Butterfly Harmonic Patterns Analyzing Price Fluctuations

 

Dear friends, it is evident that the primary goal of all of us when trading in the financial markets is to grow our capital and make a profit. The global Forex market offers this opportunity to everyone, regardless of where they live in the world. However, to be successful in financial trading, it is necessary to have the right knowledge, analysis, and strategy. Harmonic formations are technical analysis tools that benefit us in this field. Today, we will share some information about one of these tools, the Butterfly harmonic pattern.

What is the Butterfly Harmonic Pattern?

The Butterfly pattern is a harmonic pattern that indicates a reversal in technical analysis. The structure of this formation on the chart resembles the wings of a butterfly. Due to this resemblance, the formation is called the "Butterfly pattern". The Butterfly pattern has several key characteristics. Firstly, they form in a specific shape and manner. They create a distinct structure on the price chart as X-A-B-C-D, usually indicating the end of a trend or a reversal. Also, the Butterfly pattern often exhibits clear symmetry on the price chart. This symmetry makes it easier for the pattern to be correctly recognized and interpreted. Therefore, the renowned Butterfly pattern attracts keen attention among traders. There are two main types of Butterfly pattern:

1. Bullish Butterfly harmonic pattern
2. Bearish Butterfly harmonic pattern

The Bullish Butterfly pattern usually predicts an upward turn in price movements following a downtrend. Conversely, the Bearish Butterfly pattern indicates that prices may make a downward turn from an uptrend. Both types are based on Fibonacci levels and show related price movements between specific Fibonacci retracement and expansion levels.

The Butterfly Harmonic Pattern

How to Identify the Butterfly Harmonic Pattern?

Defining the Butterfly pattern consisting of 5 points (X-A-B-C-D) and based on specific Fibonacci ratios requires accurately identifying points X and A. When determining these points, the wicks of the candles involved in the pattern formation can also be considered. These points represent impulse and correction stages, combining with a total of four waves to form the Butterfly pattern.

Here are the components of the Bullish Butterfly pattern:

• Point X: This point is the starting point of the formation and usually represents the low point of a downtrend.
• Point A: It is the end point of an upward correction movement starting from point X. This correction movement usually extends to the 38.2% or 50% Fibonacci retracement levels.
• Point B: It is the end point of a downward movement starting from point A. This movement typically goes up to the 78.6% Fibonacci expansion level.
• Point C: It is the end point of an upward movement starting from point B. This movement generally extends to the 38.2% or 88.6% Fibonacci expansion levels.
• Point D: It is the end point of the downward movement starting from point C. This point often reaches the 161.8% Fibonacci expansion level of the X-A leg's rise.

Bearish Butterfly pattern components:

• X Point: This point is the starting point of the formation and typically represents the peak of an uptrend.
• A Point: It is the end point of a downward correction movement starting from point X. This correction movement usually extends to the 38.2% or 50% Fibonacci retracement levels.
• B Point: It is the end point of an upward movement starting from point A. This movement typically goes up to the 78.6% Fibonacci expansion level.
• C Point: It is the end point of a downward movement starting from point B. This movement generally extends to the 38.2% or 88.6% Fibonacci expansion levels.
• D Point: It is the end point of the upward movement starting from point C. This point often reaches the 161.8% Fibonacci expansion level of the X-A leg's decline.

Participant behavior in financial markets manifests itself in waves on price charts. The impulse and correction waves formed in the Butterfly pattern are also a reflection of this phenomenon. These waves are plotted using mathematical ratios such as Fibonacci ratios. Once the Butterfly pattern is complete, the probability of price reversal increases. Therefore, this pattern is considered a reversal signal.

How to Trade the Butterfly Harmonic Pattern?

The Butterfly harmonic pattern can provide us with great benefits in our buy-sell transactions as a main part of our trading. This pattern enables us to understand market changes and make the right trading decisions at the right time. However, it should be used carefully and evaluated alongside other analysis tools. Once the pattern is complete and other indicators confirm, we can determine entry points in our trades.

Trading the Bullish Butterfly Pattern

The Bullish Butterfly pattern indicates the beginning of an upward movement by breaking out of a downtrend. This pattern usually signifies that prices will gain momentum and start rising. The D point holds great importance here, offering flexibility between approximately 1.27 or 1.618 levels, considered an ideal point for reversal. Long positions are generally preferred at this point. In addition, the following points can be considered to increase the signal reliability in the Bullish Butterfly pattern:

• D point on a support line: D point is the reversal point of the pattern, and being on a support line indicates that this reversal has a stronger foundation.
• Indicators in oversold zone: Observing a pattern when indicators are in oversold zone suggests a higher probability of prices rising.
• Positive divergence between points B and D and corresponding points on the indicator: This divergence helps to confirm the validity of the pattern and the strength of the reversal.

Long (Buy): Buy orders can be placed when the price breaks above point D.

Stop Loss: Generally, a level slightly below point D is used when determining the stop loss level.

Target: A level near point C can be preferred when determining the target price, or Fibonacci retracement levels can also be used.

This image showcases an example of a trade using the Bullish Butterfly harmonic pattern seen on the 4-hour chart of the Euro/Japanese Yen (EUR/JPY) currency pair. The pattern indicating an upward movement in prices has been considered a noteworthy buying signal. Take a look at the image for details:

Bullish Butterfly harmonic pattern on the EUR/JPY chart

Trading the Bearish Butterfly Pattern

The Bearish Butterfly pattern indicates that an uptrend is nearing its end and prices may start turning downward. This pattern signifies a rapid downward movement as a reversal. Point D is a significant marker of this reversal and can act as a trigger for prices to enter a downtrend.

Considering the following points when taking a short position can increase signal reliability:

• The D point being below a resistance line,
• Indicators being in overbought zone,
• Negative divergence between appropriate points in the indicator and points B and D.

The reliability of the signal increases when all these details are present.

Short (Sell): When determining the selling point, choosing an entry point below or near point D is often a preferred strategy.

Stop Loss: The stop loss order can be placed just above point D (above the 1.618 level).

Target: When trading the Bearish Butterfly pattern, the target price is determined following the same rules as the Bullish Butterfly pattern.

This image shows an example of a trade using the Bearish Butterfly harmonic pattern seen on the 4-hour chart of the New Zealand Dollar/US Dollar (NZD/USD) currency pair. The Bearish Butterfly pattern provides a clear signal of a change in price direction towards a downtrend, highlighting its impact in trading. Examine the details in the image to learn how this pattern can be used to predict future price movements:

Bearish Butterfly harmonic pattern on the NZD/USD chart

Remember: The Butterfly harmonic pattern, like all other financial trading patterns, can occasionally generate false signals. Therefore, it is advisable to avoid trading solely based on one pattern. Always confirm the accuracy of the signal with other indicators and consider fundamental analysis data as well.