What Is The Butterfly Pattern & How To Trade With It

Butterfly Pattern

The Butterfly pattern belongs to a family of Harmonic patterns and indicates a potential reversal. H.M. Gartley developed the pattern, later Scott Carney introduced Fibonacci levels and fined tuned it.

What is the Butterfly pattern?

The Butterfly pattern appears at key market reversals and pinpoints price’s highs and lows. It compromises of five points or legs (X, A, B, C, D) which are connected through Fibonacci ratios.

Scott mentioned in his book, “Harmonic Trader” that the Butterfly requires specific Fib ratios for its formation. To validate its structure, he described that:

  • The AB has to retrace up to 78.6% of the XA leg.
  • BC needs to retrace between 38.2% to 88.6% of the AB leg.
  • CD should show an extension of 1.618% to 2.618% of the AB leg. Also, CD could extend up to 1.272% to 1.618& of the XA leg.
  • The point D is where the PRZ (potential reversal zone) begins.

This is how the pattern looks like on the chart:

Butterfly pattern on a chart
Butterfly pattern on a chart

At point D, a trader takes a long or short position. A trader can set a profit-target at 61.8% of CD and second target at 127.2%.

The Butterfly pattern resembles the Gartley pattern in structure. But, the difference lies in Fib ratios. The D leg of Butterfly extends beyond the leg X.

How to use the Butterfly pattern?

To enter the trading positions, a trader must acquaint himself/herself with the Butterfly variations; bullish and bearish.

a. Bullish Butterfly pattern

The bullish Butterfly emerges in an uptrend and signals a price reversal at point D. Traders take long positions at point D, with stop-losses below it. It looks like M.

The AB leg of the bullish Butterfly retraces up to 62.1% of the XA leg. The BC leg retraces to 65.6% of the AB leg. And, CD leg extends XA leg by 1.40%. It resembles M.

Bullish Butterfly Pattern
Bullish Butterfly Pattern

b. Bearish Butterfly pattern

The bearish Butterfly occurs in a downtrend and identifies a price reversal at point D. Traders take short positions at point D with stop-losses above it.

In the bearish version, the AB leg retraces up to 79.9% of the XA leg. The BC leg retraces to 96.9% of the AB leg. CD shows an extension of 1.17% of XA leg.

A keynote to add is that these bullish and bearish patterns may not meet the exact Fibonacci ratios, as described above. When the pivot point forms at D, traders should look for the rise/decline of the price.

Sometimes the Butterfly presents false signals on shorter timeframes. To compensate for the issue, traders could use momentum oscillators to confirm the price reversal. Besides this, a trader could take position after point D.

Bearish Butterfly Pattern
Bearish Butterfly Pattern

Butterfly pattern trading strategy

For a trading strategy, traders may look for the Butterfly pattern on any timeframe according to their own individual trading needs.

Butterfly pattern buy strategy

  • Locate the pattern in an uptrend.
  • Wait for the price bar to go bullish before entering.
  • Enter the trade at point D or after it.
  • Place a stop-loss near the recent low from point D.
  • Exit the trade before the price drops.

Butterfly pattern sell strategy

  • Look for the pattern in a downtrend.
  • Wait for the price bar to go bearish before entering.
  • Enter the trade at point D or after it.
  • Place a stop-loss near the recent high from point D.
  • Exit the trade before the price rises.

Butterfly pattern conclusion

The Butterfly Pattern is an easy-to-spot Harmonic pattern that can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy. Before implementing, traders should consider extensions and retracements of the legs.