BUTTERFLY PATTERN DESCRIPTION

The Butterfly pattern is best described as an extension pattern. It is also a failed Gartley
pattern where the D completion point completes above the X. Remember that a Gartley
pattern is considered a failed pattern if this occurs, but with this failure a Butterfly pattern may
be forming. The extension of the AD wing and the CD leg can be thought of as a stretched
rubber band. It is at these points that the market becomes overbought or oversold and a
reversal can occur.
Because of the chance that any pattern can be a failed pattern and even the
Butterfly pattern can fail, we will note again here that this particular pattern when failed can
move very quickly against the trader’s position; if the trader does not have the trading
skills or discipline to use stops, it is best to not trade this pattern until both of those
elements are part of the trader’s tool kit.

BUTTERFLY PATTERN STRUCTURE

The Butterfly pattern should be a very symmetrical pattern in its formation and structure. As
with the Gartley “222” pattern, the Butterfly pattern is formed with four legs. The difference is
that the last leg (the CD leg) of the Butterfly pattern will extend beyond the X point and will
move toward the 1.272 or 1.618 expansion of XA. The BC leg will also be an extension, but the
completion point is generally determined by the XA swing.
The AB leg of the pattern will usually be at the .618 or the .786 retracement levels. The
pattern also is valid if this retracement is at the .382 or .50. This retracement of the AB leg can
go further than the .786, but the pattern will be negated if it goes beyond X. One clue that a
Butterfly pattern may be forming is if the first retracement, the AB, goes to the .786
retracement level or further.
It is important to know what invalidates this pattern; here are five items that would
negate this pattern:
1. Absence of an AB=CD within the AD swing. This pattern must contain an
AB=CD.
2. An extension move beyond the 2.618 of XA. The 1.618 expansion is generally
the maximum risk.
3. B point above (for a sell pattern) or below the X point (for a buy pattern).
4. C above or below the A point.
5. Failure of D to extend beyond X: D must extend beyond X to be a Butterfly
pattern.

It is not unusual to see smaller “ab=cd” patterns within one of the main legs; for
example, a small ab=cd may be seen within the larger AB=CD formation of the AD swing.

IMPORTANT CHARACTERISTICS OF THE BUTTERFLY PATTERN

-Excerpts from "Trade What You See"-

This pattern, of all the patterns in this book, can be the most rewarding one if it is indeed a
major turning point in a market. It is the ultimate contrarian’s trading pattern. The risk,
however, can be great if the trader does not take the time to study and learn how to properly
assess and manage this pattern. There are several characteristics that should be studied when
learning this pattern that will help the trader to identify acceptable risk-to-reward setups and
valid patterns

Here are three points that are important characteristics of the Butterfly pattern:
1. Thrust. How the move from the C point starts is important to watch as it will give the
trader information on whether the pattern may form a Butterfly pattern rather than a
Gartley pattern—that is, long bars or gaps through the .618 or .786. Gaps should be
watched closely by the trader. They indicate an unknown or a change in sentiment and
potentially signal changing market conditions. The trust coming out of the CD leg
strongly suggest that the extension has a higher probability of making a 1.618 new high
versus a 1.272 new high.
2. Symmetry. Study the symmetry of the AB=CD; note the slope and angle of the AB leg
and then the CD leg. If the CD leg is exhibiting a steeper angle, that may be a clue that
the CD leg will extend beyond X and form a Butterfly pattern. The symmetry or slope of
the AB leg should be very close to that of the CD leg in order to keep the ideal
symmetry in the pattern. Note also the time bar relationship in these legs; for instance,
if the AB leg has taken eight bras to form, then the CD leg should also take
approximately eight bars to form, thus forming an ideal Butterfly pattern.
3. Failure signs. Beware of price beyond the 1.618 expansion of XA. Generally a move
beyond the 1.618 will indicate a continuation of the trend. If the technician will keep
focused on these characteristics, it will greatly reduce the potential for getting into
trouble with the Butterfly pattern. Butterfly trades are not for the faint of heart, as they
enter counter to the trend in markets when they appear the most bullish and the most
bearish.

PSYCHOLOGY OF THE BUTTERFLY PATTERN

Since the Butterfly pattern is an extension pattern, is found for the most part at major tops and
bottoms, and often signals a major reversal point, then we can apply basic mass crowd
psychology and witness it at extremes. When this pattern is a major reversal turning point in a
market, what you will witness is a market turn and masses heading for the door at the same
time. It is an extreme in market emotions of fear and greed.
At the tops, market participants start heading for the door trying to sell. There is fear of
losing money on wrong or early short positions, fear of losing profits, profit taking on longs, or
initiating new short positions. At the bottoms, market participants start buying perceived
bargain prices; others are still heading for the door selling out losing long positions (this has
been called the puke point, the point at which traders or investors cannot hang on to a losing

-Excerpts from "Trade What You See"-

position one more cent); still others are taking profits on short positions. At this point, any new
shorts will be forced to cover losses as prices rise against them, adding more momentum. This
point is an extreme of fear of losing or missing out.
Traders should remember that very few traders ever buy the exact high or low of a
stock or market and that the Butterfly pattern turns as the last bull buys at the top or the last
bear sells at the bottom.

-Excerpts from "Trade What You See"-