Butterfly: How to Trade the Graphic Pattern?
Author: Andrey Goilov
Dear Clients and Partners,
Technical analysis suggests a whole range of patterns. Each author tries to make their pattern unique and describe it in as much detail as possible. At a certain point, there even appeared a whole trend of adding the Fibo grid to already existing patterns to enhance identification. Such price structures are called Harmonic patterns.
Many investors add Fibo levels even to such simple patterns as Head and Shoulders to evaluate the position of Shoulders and whether it complies with the requirements to the pattern. For the Double Top pattern, they have invented the Dragon pattern, in which the author also uses the Fibo grid to assess the correctness of the pattern and whether it will work.
I have a reason to tell you all this. To the Butterfly pattern that I am describing below, the same principle is applied. To check whether the pattern has formed correctly, Fibo levels are used. The main issue is how to do it. Before answering this, let us get into the history and the specifics of the topic.
What is the difference between the Butterfly and Gartley?
The Butterfly pattern is very similar to the Gartley pattern (also called Gartley Butterfly). We already have an article on it. Many traders mix these two up but if you look closely, they are absolutely different.
The Gartley pattern was designed and presented by Harold Gartley in his book "Profit on the Stock Market". At that time, it did not include Fibonacci levels. Later, Harmonic traders added the levels and concluded that the B point of the pattern must be near 0.618 of the correction and point D — at 0.786.
As for Butterfly, point B is near 0.786, while point D is near the projection of 1.27 of the XA wave. This is the main difference between the Butterfly and Gartley patterns. As you can see, it would be a hard job to find this difference without Fibo levels.
The structure of a bullish Butterfly
A bullish pattern gives the trader a signal to buy. Each of the five points of Butterfly coincides with its own Fibo level.
Mind that even if the price reaches the marked level of point D, where we expect the pattern to end, do not rush at opening a buying position. This area is called the "Potential reversal area", which means that the price will not necessarily grow.
The bullish Butterfly pattern forms as follows:
- The price starts going upwards in the first point X. This is where the Butterfly starts forming.
- Upon testing the next point A, the quotations go down but no lower than point X. The place where the decline stops gets the name of point B.
- Upon testing point B, the quotations form an ascending impulse again but do not renew the high. The place where the growth ends is called point C.
- After they test this latter point, the quotations start their final decline which ends in point D. This will be the largest movement of all, and traders prepare to buy from this point.
Closing thoughts
The Butterfly pattern is a graphic structure that consists of five points. It has clear entry and exit rules.
Harmonic Trading on the whole presumes trading by such patterns, not just describing them. A trader does not only open and closes positions near the levels that they have drawn by the Fibo grid but also learns to manage their trading, draws trendlines to find a good entry point, splits the position into parts for the sake of comfortable work, and uses Trailing Stop.
The Butterfly patterns should be traded by the trend because this way your potential profit will be much higher. Finally, never forget about money management, no matter how well the points coincide with Fibo levels and how harmonically the whole pattern looks.
Read more at R Blog - RoboForex
Sincerely,
RoboForex team
