The butterfly pattern is known as one of the most developed and complicated reversal patterns that appear at the end of a trend. If used correctly, it is also known to be reliable and precise.
The butterfly chart pattern is a reversal figure with a butterfly-like shape which is a part of the harmonic group. It helps to identify the ending of a solid trend and allows traders to enter the market at the very beginning of a new one. There are bullish or bearish butterflies:
- The bullish butterfly harmonic pattern appears at the end of a downtrend and provides buy signals.
- The bearish butterfly pattern is formed at the end of an uptrend and provides sell signals.
Benefits for traders:
- It is easy to identify if a trader follows predetermined rules.
- It offers strong indications.
Downsides for traders:
- Broad forex analysis knowledge is required.
- Its structure can be a burden.
- It is less often identified than the Gartley. It is so because the Gartley offers similar signals and can be spotted more frequently.
The butterfly harmonic pattern has a structure of four legs — XA, AB, BC, and CD, which make up three swings, and five points — X, A, B, C, and D.
The Butterfly formation is built on the following parameters. Only by using them will a trader find the pattern on a chart.
- The XA line is where the pattern begins.
- The CD leg exceeds X; D is either equal or exceeds B.
- The AB line doesn’t exceed X, while the BC leg doesn’t exceed A.
- B isn’t located higher than at 78.6% retracement of the XA line, and C lies at 38.2%-88.6% retracement of AB.
- D is at the 127.2%-161.8% extension of the XA line or at the 161.8%-261.8% extension of AB.
- CD and D confirm if the price starts a new trend.
There are a few steps to take for using the butterfly harmonic reversal pattern on a price chart:
- Traders analyse the chart and find a figure with two decreasing highs and two decreasing lows or with two increasing highs and two increasing lows — these are bullish and bearish Butterflies respectively.
- After, traders apply the Fibonacci tool to specified legs and determine the following points.
- To enter a trade, they look for a confirmation of a trend reversal — C shouldn’t exceed A.
- Traders usually use B and C as profit objectives.
- X is a common stop-loss level.
These are general rules for trading bearish and bullish Butterflies include:
The butterfly is an effective tool for predicting future prices with potentially some probability. Butterfly patterns are an irreplaceable part of Forex market trading.
