Module 5 - Gartley Pattern

Module 5: The Gartley Pattern

What is the Gartley Pattern?

The Gartley pattern offers traders an early entry point with minimal risk, allowing them to potentially capitalise on a longer-term trend reversal. For short-term day traders, this pattern can also be used to buy and sell within a prevailing trend. As noted by H.M. Gartley, the pattern can be highly effective when applied to the first AB = CD pattern in a new bull or bear market, providing traders an opportunity to enter a trade as a trend begins or to join an already established one.

While this pattern does not guarantee a major reversal in all cases, it offers the potential for profitable trades when proper trade management skills are applied.

Gartley Pattern Description

The Gartley pattern is very similar to the AB = CD pattern, with one primary difference: it includes an additional leg. Where the AB = CD pattern consists of three legs, the Gartley pattern is composed of four legs.

For a Gartley pattern to be valid, it must include an AB = CD formation. The pattern begins at an initiation point labeled "X". Once the first leg (XA) is complete, the market moves through the AB = CD structure. The D completion point in the Gartley pattern cannot exceed point X, and point C must not exceed point A.

However, it is possible for C to form a double top or double bottom with point X, although this is a rare occurrence. For the pattern to remain valid, B cannot exceed X.

Like the AB = CD pattern, the Gartley pattern can be found across all time frames and all markets. It often acts as a retest of a high or low price and offers traders an entry point aligned with the trend. As always, understanding the rules of invalidation is key to trading the Gartley pattern successfully.

Important Characteristics of the Gartley Pattern

The Gartley pattern can be broken down into four distinct segments:

Point X: This is the high or low point of the swing, marking the start of the pattern. On longer time frames, point X often represents a major top or bottom, but it can also form as a part of a larger trend swing.
XA Leg: This leg forms after point X. Initially, it's impossible to determine where the XA leg will complete, but characteristics like gaps, wide range bars, and tail closes in the direction of the trend can provide clues about the leg's length and strength.
AB Leg: The AB leg forms after the XA leg and serves as the first reaction following the initial impulse wave from X. Key factors to observe include the Fibonacci retracement level, the number of bars forming the leg, and its slope and speed.
BC Leg: Once the AB leg completes, the BC leg forms. It is important to note that the BC leg cannot exceed point X. If it does, the pattern becomes invalid and could be transitioning into a Butterfly Extension pattern.

The X point is often the fulcrum that technical traders focus on, especially after the XA leg starts to form. As price action moves through the AB and BC legs, the final test occurs at point D, which offers traders an ideal entry point with low risk and clear stop levels.

Psychology of the Gartley Pattern

Much like the AB = CD pattern, the Gartley pattern is driven by the crowd psychology of market participants, particularly the interplay between fear and greed.

When the Gartley pattern forms at a major top, for example, the initial move finds support at point A. As market participants view this point as an opportunity to buy, the price rallies from there. The formation of points B and D represents areas where sellers step in, viewing these as opportunities to exit or initiate short positions.

The D point becomes the critical level at which the market determines whether buyers or sellers will prevail. A price decline favors sellers, while a breakout above X marks a failed pattern.

If the pattern completes successfully, the price typically moves quickly below point A, breaking multiple support levels and often leading to further declines. As prices fall, market participants who bought above point A will begin to exit at a loss, accelerating the downward movement.

Trading the Gartley Pattern

The Gartley pattern can be traded in any time frame, offering a retest of the most recent high or low. This makes it a powerful tool for traders who want to avoid picking tops or bottoms while still entering a trend at a favourable risk level.

The pattern typically aligns with the trend, allowing traders to either buy a higher low or sell a lower high, a strategy that works well in both uptrends and downtrends.

Trade Setup #1: Gartley Buy Pattern

Market: NZD/USD (Forex Pair)
Contracts: 2

In this trade example, the entry point is located at the 78.6% retracement at point D. Notice that a second AB = CD pattern forms within the CD leg, offering clues about where the pattern may complete.

Entry: A limit order is placed just above the 78.6% retracement at point D. By doing this, the trader enters the market as the pattern completes.
Stop-Loss: A protective stop-loss is placed below point D. Ideally, the stop could be placed below point X, but sometimes this would represent too much risk based on money management rules. The trader should always evaluate whether the risk is within their acceptable limits; if not, the trade should be avoided.
First Exit: Once the trade moves in favor of the trader, the first exit point should be at the 38.2% Fibonacci retracement of the CD leg.
Second Exit: The second exit point should be placed at the 61.8% Fibonacci retracement. This allows the trader to scale out of the position and capture profits as the trade moves in their favor.

Traders must always manage their risk, especially in the Gartley pattern. If the initial stop level is too far away from the entry and the risk is too large, the trade should be skipped. The trader can always look for another opportunity with better risk management.

Trade Setup #2: Gartley Sell Pattern

Market: AUD/CHF (Forex Pair)

In this sell pattern, a limit order is placed just below the 61.8% retracement to enter a short position. Here’s how the setup works:

Entry: Place a sell limit order just below the 61.8% retracement at point D. This ensures the trader enters the market as the pattern completes and moves downward.
Stop-Loss: A protective buy stop is placed above the 78.6% retracement. Since the stop level at X can sometimes be too far for risk tolerance, placing the stop above 78.6% allows for managing risk effectively while still protecting against large market moves.
First Exit: The first exit target should be placed at the 38.2% retracement of the CD leg. This allows the trader to take partial profits and reduce risk early in the trade.
Second Exit: The second exit should be placed at the 50% or 78.6% retracement, depending on the trader’s risk appetite and profit target. Some traders may choose to exit fully at 50% or scale out further at 78.6%.

This example shows the importance of scaling out of trades, as traders can lock in profits while still allowing the trade to develop fully.

Trade Setup #3: Failed Gartley Pattern

Market: S&P 500 E-mini

In this failed Gartley pattern setup, a limit order is placed under the 78.6% retracement. In this case, the trade failed due to a wide-range bar near the D completion point, which is one of the warning signs.

Entry: A sell limit order is placed just under the 78.6% retracement at point D. The trader expects the price to move downward as the pattern completes, but in this case, the trade fails.
Stop-Loss: The protective buy stop is placed above point X. In this example, the stop-loss keeps the risk small, despite the failure of the pattern.
Outcome: The trade is stopped out as the wide-range bar causes the pattern to fail. The protective stop-loss keeps the loss manageable, and the trader can move on to the next opportunity.

One of the most important aspects of trading the Gartley pattern is to accept losses as part of the trading process. Not every pattern will be successful, but managing risk effectively will allow traders to continue trading successfully over the long term.

Lesson Summary

The Gartley pattern provides traders with a structured method for entering a trend reversal or following a trend at a low-risk point. It is a powerful tool in both trending and ranging markets, offering multiple trade setups across various markets and time frames.

The Gartley Buy and Sell patterns align with the trend, offering traders a chance to buy a higher low or sell a lower high.
Proper trade management includes setting entries based on Fibonacci retracement levels, managing risk with well-placed stop-losses, and trailing stops as the trade moves in your favour.
Not all patterns succeed; failed setups are part of trading. Stop-loss orders minimise losses, allowing traders to remain disciplined and objective.

By following the rules of the pattern, utilising solid trade management techniques, and being aware of invalidations, traders can consistently find success trading the Gartley pattern.