<s> Trading the GARTLEY 222
Sometimes old trading ideas are the best ideas —
if you  can  quantify them  with  modern  analysis  and
testing  procedures.  Here,  a  "classic"  chart  pattern
is  defined  mathematically  and  tested  to  see  if  it  can
produce  profits.
BY  AARON  BEHLE  AND  MARK  CONWAY
s  an  increasingly  challenging  market has  weededout  traders  over  the  past  few  years,  many  sur-vivors  in  search  of  an  edge  are  revisiting  theworks  of  the  original  technical  analysis  masters,including  Richard  Schabacker,  J.M.  Hurst,  W.D.  Gann  andHarold M. Gartley.
Gartley wrote Profits  in  the Stock Market in 1935,  and whatmakes the book striking is not that it shows how much techni-cal  analysis  has  advanced  since  then,  but  rather,  how  little  ithas  changed.  In  many  cases,  "modern"patterns  with  catchy  names  are  simplyrehashes of price behavior observed longago by people like Gartley.
peak-to-trough or trough-to-peak) as a certain percentage of apreceding  price  swing.  Pesavento  required  these  percentagesto be Fibonacci ratios: 0.618, 0.786,  1.00,  1.27 and 1.618.
The  problem  is  that  if  you  disregard  those  patterns  whoseprice  swings  are  not  proportional  using  precise  Fibonacciratios, the Gartley 222 pattern is quite rare. Using a "tolerancepercentage"  (T%)  that expands  the  range  of acceptable  price-swing ratios produces more pattern examples and, thus, moretrade opportunities. For example, if T% = 10 percent, segment
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One  example  is  a  pattern  commonlyknown  as  the  "butterfly,"  named  for  itsresemblance  to  a  pair  of butterfly  wings(see  Figure  1,  right).  However,  Gartleydescribed  this  pattern  in  Profits  in  theStock Market as the "Gartley 222," a refer-ence  to  the  page  number  on  which  thediscussion occurred.
The Gartley 222 can be  defined objec-tively  by  establishing  specific  propor-tions  for  the  four  price  swings  (XA,  AB,ВС  and  CD  in  Figure  1),  or  legs,  thatcomprise  the  pattern,  as  well  as  by  set-ting  criteria  to  define  the  magnitude  ofthe  swing  ("pivot")  highs  and  lows  —points А, В and C.
Percentage  relationshipsIn  his  book  Profitable  Patterns  for  StockTrading,  analyst  Larry  Pesavento  usedcertain ratios  to  define  the butterfly pat-tern,  measuring  each  price  swing  (from
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AB  (the  second  price  swing)  can  bebetween 51.8 percent and 71.8 percent ofsegment  XA  (the  first  price  swing),rather than exactly 61.8 percent.
Another  criterion  that  can  be  appliedto  the  pattern  is  the  "strength"  of  thepivot  points.  For  example,  a  pivot  highhas  a  strength  of  3  when  the  three  barspreceding the high and the three succeed-ing it are all lower than the high; a pivothigh  with four preceding and  succeedinglower  highs  would  have  a  strength  of  4.Each pivot in the 222  pattern must meetthis  strength  requirement.  As  the  pivotstrength  increases,  so  does  the  length  ofthe  pattern  and  the  likely  duration  of  atrade  based  on  it.  However,  the  higherthe pivot strength, the fewer patterns thatwill  qualify  for  trading,  and  the  longerthose patterns will be.
Pivot strength can also be measured inpercentage  terms  —  e.g.,  a  2-percentswing  from  peak  to  trough  on  a  60-minute chart, or a 10 percent swing on adaily  chart.  These  parameters  should  beappropriate to the time frame; price moves on an intraday chartwill  be  proportionally  smaller  than  those  on  daily  or  weeklycharts.  (With  all  these  criteria,  finding  the  pattern by  scanningcharts is difficult, at best. Accordingly, code for defining the pat-tern  in  both  the  TradeStation  and  Wealth-Lab  analysis  pro-grams  can be  found  at www.activetradermag.com/code.htm.)Using  objective  criteria  for  defining  price  patterns  allowsyou to build a consistent strategy for trading them. We will usespecific Gartley 222 pattern parameters to enter both long andshort  trades  on  different  time  frames.  Back-testing  on  theNasdaq  100  stocks  over  the  past  several  years  will  provide  anindication of the strategy's potential.
Defining  the  swing  relationshipsIn Figure 1, which shows a bullish 222 pattern, low X to high Adefines  segment XA; high A to  low  В  defines  segment AB,  andso on. The first thing to determine is how the size of these priceswings should relate to each other.
