The Butterfly Harmonic Pattern is a technical analysis pattern that is used to identify potential reversals or continuations in financial markets. This pattern is based on the principles of Elliott wave theory and Fibonacci ratios. It is considered one of the most accurate and reliable reversal patterns in the world of technical analysis.
This guide covers butterfly harmonic patterns. This explains what they are, how to spot them on charts, and how to trade with them.
What is a Butterfly Harmonic Pattern?
A butterfly harmonic pattern is a five-point reversal chart pattern. They are used in technical analysis to help traders choose when to enter or exit a market. It is a trading pattern defined by its shape and the intervals between its individual trends.
The harmonic butterfly is applicable to any time frame chart and any liquid market. You can find similar patterns to the butterfly can in the harmonic family. These include the Gartley, crab, bat, and AB=CD shapes, among others.
What Does a Harmonic Butterfly Look Like?
Butterfly harmonic pattern nodes are X, A, B, C, and D. A line connecting these points forms four waves.
Once the creation is complete, the final image looks like a stick figure butterfly, hence the name “harmonic butterfly pattern.”
This pattern always starts at X, regardless of the trend. A butterfly pattern, which indicates a bearish reversal, will form if the trend between X and A is a downtrend. This pattern is known as the Bearish butterfly pattern.
If the trend between points X and A is an uptrend. In this case, the resulting pattern will resemble an inverted butterfly and be a bullish butterfly harmonic pattern.
Identifying the Harmonic Butterfly Patterns
The following are the butterfly harmonic pattern rules to identify it:
- First, find the pattern’s X to A move. The Harmonic Butterfly Pattern relies on this impulsive price move.
- Next, find the B to C retracement, the first corrective wave in price action. This wave should partially retrace the X-A move.
- Step 3: Find the C to D retracement, the second corrective wave in price action. This wave should partially retrace B to C.
- Identify the D to E extension: This completes the Harmonic Butterfly Pattern. This wave should end at the 127.2% or 161.8% Fibonacci extension of the X-A move.
However its much easier, by using our Auto Harmonic Pattern Software which Identifies Butterfly Patterns amongst others and takes the Long and Short Trades following the D pivot completing in the Automated Completion Zones as on the chart images above.
How to Trade the Harmonic Butterfly Pattern
Let’s now go through an approach to trading the Butterfly pattern. We will go over the three crucial trade components, long entry position, Stop loss, and exit strategy.
Placing a Long Entry Position
When placing a long entry position with the butterfly harmonic pattern, you will want to look for the following:
- The pattern should form at or near a key support/resistance level.
- There should be a clear bullish or bearish trend leading up to the formation of the pattern.
- The pattern should have formed with a clear and distinct rejection of the key support/resistance level.
- After detecting these traits, put your purchase order above the rejection candle’s greatest point (for a bullish butterfly pattern). Or below its lowest point (for a bearish butterfly pattern). Then, position your stop loss at either end of the candles.
Managing Your Trade
We will now move on to how you can manage your trade once you have identified the butterfly pattern. There are three Fibonacci ratios that are important to keep in mind when trading the this harmonic pattern with forex. These are 38.2%, 50.0%, and 61.8%. These ratios will guide your stop loss and take profit orders.
For long trades, place the stop loss order at the highest or lowest point of the XA leg. And place the take profit orders at 38.2%, 50.0%, and 61.8% Fibonacci levels, respectively.
After entering the position and establishing a stop loss, we may begin to plan our profit goal. With this pattern, where to set a take-profit target is entirely up to you. It will depend on your objectives and the market’s circumstances. Set your profit objective aggressively by placing it at pattern point A. For a more moderate profit goal, place it at point B.