Harmonic patterns are an advanced form of technical analysis which combine fibonacci ratios, market structure and symmetry to identify patterns which can be used to analyse the markets and make trading decisions. One of the most simple yet effective of these patterns is the 121 pattern which is particularly useful for helping traders enter trending markets. Read on to learn what this pattern looks like and how to trade it.
So, essentially what we are looking for here is to identify an initial bullish move in price, which we call the XA leg, meaning that the swing starts at X and finishes at A. This move then sees a correction which we call the AB leg, with the swing- low at B completing between the 61.8% – 78.6% Fibonacci retracement of the XA leg. Remember, to highlight Fibonacci levels we simply apply our Fibonacci tool to the XA leg.
Price then reverses higher from the AB leg and forms a new high above the XA leg to give us our BC leg. From here we get a final correction lower which is the CD leg and this leg needs to complete between the 50% and 61.8% Fibonacci retracement of the move from X to C. The completion of the CD leg into this Fibonacci zone gives us our entry location where we set longs, targeting a reversal higher again.
So, the bearish version uses the same measurements and structure but in reverse.
So here you can see that we first identify a bearish price swing which gives us the XA leg. We then want to see a correction higher which gives us our AB leg and completes between the 61.8% and 78.6% Fibonacci retracement of the XA leg. We then see a reversal lower from this point where price forms a new low below the XA leg giving us our BC leg. From here we then see another correction higher which gives us our CD leg and completes between the 50% and 61.8% retracement of the move from X to D. The completion of the CD leg into this Fibonacci zone gives us our entry location to set shorts targeting a reversal lower.
So, these are the measurements and parameters that we need to identify to correctly classify a structure as a 1:2:1 pattern. Because the measurements are so precise and the structure is so simple it is really easy to identify these patterns when they appear and they can be used to gain entry to the market at key reversal points.
Trading the 121 Pattern
So, now you know what the pattern looks like, let’s take a look at it on the charts to show you what the pattern looks like when formed by price.
Ok, so you can see here that we have identified our bearish swing giving us our XA leg and then we have also seen a correction higher which gives us our AB leg and you can see that the AB leg completes between the 61.8% – 78.6% retracement of the XA leg.
Once we have identified this first part of the structure we can then anticipate that we are going to see a reversal lower to give us a new low beneath the initial XA low. Once price breaks down below the XA low to give us our new low which will be the BC leg, we are then looking for price to correct higher and give us our CD leg. Remember, the whole point of this pattern is that we are looking to identify symmetry between the AB leg and the CD leg which are to be of equal lengths.
Identfying the Symmetry Swing
To make sure that we have symmetry between these two legs we can draw in a line on our AB leg and clone it to apply it to the CD leg to make sure that it is the same length. Remember, the CD leg also needs to complete between the 50% – 61.8% retracement of the overall move from X to D.
Once we have identified each part of the structure the final pattern will look like this. As you can see the CD leg is exactly the same length as the AB leg and completes precisely into the 50% retracement of the move from X to D. The completion of the CD leg is where we look to sell.
When we sell at the CD leg there are two ways that we can look to play the pattern. The first is simply looking for a short-term reaction of the level and the second is looking for a trending move to develop.
So, when playing for the short-term reaction we can place Our stop above the next Fibonacci level from where we entered. So, in this example we can see that the CD leg completed into the 50% retracement level, so we can put our stop above the 61.8% retracement level.
We are then simply looking for price to react lower giving us a two to one return so essentially we just want to see price reverse back down to the 23.6% retracement level giving us a two to one return. So, when we trade the pattern in this manner we are simply looking to profit from the initial reaction that we tend to see from the completion of the pattern and we aren’t looking to stay in the move long term.
When we are looking to trade the pattern for a trending move and stay in it for a longer term move we want to place our stop above the 78.6% retracement, we are then looking to hold the trade for a break below the BC leg low. When trading the pattern in this manner the first area that we need to be aware of for trade management is a retest of the BC level low.
This is the level at which we can move our stop to breakeven, to protect against any adverse bounce which could see price return to our entry level. Remember, moving to breakeven is simply where we move our stop to our entry level so that if prices reverses on us, we don’t suffer a losing trade.
When trading patterns there is always a key location that acts a pivot which is a make or break level for the pattern. With the bearish 1:2:1, that pivot is the BC low. Once price breaks below that level, typically the pattern will go to trend lower.