Low В  retraces a certain percentage of high A, but is higherthan low X. Segment ВС is an even smaller retracement of highA, but segment CD retraces all of segment ВС but is above lowX. Point D is the buy point.
To  measure  the  retracements,  we'll  use  the  proportions
defined  in Appendix  I  of Pesavento's book:
AB  should be 61.8 percent of XAВС should be 61.8-78.6 percent  of ABCD should be 127.0-161.8 percent  of ВСAD should be 78.6 percent of XA
Figure 2  (above) shows a bearish 222 pattern, which resem-bles  the  letter  "W."  Reversing  the  logic  of  the  bullish  pattern,
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peak X  to trough A defines the  segment XA,  trough A to  peakВ defines the segment AB, etc.
High В  retraces  a percentage  of  trough A but is lower  thanhigh X. Again, segment CD retraces all of segment ВС but doesnot reach the point X high. Point D is the sell short point.
The pattern lines in Figure 2 are based on the following cri-
teria:
1. Pivot strength = 32. Maximum number of bars in pattern =1003. T% = 10 percent
Gartley 222 strategyA Gartley 222 setup should  always have a minimum potentialreward/risk ratio of 2:1. This system uses a stop-loss at Point Xand a profit target equal to 61.8 percent of segment CD ("DT"in  the  following  calculations).  The  profit  target  for  a  bullishbutterfly will be equal to Point D + DT, and the short target fora bearish butterfly will be D - DT.
The calculations used are:
XA  =  |  X - A  |AB  =  |  A - В  |BC=  |  B -C  |D = A - (0.786 * XA) for bullish butterflyD = A + (0.786 * XA) for bearish butterflyC D = | C - D|AD  =  |  A - D  |DT  =  0.618  *  CDTolerance = T%
continued on  p.  40
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222  trade.  The  stock  twice  closed  within10 cents of the pattern high. A short tradeinitiated at this level would have  a profittarget of at least 60  cents  with  risk limit-ed to 10 cents  -  a 6:1  reward/risk ratio.Note  the  two  different  lines  denotingsegment CD. In a bearish 222 pattern, Dis the price level at which to short — e.g.,it is based  on the high  of a bar  satisfyingthe  condition  that  segment  CD  retracesat least 127 percent of segment BD. If thiscondition is true, the pattern is drawn.
Now, suppose the next bar's high priceis  lower,  and  that  segment  CD  nowretraces only  125 percent of segment BD.This is not a valid Gartley pattern and nopattern is drawn. In this case, though, thesecond  bar  did  have  a  higher high,  so  anew segment CD line is drawn. Althoughthe  strategy  calls  for  entry  at point  D  onthe initial bar that completes the pattern,it  is  useful  to  keep  tracking  subsequentbars that fulfill the pattern criteria in the event you miss the firstopportunity and need a second chance to enter the trade.
However,  if  the  next  bar's  high  is  higher  and  comes  backinto  the  "Gartley  range,"  the  pattern  will  be  drawn  again.These  "multiple"  patterns tend  to develop when price is trad-ing in a range. The T% has been loosened to 20 percent in thiscase; the higher the tolerance, the more patterns that will occur.Although  this  is  a  modified  version  of  the  Gartley  setup,  weprefer to see  all potential patterns as they take shape.
Varying  the  input  parameters  to  reflect  different  swing  pro-portions  and  pivot  strengths  will  identify  different  kinds  ofGartley  setups.  For example,  higher  pivot strengths  will  revealsetups  that  are  developing  over  longer  time  frames.  A higher-
EMC Corp.  (EMC),  60-minute
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Entry rulesBullish Gartley 222:1. A > С and С > В and В > D and D > X2. The pattern must be a trough-peak-trough-peak
sequence
3. AB  /  XA > 0.618 - T% and AB  /  XA < 0.618 + T%4. ВС / AB > 0.618 - T% and ВС / AB > 0.786 + T%5. Repeat for CD  / ВС and AD  /  XA.6. If the conditions above are true, then buy at price D with
a limit order.
Bearish Gartley 222:1. A < С and С < В and В < D and
D <X
2. The pattern must be a peak-trough-
peak-trough  sequence
3. AB  /  XA > 0.618 - T% and
AB / XA < 0.618 + T%4. ВС / AB > 0.618 - T% and
ВС / AB > 0.786 + T%
5. Repeat for CD  / ВС and AD  /  XA.6. If the conditions above are true,then sell short at price D with alimit order.
Exit rulesBullish Gartley 222:1. Profit Target: D + DT2. Stop Loss: X
Bearish  Gartley:1. Profit Target: D - DT2. Stop Loss: X
Example 1Figure  3  (left)  is  an  example  of  a  veryfavorable  reward/risk  ratio  for  a  Gartley
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parameters  to  your  holding  period.  Inthis case,  the pivot strength was set to 5and  the  pattern  developed  over  seventrading  days.  A  trader  may  decide  tohold  a  position over the same period  for"time  symmetry"  -  that  is,  sometimesthe  moves  that  spring  from  a  Gartleysetup are proportional to the original pat-tern length (in time).
