A trading strategy based on Cypher pattern is a trend-following system allowing Forex traders to identify a moment when a retracement is over and the previous trend is ready to resume. The method applies the graphical analysis with Fibonacci retracement levels and fixed ratios between legs of the retracement. Cypher pattern is one of the harmonic patterns using geometry assessment of price charts of any asset on any timeframe, so the trading strategy is flexible and the percentage of winning deals is high.
What is a Cypher pattern?
Cypher pattern is a XABCD formation with five touchpoints and four legs or waves between them. Each leg represents a price action, while every touchpoint highlights reversal levels. In most cases, the Cypher pattern has to come in line with the previous long-term trend as it is a continuation pattern. Therefore, the first leg XA has to keep the same direction of the trend as the previous price action. Waves AB and CD represent retracements, while levels of both points B and D have a certain displacement on the price chart, pointing to attractive entry levels and reasonable stop-loss orders.
In contrast to the most widely-used harmonic pattern - Gartley pattern - the Cypher formation allows point C to be higher than point A. That means that the second wave of the by-trend action underlines the sequence of higher highs, which makes the continuation pattern easier to spot. On the other hand, retracement waves have to meet the requirement of certain ranges in the pattern geometry, so extensions have to be limited by ranges using Fibonacci retracement levels. Another advantage of the Cypher pattern application is that point D, which completes the formation, is above the initial point X for bullish patterns or below point X for bearish ones. That helps Forex traders to identify exact level for the stop-loss order because if the rate breaches point X during the retracement, the reversal is getting more likely than a continuation, so opening deals in the previous direction does not make sense any more. Here is the full list of conditions to spot the Cypher pattern on the price chart.
Cypher pattern conditions
- Point X is the initial point of the formation, while leg XA continues the previous trend;
- Point A reverses the previous action and starts the first wave of retracement AB;
- The ratio between waves AB and XA must be in the range of 38.2/61.8%;
- Point C is the highest/lowest point of the pattern as it continues the initial price action;
- The ratio between legs BC and XA must be in the range of 113.0/141.4%;
- Point D completes the pattern and it has to be above/below point X for bullish/bearish formations;
- Wave CD is larger than wave BC by 127/200%;
- Point D is a 78.6% retracement of the entire action from point X to point C.
Cypher pattern & Gartley pattern
Both patterns are similar, especially in the two crucial conditions. First, the ratio AB/XA is the same, meaning that the depth of the retracement AB is similar. Second, the final point D is above point X for bullish patterns and below for bearish ones. This geometry makes both patterns reliable in terms of placing reasonable stop-loss orders. The key difference is that point C is higher than point A for the Cypher pattern, which makes the formation more similar to continuation patterns as the sequence of higher highs or lower lows makes the pattern easier to spot. In contrast, the Gartley pattern has point C lower than point A, which makes the overall formation similar to the double-top reversal pattern. Therefore, the rest of the geometry is also different as ratios between legs BC, CD and XA are getting larger due to the main distinction.
How to draw a Cypher pattern?
As far as the Cypher pattern has higher highs or lower lows depending on the trend’s direction, Forex traders can define the double-top or double-bottom formation on the price chart. Next, traders need to turn the XABCD graphical analysis tool on and connect all of the five touch points consequently. The ratios between legs will appear automatically on the instrument, so traders need to check them out in order to meet the requirements of the ranges described above. The ratios don't need to be the same, the main condition is to keep the ranges between the key Fibonacci levels. Besides, traders should check the displacement of all touchpoints so they should be in the correct order. If conditions are not met, the pattern has to be ignored.
How to trade the Cypher pattern?
The most essential task for any analysis of the price chart is to measure the depth of retracement, which comes after the previous trend charted two consecutive peaks or bottoms. In other words, the graphical analysis helps Forex traders to answer the key question: are the bears strong enough to reverse the previous bullish trend. This is why the Cypher pattern and its ratios between the legs are so important for identifying further trend direction. If the counter-trend price action failed to breach the initial point X and point D remained above/below it, then the retracement is getting exhausted and by-the-trend continuation is likely. What the ratios of leg CD shows are the price range where the correction could finish, so traders can forecast the reversal point.
After that, two options are available:
- First, traders could wait for the Cypher pattern to complete at point D and make sure that rates are starting to bounce in the correct direction before opening trading positions;
- Second, they can place postponed buy-limit or sell-stop orders in the ranges of ratios between the waves after point C signalled the beginning of the last wave and before the pattern is complete.
Cypher pattern trading rules
- Once the Cypher pattern is complete on a price chart, traders should enter the market at point D, opening long positions for the bullish pattern and short for the bearish one;
- Another option is to set a postponed buy-limit or sell-stop order after point C is formed and leg CD started. The main requirement is that the length of wave CD does not have to exceed 200% of wave BC, while the entry-level should be above point X;
- The stop-loss order has to be placed at around point X but not deeper than 50 pips counting from point D;
- After the price action reversed at point D and the asset rate crossed the level B from below/above, traders should remove the stop-loss order to the non-risk mode;
- Once the price hit point C, traders should take profits manually or place the take-profit order several pips before it.
If you like this strategy, you might also be interested in this Heiken ashi strategy
Bullish Cypher pattern
A bullish Cypher pattern is shown on the price chart below:
Bearish Cypher patternAn example of the bearish Cypher pattern looks like this:
Examples of profitable deals using Cypher pattern
The example below shows the USD/JPY currency pair in an uptrend. After the continuation leg XA peaked, the pair started an initial wave of retracement towards point B, while the ratio of leg AB to wave XA was in the required range for the Cypher pattern conditions. Next, the rate had a continuation wave BC, while point C was higher than point A, and ratio BC to XA was large enough to appear in the range of Fibonacci retracement levels. Point C signalled a local peak, while wave CD was the final bearish correction. As long as the leg CD did not exceed restrictions for the ratio range between legs of the pattern, the retracement exhausted and the price action continued the previous uptrend in the same direction. After the Cypher pattern was complete, a trader opened long positions for USD/JPY at point D with a stop-loss order at point X. As a result, the final destination of the formation was achieved at point C and the trader took a nice profit of more than 120 pips, having a potential risk of just 30 pips, which created a reasonable reward-to-risk ratio.
The trading strategy based on the Cypher pattern is a part of the graphical analysis, using Fibonacci retracement levels. The pattern should continue the previous trend, while point D is a reversal point, highlighting the end of the counter-trend retracement. Ratios between legs of the formation have to be in certain ranges, meeting the conditions of the pattern. The trading method could be used as a standalone algorithm or in conjunction with additional technical indicators measuring the momentum and showing the trend’s direction. The reasonable reward-to-risk ratio and high efficiency of the trading system make the Cypher pattern flexible and reliable formation to measure correction depth and determine profitable entry levels when the counter-trend price action is getting exhausted and by-the-trend continuation starts.