Fear and greed create a balance in the financial markets. Since these are human emotions, when they are amplified in the markets, they create distinctive patterns over time. One such pattern is the parabolic arc, a striking reversal chart pattern.

Traders use the parabolic arc pattern in technical analysis to anticipate a bearish reversal after an asset’s price has accumulated bullish momentum. But why is the pattern called the parabolic arc?

Understanding the Parabolic Arc Pattern

What is a Parabolic Arc?

The parabolic arc pattern is a chart pattern that can be recognized when the price of a cryptocurrency (or any other asset) makes a rapid or almost exponential increase (bullish) but is soon followed by a sharp reversal (bearish). Because of the potential for a bearish reversal, traders may use the pattern to spot shorting opportunities in the market.

The pattern is named the parabolic arc because of the shape it forms on the chart due to the buying pressure. The bullish momentum should be very steep to be regarded as a parabolic arc pattern.

The image below shows the parabolic arc pattern on the BTCUSDT daily chart.

Source: Tradingview

What Causes the Parabolic Arc Pattern?

Price movements increase and decline when market participants accumulate buy positions, thereby increasing an asset’s trading volume. Other traders see the bullish momentum on the chart and join in the buying euphoria. In trading, this urge to buy a cryptocurrency or any other asset is known as FOMO (fear of missing out).

The buying frenzy drives the asset’s price to unsustainable levels, and eventually, market sentiment shifts. This shift could be due to early buyers taking profits or unexpected negative events, causing a decline in the asset’s price.

Although the parabolic arc pattern rarely occurs, it can be reliable, especially when combined with other trading strategies. Some of the pattern’s characteristics can help traders to easily spot it on the charts.

Characteristics of a Parabolic Arc Pattern

Three distinct phases characterize the pattern. A gradual phase, an acceleration phase, and an exhaustion phase.

A Gradual Phase

The trend begins to form when a cryptocurrency’s price steadily increases. Buyers gradually enter the market, and price gains momentum. The price increase will exhibit a steep upward curve on the price chart significantly different from the previous price action.

An Acceleration Phase

The trend gains traction, increasing trading volume, and indicating growing buyer interest. High trading volume confirms the strength of the bullish trend.

The parabolic arc pattern begins to take shape as the market consecutively forms a series of higher highs, with each new high significantly higher than the previous one. Of course, traders view this as a signal for a ‘strong’ bullish market trend.

An Exhaustion Phase

At the exhaustion phase, the asset loses its high trading volume, and its price may begin to compress. This warning indicates that the bullish momentum is weakening, and a bearish reversal is imminent. Traders who fail to identify this phase promptly could lose most of the profits accumulated or even record a net loss from their entry point.

Identifying the Parabolic Arc Pattern

• The first step is to identify the beginning of a prevailing bullish trend. The pattern usually forms after an asset’s price increases, indicating buyers are in control.
• Observe the price movements by looking for measured pullbacks or consolidation within the uptrend. These pullbacks form the basis of the parabolic shape.
• Draw a curving trendline beneath the troughs of the pullbacks. Take care not to force the curve. It is not a parabolic arc pattern if it is not curved.
• Identify reversal signals. The safest bet is to wait until the price breaks and retraces below the trendline.

How to Trade the Parabolic Arc Pattern

Effectively trading the parabolic arc pattern would require identifying your entry point, stop-loss level, and profit target. Sound risk management could safeguard your trading portfolio if you are wrong about the trade.

Market Entry

Source: Tradingview

After you have identified the trend and constructed the curving trendline, the most important step is ensuring that price is retracing below the trendline connecting the troughs. You may take a short entry.

However, you may also wait for the asset’s price to pull back into a fresh supply zone formed after the trendline break. Then, you may take a short entry.

In the example above, a short position was opened after identifying a significant supply zone.

Stop-Loss Placement

Source: Tradingview.com

The stop-loss was placed well above the supply zone in the example above. Knowing where to place your stop-loss is relatively straightforward using the parabolic arc. Place your stop-loss above the top of the parabolic arc. Traders may also give a little allowance to make room for potential fakeouts. This will prevent traders from getting kicked out of the market before the pattern plays out.

The distance between a market entry and a stop-loss order may vary, depending on the asset and timeframe. Notably, a suitable stop-loss level could give traders an optimal risk-reward ratio when trading the parabolic pattern.

Profit Targets

Source: Tradingview

Although catching a reversal can tempt a trader to hold a position for a long time, it is better to set reasonable profit targets. It has been observed that after the parabolic arc pattern is formed, the price usually retraces down to 62% after the initial price increase. The Fibonacci retracement tool can be used to calculate this.

The example above shows how to set profit targets using the Fibonacci retracement tool. If this method feels random, you can set your profit targets using resistance levels or opposing demand zones. Better still, consider using risk-to-reward ratios.

Source: Tradingview.com

An opposing demand zone was used to estimate the profit target in the example above. Since the asset’s price could still trend downwards, traders could use this zone as their first profit target and the 62% Fibonacci level as the second target.

Benefits of Using the Parabolic Arc Pattern in Trading

Predictable Reversals

The pattern is often associated with a predictable market reversal. Thus, traders can anticipate potential bearish opportunities after observing a long, bullish trend on the chart.

Straightforward Entry and Exit Points

The structure of the pattern on the chart makes it easy to identify entry and exit points. This helps traders know where to place stop-loss orders to minimize risk.

Applicable Across Markets

The chart pattern can be spotted in various asset classes, such as cryptocurrency, forex, commodities, and stocks.

Limitations of the Parabolic Arc Pattern

False Signals

Even though it may seem that the pattern has a predictable outcome, traders may make mistakes with entry points by taking early short positions. Although the pattern’s outcome is predictable, determining the top of the trend can be challenging because the market can create false signals.

Sellers who take early shorts may get stopped, and the rally may resume. Professional traders may wait for the reversal before selling off a fresh supply zone.

It Requires Additional Analysis

For traders who love simplicity, using the parabolic arc pattern may be challenging. Relying solely on the pattern may not be sufficient, as it may require incorporating other trading indicators or strategies to confirm signals.

Conclusion

The parabolic arc pattern can be a powerful tool for technical analysis for all traders. If traders can properly identify the pattern on the charts, they can anticipate potential reversals and capitalize on market opportunities.

Although the potential to earn big rewards is enticing, traders should always ensure they know the risk of trading the parabolic arc pattern and employ proper risk management.