Trading the Gartley Pattern

10/18/2011 3:30 pm EST

Focus: STRATEGIES

Derek Frey

Chief Market Strategist, Carnac Investment Advisors, LLC

The Gartley pattern is an excellent way to spot trend reversals and turning points in the markets, and trader Derek Frey shares ideas on how to trade this popular, proven technical pattern.

Traders are always looking for good patterns in the market, and the Gartley pattern is one of those popular ones that traders are always looking for. 

Our guest today is Derek Frey, he’s going to talk to us about that and what it is. Derek, first of all, what is a Gartley pattern?

A Gartley pattern was recently discovered by Gartley in 1935, and it’s a pattern that helps us identify high-probability reversal zones in any given market and any given time frame. 

Gartley did his original work in the stock market, but I use them almost exclusively in the forex markets now, so they do apply to all markets, all time frames, and what have you.

And there are many other derivative patterns, if you will, that are kind of sourced from the original Gartley. They are slightly different but give you the same kind of basic odds and everything, and that’s really what the patterns are all about.

They give us a statistical edge—usually about a 70% edge—of being able to forecast what’s coming next. Doesn’t mean we know what’s coming next; it just means we have probability on our side, and that’s really what they’re all about.

The basic Gartley pattern I know has something to do with A, B, C, and D, right? 

Right, you have an X point. I’ll use a bullish one for an example, so you have an X point, which is a low, and the market rallies up to the A point, then it has its normal pullback to a B point, and then it retests that prior high at A, fails to go through it, and then goes back down and retests the X point—the original support level, basically. 

In some of the patterns it retests and holds, and in other patterns it actually falls through and then reverses, but in any case, that’s the basic kind of construction of them.

You don’t actually get to trade until you’re at what’s called the D point, and then we assess risk/reward ratios and determine if we want to take that trade.

This is a good example then, so we talked about if the D goes below that X, it may continue on or it may reverse. At what point to you have confirmation that you’re going to make a trade on this? What are you looking for at that D point?

I’m specifically looking for a risk/reward ratio of 1.5-to-1 or greater. If I can risk 50 pips to make 75—and it’s not hope, of course—the risking of 50 is based on where that reversal zone within the pattern is supposed to occur, and then the 75 pips is the real potential that it should give you. 

I know a lot of people hope to make 100 pips or something; it’s not like that. It’s that I should mathematically have a real 70% shot or greater of hitting that 75 while only risking 50, so then it’s all about repetition of doing that over and over again and getting as many of those opportunities as you can, and they’re always present. 

We have a thing called Trade Finder that will sniff out all the trades and on any average day—just in forex, and just across like 25 of the major pairs and crosses—and it will routinely find four hundred or five hundred patterns a day. 

They’re ever present; it’s not like you’ve got to sit there with bated breath waiting for weeks on end or anything. 

How do you decide which patterns are the ones that you’ll trade?

Risk/reward. A lot of them that come up do not have positive risk/reward ratios. You’re going to have a lot of them that you have to risk 50 to make 25. I’m not interested. That’s the main filter, the risk/reward ratio.

A lot of new traders when they’re trying to count waves or the Gartley pattern, they’re not sure exactly what to look for. How long does it take you to get confident in seeing those patterns and counting those different areas?

We actually have software that does all the pattern recognition for us, and there’s lots of it, not just ours, but there’s lots of software out there. That job of being like the bloodhound or the grunt worker, or whatever, that’s all done for us.

Then it really comes down to simply when a pattern pops up, we get notified on either e-mail or on the phone and all that, and we just go look if it is an acceptable risk/reward ratio, and if it is, we’re in.

Then you can, depending on what pairs you want to trade of course, but I prefer trading fifteen minute, hourly, and four hour charts.  Not because they’re better, these fit my personality and the way I like to trade. 

I don’t like to stare at a chart for three hours on a five minute basis trying to catch the little moves, I want to be more passive and catch a bigger move. 

What does it tell you about position sizing? Does the pattern tell you something about how much you should risk or how much you should put on? 

I run a static position size. I don’t do bet variance; I do straight. For me, it’s a function of leverage and how much I’m trading in my account; how many actual dollars are in my account.

Leverage has been figured out, optimized, and four-to-one is the point where the point of diminishing returns kicks in—four-to-one in forex—so I’m usually somewhere around there, give or take very little bit.

You can’t really break that rule. It’s one of the biggest problems with forex, is they give you the ability to go to 50, 200, whatever to one, and just because you can do it doesn’t mean you should.

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