What is Harmonic Trading?
In the field of technical analysis, harmonic trading represents an advanced area which, while more difficult than regular technical elements, can present fantastic trading opportunities once understood. Harmonic trading combines Fibonacci ratios, symmetry and structural analysis to highlight patterns in the market which tend to yield exploitable outcomes. One of which is the “Three Drives Pattern”.
What is the “Three Drives Pattern”?
The “Three Drives Pattern” is a reversal pattern which comprises of three swings of equal length in the same direction, corresponding to specific Fibonacci ratios to identify a potential reversal zone. The pattern can be both bullish and bearish and once highlighted, can be a precursor to powerful turns in the market.
Bullish “Three Drives Pattern”
The pattern starts with a bearish swing to give us our 1st drive. We then see a retracement higher into the 61.8% level of the 1st drive to give us our A point. From here we then see price turn lower again to give us our 2nd drive which should complete into the 1.27% extension of the 1st drive. From here we then see price correct higher once more, moving back up into the 61.8% retracement of the 2nd drive to give us our B point. From here we then see one final push lower with price trading down to the 1.27% extension of the 2nd drive to give us our 3rd drive which completes the pattern and gives us our buying zone.
Bearish “Three Drives Pattern”
This pattern starts with the 1st drive which is a bullish move. We then get a retracement lower to give us our A point, which should complete into the 6.18% – 78.6% retracement of the 1st drive. From here we then get another move higher, giving us our second leg which completes into the 1.27% extension of the 1st drive. From here we then get a second retracement lower which should complete into 61.8% – 78.6% retracement of the 2nd drive, to give us our B point. Finally, we want to see one final push higher, giving us our 3rd wave, which should complete into the 1.27% extension of the 2nd drive, giving us our 3rd drive and the level at which we want to look to sell.
“Three Drives Pattern” on the Charts
In the image above, you can see a great example of a bearish “three drives” pattern with the three equal legs all completing in line with the specific parameters discussed above.
At the point the pattern completes, we can then look to sell. When it comes to entering a trade with this pattern, we have two options. Firstly, we can simply “trade the level” which is where we place a trade at the completion point of the pattern, which is a slightly more aggressive approach. Or, we can take a more conservative approach and wait for price action confirmation which is where we wait for reversal candles to setup at the level before taking a trade.
In terms of how we place our stops, because this pattern doesn’t have an X point behind the entry like we see with other harmonic patterns such as the gartley, or bat for example, we need to use market structure and or price action to place our stop. However, as this pattern tends to occur during trending markets, there won’t always be a clear structural level such as a local high or low to put our stop behind.
In these instance, our best option is to use the next extension level. So, where we enter at the 1.27% extension of the 2nd drive we can put our stop above the 1.61% extension of the 2nd drive. This is a sensible place because if we are right that the market is going to reverse, it shouldn’t go any higher than that point but we also still give the market room for any volatility which might occur at that level.
Alternatively, we can use a price action based stop. So, where we sell on the break below the candle which touched the level, we can simply put our stop above that candle high by 10 pips or so. This is a much tighter stop, however, the upside is that we only need to see a small reaction from the level to achieve a good risk:reward target.
So, in terms of target. As with all of our trading we want to make sure that we target at least 2 – 3 x risk. So, if we use the level entry and our stop at the 161.8% extension, we simply need to measure that distance and x it by 2 or 3 to find our target. Alternatively, if we use a price action entry, again we need to measure the distance between our entry and our stop and x it by 2 – 3 to establish our target.