More in-depth study of how each of the individual legs that comprise the popular Gartley pattern unfold can help traders to better identify and trade this proven, high-probability set-up.
One of the most important aspects of adhering to any particular trading strategy is to believe that the strategy is a high-probability strategy. It is very hard to believe in a trade strategy if you don’t know how it works (i.e. black boxes).
With this in mind, let’s carefully consider each of the individual legs that unfold in the Gartley pattern in order to understand the psychology behind this high-probability set-up.
See related: Trading the Gartley Pattern
Referring to the first example “A” in figure 27 from H.M. Gartley’s book, Profits in the Stock Market, Gartley first identifies a bearish A-B leg . This leg appears to be a significant trend move or impulsive phase with minor rallies punctuating the downtrend.
At the completion of this A-B leg, we notice a significant rally that is labeled as the B-C leg. This B-C rally exceeds the previous rallies in the A-B downtrend in both price and time. This B-C price action indicates that the previous downward trend might be complete and that the B-C leg might be indicating the beginning of a new impulsive trend move in the opposite direction of the previous A-B move down.
This B-C leg is very typical of what happens when traders all begin to cover their short positions after a sustained bearish trend.
The B-C leg completes when the short covering is complete. With this in mind, the assumption is that the market will not take out the low at point B as a new trend up will probably continue higher and never look back.
Based on this information, Gartley puts his protective sell stop just below point B. Though Gartley mentions the A-B leg in his book, most educators of the Gartley pattern omit this important aspect of the pattern.
At the completion of the B-C move, Gartley mentions that there will be a minor decline that cancels a third to a half of the preceding minor advance (B-C). In other words, Gartley is looking for a 33% to 50% retracement of the B-C move up.
Why does this minor decline take place? This minor decline could be caused by traders who were anxious to get short in the previous A-B decline. These bears were waiting for a significant pullback during this bearish trend down, however, the market kept missing their sell limit orders on the rallies. Now that the market has had a significant rally against the downtrend, they start selling at point C and push the market down. Depending on where they get filled, they will put their stops just above point C.
This selling from the “late bears” pushes the market down into what Gartley describes as a minor decline. This original Gartley pattern ends up having a very different look and feel compared to how it is being taught today.
NEXT: 5 Main Differences Between Old and New Gartley Patterns