Butterfly, and Three Drives patterns.

AB = CD Pattern Structure

The AB = CD pattern appears across all markets and time frames. It’s the foundation for many other key patterns like the Gartley and Butterfly. The structure consists of three legs: AB, BC, and CD. The CD leg is typically a measured move, often matching the length of the AB leg, but it can sometimes extend beyond AB. Below are the key characteristics of this pattern:

Legs of the Pattern:

AB: The first leg.
BC: A retracement, typically finding support or resistance at Fibonacci levels (38.2%, 50%, 61.8%, 78.6%).
CD: Resumes the direction of AB, and when it surpasses point B, the price is projected to reach point D.

Pattern Completion:

Once the CD leg begins, traders can project potential completion at point D and devise a strategy.
It’s essential to monitor for any warning signs in the final CD leg that may indicate a market shift.

Pattern Invalidations:

BC cannot exceed the length of AB (i.e., retracement must not be more than 100%).
For a valid pattern, point D must exceed point B.

Important Characteristics of the AB = CD Pattern

About 40% of the time, the AB = CD pattern will be symmetrical, where AB equals CD.
However, in 60% of cases, the pattern variations will see the CD leg extending beyond AB, with an extension typically ranging from 127% to 200%.

The CD leg can also have a steeper or wider slope than AB, but these variations are still tradable if identified correctly.

CD Leg Variations

The CD leg can vary in multiple ways:

Gaps in the Direction of Point D: If a gap forms after point C, it often suggests that the CD leg will extend significantly beyond AB—typically 127%, 161.8%, or more.

Symmetry in Time and Price: Ideally, AB = CD moves are symmetrical in both price and time. For example, if the AB leg takes 40 bars to form, the CD leg will also take 40 bars.

Rapid Formation of CD Leg: If the CD leg forms in just a few bars, this strongly indicates that the CD leg will expand beyond the AB leg.

Psychology Behind the AB = CD Pattern

The AB = CD pattern is driven by herd psychology, reflecting the interplay between fear and greed. Market movements are dictated by either more buyers or more sellers. Fear tends to outweigh greed, causing markets to fall faster than they rise. This pattern encapsulates the typical stages of market behaviour—up, down, and sideways moves—in a simple geometric form.

In a sell pattern example:

AB leg: Institutional buyers and speculators drive the price up.
BC leg: Profit-taking causes a retracement, and new buyers enter the market.
CD leg: Price resumes upward as fear subsides, completing the pattern at point D.

Introduction to Trading the AB=CD Pattern

The AB = CD pattern is a versatile tool that can be found and traded across any market and any time frame. Its simplicity, combined with its reliability, makes it one of the fundamental patterns in technical analysis, suitable for both novice and experienced traders alike.

In this section, we will walk you through real trade examples, demonstrating how to trade the AB = CD pattern under different market conditions. You’ll see how we approach both winning and losing trades, with a focus on strategic trade management that helps mitigate risks while maximising potential profits.

Each example will include practical applications, showing how to:

Enter trades using limit orders at the projected completion point (D).
Set stop-loss orders to manage risk effectively.
Exit trades at key Fibonacci retracement levels to scale out profits in stages.
Manage trades through real-time decisions and adjustments, including when to exit early or hold for further gains.

For the futures and commodities markets, we demonstrate scaling out of trades in two parts, using two contracts to show how risk and reward are managed at different stages of the trade. In stock market examples, we use 200 shares as the unit to illustrate how a similar strategy can be applied by scaling out in two parts.

Ultimately, the success of trading the AB = CD pattern relies on having a well-thought-out and carefully studied trading plan, adapted to the specific market and time frame you are trading.

Trade Setup #1: AB = CD Buy Pattern

Market: GBP/CHF Forex Pair

In the trade shown in the chart below, the market completes a perfectly harmonic AB = CD buy pattern.

