Butterfly pattern was developed by Bryce Gilmore and was named so because of its visual resemblance of butterfly. This pattern is one of the most frequent of all harmonic patterns. There are 2 versions of the pattern bullish (looks like letter ‘M’) and bearish (looks like letter ‘W’). Below are the schematic pictures of the Bullish and Bearish Butterfly patterns:
- AB movement should be 0.786 retracement of XA.
- BC movement must be 0.382 or 0.886 retracement of an AB.
- If the retracement BC 0.382, then the CD must move 1.618 of BC. Consequently, if BC is 0.886, then the CD should be 2,618 BC.
- Movement CD should be 1.27 or 1.618 retracement of XA (but it cannot exceed 2.618 of BC)
Butterfly Pattern is a trend reversal pattern, it is traded against the trend when the price is approaching point D. The stop is placed few ticks below/above the farthest possible D level. The safe target lies within 38.2-61.8% of AD move. Many patterns can do much better than that, but the conservative targets must be used to lock in profit and possibly unloading part of the position. Entries might be done with a limit order or on price reversal away from D. All entries must be tested for risk/reward ratio. Entries with low risk/reward has to be taken cautiously or discarded altogether.
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