If you’re an avid trader, you’re probably familiar with harmonic patterns. One of the rarer and more advanced patterns is the Cypher, which can be an effective tool for identifying potential trend reversals and entry points.

However, successfully trading the Cypher pattern requires a thorough understanding of its structure and rules. In this article, we’ll delve into the specifics of the Cypher pattern, how you can spot it, and offer some practical tips on how to trade it.

What Is the Cypher Chart Pattern?

The Cypher is a type of harmonic pattern used by traders to identify potential buying and selling opportunities in the markets. Specifically, it’s used to help find areas where a reversal may occur.

The pattern is made up of five swing points (X, A, B, C, D) and four legs (XA, AB, BC, CD). It’s characterised by an “M” shape when bullish and a “W” shape if bearish. Traders typically place orders at D to catch the potential reversal.

Like other harmonic patterns, the Cypher requires that specific Fibonacci ratios be met before it is traded. However, the ratios used for the Cypher are relatively unique, which makes the formation one of the less common harmonic patterns.

The Cypher is also more advanced than other patterns, like the Gartley, Bat, or Butterfly, so you may need to spend some extra time learning how to recognise and trade it effectively. Once you master the skill, however, you’ll find that the Cypher can be a valuable addition to your trading arsenal.

Identifying the Cypher Pattern

At its simplest, the Cypher pattern comprises an impulse leg, XA, that retraces to form AB. Another impulse beyond the swing point A creates the BC leg, and a final retracement to D generates the CD leg.

Here are the Cypher harmonic pattern rules that must also be met:

• AB retraces XA by 38.2% to 61.8%.
• BC extends XA by 127.2% to 141.4%.
• CD retraces XC by 78.6%.
  

It’s acceptable if the ratios don’t line up exactly. For example, if AB retraces XA by 63% and the rest of the pattern looks correct, you can still consider trading. This is especially true for the final rule. Generally speaking, CD often moves slightly beyond the 78.6% area before reversing but can sometimes stop just short of the actual point, so don’t be discouraged if the ratios aren’t perfect.

Drawing the Cypher Pattern

Now that we know how to identify the Cypher, we can begin plotting it on live charts. To help develop your Cypher drawing skills, try using the TickTrader platform offered by us at FXOpen. You’ll be able to use the built-in XABCD drawing tool, as seen in the chart above. To draw the Cypher pattern:

1. Choose the XABCD tool from the sidebar in “Patterns.”
2. Click to place X at your first swing point.
3. Add the following A, B, and C points at the corresponding swing highs and lows.
4. Place D at 78.6%. To be notified as soon the price reaches the area, open an FXOpen account to gain access to customisable alerts.
   

You may notice that the ratios on the chart are expressed as numbers instead of percentages. Just multiply the number by 100 to get the percentage, such as 1.272 = 127.2%.

Using the Cypher Pattern While Trading

So, now we know how to identify and draw the Cypher pattern, but how do you trade it? Follow these steps to get an idea of how you can apply the Cypher pattern to forex and other markets.

Entry

Traders have two options when it comes to entering a Cypher pattern. They can either set a limit order at the 78.6% level or use a market order after confirming that the price is beginning to reverse.

Setting a limit order runs the risk of missing an entry if the price just goes beyond the level, but it can also make life easier since you don’t need to actively watch for confirmation. Meanwhile, looking for validation, like if D begins to reverse at a support/resistance level or with a candlestick pattern (such as a pin bar or tweezer tops/bottoms), and entering with a market order may potentially offer you a worse risk/reward ratio, but can get you into trades with more certainty.

Stop Loss

Since X should always be the most extreme point out of X, B, and D, stop losses can be placed just above (bearish Cypher) or below X (bullish Cypher). Beyond X, the setup becomes invalid, so this is a suitable area to set a stop.

If entering with a market order, you could set a stop loss above (bearish Cypher) or below (bullish Cypher) the candle you entered on for potentially greater risk/reward, but be aware that the price could still hit your stop loss and take off without you.

Take Profit

Many traders begin to partially close their position at A, although you could choose C if you want to take a more aggressive approach. Beyond the structure, you could set targets based on Fibonacci extension levels, like 1.272 or 1.618. This is done by applying the Trend-Based Fibonacci Extension tool to X, A, and B, which will project levels outside the formation.

Bullish Cypher Pattern Example

Here, we have an almost perfect AB retracement of 61.4%, followed by a pinpoint CD retracement to the 78.6% level. Note that the tool shows the pullback as 73.7%, but we know by applying the Fibonacci retracement tool to X and C that it actually hit the expected level. Even if you weren’t using the Fibonacci retracement tool, you could still consider the hammer and following bullish engulfing candle signs of a reversal and enter with a market order.

The stop loss was placed suitably, just below X. Given how well this example aligns with the ratios, you could decide to be more aggressive and set a profit target at C. You might also use the Trend-Based Fibonacci Extension tool, as we’ve used here, to find further targets, such as 127.2%.

Bearish Cypher Pattern Example

In this example, we can see a bearish Cypher forming as part of a larger downtrend. The AB retracement of 62.9% and BC extension of 129.6% are very close to the ratios of 61.8% and 127.2%, so we can be confident that the price is likely to reverse at 0.786 before breaking down further.

As such, a limit order at 78.6% would have been ideal, as the price retraced to 79% before plummeting. The risk/reward ratio here is also attractive with a stop loss just above X. A conservative profit-taking approach would be to partially close the position at A, although C would have also been suitable in this scenario. Using the Fibonacci extension tool applied as described above showed us an optimal second target at 161.8%.

Your Next Moves

Now that you have an overview of what the Cypher pattern is, how to identify it, and how to trade it, you can put your knowledge to the test. You can follow these steps:

1. Head over to TickTrader and hunt for the hallmark “W” and “M” shapes the Cypher creates to get used to spotting them.
2. Once you’ve identified a few, try using the guide and examples above to determine how you would have traded the pattern and note the results.
3. Take a look at the Cypher pattern indicator to help you identify formations you might have missed.
4. Draw up some rules around how you’d like to incorporate Cyphers into your own system. You could also explore how other technical factors, like trendlines, support/resistance levels, and chart patterns, can add confluence to your Cypher trades.
5. Open an FXOpen account and have a go at trading Cyphers in live markets, continuing to refine your strategy. Broaden your horizons by learning more about harmonic patterns. If you’ve mastered the Cypher, you’re probably ready for other advanced patterns, like the Shark, 5-0, and Three Drives.

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