The Butterfly pattern is a very popular Fibonacci or harmonic pattern that
professional Fibonacci traders swear by. Moreover, those who master the 50% Fibonacci retracement market principle have a deeper understanding of the Butterfly pattern. Like other Fibonacci patterns, two conditions must be completed before one can expect a Butterfly pattern.
A butterfly pattern often begins to form after the correction (pullback or rally
XA) of a trend. There is a trend or clean cut impulsive price move from A to B,
then a pull back (after a bullish trend) or rally (after a bearish trend) before a
Fibonacci pattern (Butterfly pattern) begins to form.
Like the Gartley pattern, the retracement of AB to XA must be precise.
AB must retrace XA exactly by 78.6%. AB must be 78.6% Fibonacci retracement of XA.
That condition is mandatory.
It is the deepest retracement of XA in comparison to other Fibonacci patterns. Note that the Bat pattern has the shallowest AB retracement
to XA. The retracement of AB to XA in the case both Gartley and Butterfly patterns must be precise.
That is in theory.
The condition for BC retracement to AB is the same for all Fibonacci pattern. BC must retrace AB 38.2% to 88.6% Fibonacci retracement. The last piece of the structure of a valid Butterfly pattern is CD.
To cut a long story short, just remember that CD is expected
to end at the 127% Fibonacci extensions of XA. Yes, powerful reversals do occur at the point D of a valid Butterfly pattern because the 127% Fibonacci extension is just in the vicinity of the most powerful Fibonacci extension, the 138.2%.
How To Trade Butterfly Pattern
Ask first the following questions.
Have the two conditions necessary for the formation of a Fibonacci pattern taken place?
Is this a valid Butterfly pattern?
Now, look for a high probability trade setup at the point B and C if the butterfly pattern is being formed. Also do the same thing if the pattern is completed at the point D. Understand that best trading setups often take place at the points C (mostly) and D.
So, expert Fibonacci patterns traders will be hanging around at points C and D. In all cases, do not rush, but use the top-down trading method after isolating a valid trading opportunity.
Apart from the points C and D, be also ready to add to your positions like a pro if a valid bullish breakout is in place above the point B during CD. I will be adding a practical Butterfly trading video to this article in the near future.
One is more likely to spot a butterfly pattern on 1H, 4H, daily and weekly charts. If one spots a valid butterfly pattern on the monthly, quarterly or yearly chart, one must perform also the fundamental analysis before jumping up like a kangaroo to buy or sell because of the highly sophisticated market participants.
If one buys at point C the next price target will be at point B. Those who buy the breakout above B will set a price target at D (127% Fibonacci retracement of XA).
The butterfly pattern is a unique Fibonacci pattern that exposes the secrets of 50% Fibonacci retracements market principle. It generously pays technical traders and investors that know how to trade it at the point C and D.
The key point about the butterfly pattern is the AB that must stop precisely at the 78.6% Fibonacci retracement of XA.
It is a special ABCD pattern where CD is strictly superior in length and magnitude to the initial AB. Truly, the butterfly pattern offers one the highest probability trade setup at point C (mostly) and D.
One must take into consideration other factors at point D such as a broken common sense trend line, viable candlestick pattern and other key levels in that zone. It is essential that technical traders improve their market timing with a different times frame trading method.
Finally, it is also prudent that one always combines the technical trading with fundamental analysis to avoid being gradually cooked like a crab.
As always, I enjoy writing this article, and if it has been useful to you, do no hesitate to share it on the social media. I will be back shortly writing about another Fibonacci pattern. That is the crab pattern.
This article is written by George Beaulieu