Entry Strategy:
- A limit order would be placed just above the completion point at D.
- This is the optimal entry point where the price aligns with the expected completion of the pattern.
Stop-Loss Placement:
- Once the limit order is filled, a stop-loss buy order should be placed below point D.
- This placement is critical to protect against unexpected market movements and ensures a defined level of risk for the trade.
Exit Strategy:
- First Exit: The first target exit would be placed at the 61.8% retracement of the CD swing. This level typically offers strong support or resistance, making it a suitable initial profit-taking point.
- Second Exit: The second exit order would be set just below the 78.6% retracement. This gives the trade additional room for profit, targeting a deeper retracement of the CD leg.
Trade Management:
- Occasionally, the market may trade at but not fully through the exit price levels. This is where discretion comes into play, as the trader must decide whether to exit early or hold for the full target.
- We prefer to exit if the price is traded at, even if it results in slightly less profit. The focus is on avoiding a scenario where a winning trade turns into a losing trade due to holding out for a slightly higher gain.

Trade Setup #2: AB = CD Sell Pattern

Market: FTSE 100 Index

In the chart below, the market completes a perfectly harmonic AB = CD sell pattern.

Entry Strategy:
- A limit order would be placed just below the completion point at D, which aligns with the expected pattern completion.
- This is the critical point to initiate the short trade, as the price is projected to reverse at this level.
Stop-Loss Placement:
- After the order is filled, a stop-loss sell order is placed above point D.
- This stop placement is essential to limit risk, ensuring that the trade is protected from a reversal beyond the anticipated turning point at D.
Exit Strategy:
- First Exit: The first exit point should be placed at the 38.2% retracement of the CD leg. This level often serves as a shallow but effective take-profit target, offering a balance between risk and reward.
- Second Exit: The second exit order is set at the 50% retracement. This gives the trade further room to capture profits as the price continues to move in the anticipated direction.
Trade Management:
- If the price comes close to but does not quite reach your exit points, it’s important to exercise discretion. Some traders prefer to exit early to lock in profits, while others may wait for confirmation of further price action.
- In general, we prefer to exit if the price is traded at rather than risking a reversal, even if it means slightly less profit. The primary goal is to secure profits and avoid turning a winning trade into a loss.

Trade Setup #3: Failed AB = CD Buy Pattern

Market: Accenture Shares (ACC)

This example highlights a failed AB = CD buy pattern. As shown in the chart below, certain conditions make this trade unsuccessful.

Identifying the Failure:
- The failure of this setup is visible due to gaps and steep downward movements leading up to the completion point at D.
- In such scenarios, it is important to recognize early signs that the pattern might not perform as expected.
Entry and Stop-Loss Strategy:
- If a trader had entered with a limit order at point D (following the pattern), the trade would have been positioned for a potential buy.
- However, given the gaps and rapid downward movement, the market did not behave as expected. A stop-loss order below point D would have been crucial in mitigating losses.
Why the Trade Failed:
- The gaps and steep moves leading into the completion of the AB = CD pattern are red flags. These conditions suggest market instability or strong selling pressure, which often invalidate otherwise reliable patterns.
- It’s vital to avoid trading an AB = CD pattern when gaps are present, especially in the CD leg, as these can indicate a lack of smooth price action, making the setup unreliable.
Trade Management:
- This example emphasises the importance of using stop-loss orders to limit downside risk.
- Even with solid technical patterns, external factors like gaps or unanticipated market events can disrupt the trade. Risk management in such cases is critical.

General Insights for Trading the AB = CD Pattern

Across all time frames and markets, the AB = CD pattern can offer significant trading opportunities. However, it is essential to:

Recognise invalidations and avoid forcing trades when conditions such as gaps or volatile price action are present.
Use proper stop-loss orders to mitigate risk and ensure you can confidently move on to the next trade.
Scale out of positions at key Fibonacci retracement levels to lock in profits while giving the trade room to continue performing if the market allows.
Always have a trading plan in place that outlines entry, exit, and stop-loss criteria based on real-time market analysis.