Figure  5  (left)  is  a  good  example  oftime symmetry.  The bullish setup  devel-ops  over  16  trading  days,  and  16  dayslater  EBAY  had  gained  more  than  sixpoints from the entry. Here, the stop-lossamount is less than one point, so even ifyou chose to exit the trade on the first upmove,  the  trade's  reward/risk  ratio  wasat least 3:1.
As  long  as  price  stays  in  the  zonebetween  the  troughs,  the  pattern  is  validuntil  price  either  breaks  below  the  firsttrough or moves above the second trough.Some traders wait for a confirmation bar - a close above the openor  a  close  greater  than  the  previous  close.  However,  if  thereward/risk ratio is good, place a limit order close to the bottomof the pattern and let the price action do the rest.
Figure 6 (below) shows another intraday  (five-minute bars)setup. Like the Figure 5 example, this pattern is time-symmet-ric, and the high occurs around one hour later. Also, this setupwas based on a pivot strength of 4, and the pattern is 16 bars inlength — referred to as a "4x4" because of its perfect symme-try and  compact form.
Gartley 222 patterns can be traded on 1-, 2-,  and 3- minutecharts.  The  only  caveat  regarding  these  time  frames  is  to  becareful  of  a  bullish  setup  that  occurs  after  a  run-up  -  youcontinued on p.  42
10:05  10:20  10:35  10:50  11:05  11:20  11:35  11:50  12:05  12:20  12:35
strength  pattern  combined  with  a  lower-strength  pattern  is  apowerful combination for trading  these  setups.  In some situa-tions, a lower-strength (shorter-term) pattern will form within ahigher-strength  pattern,  in  which  case  you  can  enter  a  tradebased on the shorter-term pattern and have the potential to cap-italize on the longer-term pattern.
Intraday  setupsThese patterns can also be traded on intraday charts. A Gartley222  setup  on  a  60-minute  chart  is  suitable  for  a  swing  tradewith  an  approximate  holding  period  between  one  and  threedays.
In  Figure 4  (opposite  page),  the  stock does  not initially hit
the  profit  target,  but  pulls  back  to  thebuy  point.  However,  it  stays  above  thestop-loss point at the bottom of the chartand,  finally,  the  real  move  occurs  twodays later.
Remember 
to  adjust 
the  pattern
Additional  reading
Professional Stock Trading: SystemDesign  and Automationby Mark R.  Conway and Aaron  N.Behle.(2003, Acme Trader LLC,  Waltham,Mass.).
Profits  in  the  Stock  Marketby Harold M.  Gartley(1935,  Lambert-Gann  PublishingCo., Pomeroy, Wash.).
Profitable  Patterns  for  StockTradingby  Larry  Pesavento(1999,  Traders Press  Inc.,Greenville,  S.C.).
ACTIVE TRADER  •  August 2003  •  www.activetradermag.com
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could be looking at an  "M"  top pattern.Similarly, a bearish setup after a mid-daycorrection may be a "W" bottom pattern.Context is important for intraday  pat-terns, so keep an eye on the longer-termtime frames.
Test  resultsTable  1  (above)  shows  the  back-testingresults for daily Gartley 222 setups usingthe  rules  we  defined  earlier.  The  resultsreflect 165 trades in 100 stocks. In all thetests the profit factor (gross profit dividedby gross loss) was consistently in a rangeof 1.4 to 1.5. These trades were not filteredin  terms  of their reward/risk ratios  (thatis,  all  setups  were  traded,  not just  those
above a favorable threshold, such as 3:1).The test reflects only one set of patternparameters, in this case, a T% of 10 per-cent  and  a  pivot  strength  of  7.  Oneparameter  set  does  not  capture  all  thepossible  patterns  that  occurred  over  thethree-year  period.
The approach used here makes it pos-sible  to  find  price  patterns  using  objec-tive criteria, which in turn makes it pos-sible  to  test  trading  ideas  based  on  thepattern to see if they have potential.
For information on the authors, see p. 10.
Code  for  this  pattern  can  be  found  atwww.activetradermag.com/code.htm.
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