The Butterfly pattern, some traders love it, some traders run from it. But if you have not traded it yet, you are missing out on some nice opportunities. Before I started digging into Elliott waves, Harmonic patterns were my playground. If there is one strategy that can teach you both patience and discipline in trading, it is Harmonic trading.
In order to trade a pattern you have to wait till the pattern completion and then confirmation – trust me you will need a lot of patience to do this. Here’s why:
Butterfly pattern which took almost 9 months to complete
But there is a caveat with Harmonic patterns. A pattern completion in my rules is not necessarily a pattern for all harmonic traders. Meaning, for each trader – his own tested ratios. However there are some cardinal ratios that should never change. e.g. 78.6% B point retracement of the XA leg for a Butterfly pattern and 50% for Bat pattern. Likewise, the Butterfly in the above image might not be qualified as one per “industry standards.” As with any strategy, you have to do the work – find ratio combinations that provides better returns in your trading.
Ratios of the above Butterfly pattern:
- B retracement of XA = 78.6
- C retracement of AB = 78.6
- BC expansion at D = 161.8
- XA expansion at D = 114 (This needs to be at least 127.0% according to most)
As per my rules of engagement, above is a valid Butterfly pattern.
However when you do have a pattern completed, you will have ratio based entry, exit and target levels – which teaches precision and discipline in trading.
ABCD in the Butterfly pattern
ABCD points in the butterfly pattern must constitute a standalone ABCD pattern in order to complete a Butterfly. This is true for most XABCD advanced harmonic patterns. In fact, when XA leg is an impulse, ABCD is actually an ABC correction in terms of Elliott waves. After all, harmonic trading is a method to add precision and ratios for the same wave patterns described in the Elliott wave principle.
Like any strategy, higher the timeframe higher probability and reward for the pattern to play out. This is not just true for Butterfly pettern, but for any trade setup. But the problem with trading on higher timeframes is the risk. You must know that risk too is high, when trading on higher timeframes.
Should you trade the Butterfly?
Only you should answer the question. The point is that you must know what sort of returns to expect with a strategy over time. One specific trade does not account for the success or the failure of a strategy. But you must carefully backtest the Butterfly pattern according to your preferred ratios, whether it produces the required results from a series of trades.