The Butterfly pattern is another popular harmonic pattern widely used in technical analysis.

It is
considered a reversal pattern that aims to identify potential turning points in the market. The
Butterfly pattern was developed based on the concept of Fibonacci ratios and was introduced by
Bryce Gilmore in his book "Geometry of Markets."

The Butterfly pattern has a distinct structure and consists of specific Fibonacci retracement and
extension levels. The key Fibonacci ratios used in the Butterfly pattern are 0.786 and 1.27. The
pattern is named after its shape, which resembles a butterfly with symmetrical wings.

Here are the main characteristics of the Butterfly pattern:

1. XA Leg: The pattern begins with the XA leg, which represents the initial price swing. It can be an
uptrend or a downtrend and serves as the starting point for identifying the pattern.

2. AB Leg: The AB leg is a retracement of the XA leg. It typically retraces a portion of the XA leg and
ends at the 0.786 Fibonacci retracement level. This retracement level is critical in recognizing the
potential Butterfly pattern.

3. BC Leg: The BC leg is an extension of the AB leg. It continues the price movement beyond the XA
leg and usually reaches the 1.27 Fibonacci extension level of the AB leg. The BC leg is the longest
among the price swings in the pattern.

4. CD Leg: The CD leg is the final leg of the pattern and represents the reversal back in the direction
of the original XA leg. It retraces a portion of the BC leg and typically terminates at the 0.786
Fibonacci retracement level of the XA leg. The CD leg should be roughly equal in length to the AB leg.

The completion of the Butterfly pattern suggests a potential reversal zone, where traders may
consider entering trades. The pattern indicates that the price is likely to reverse and continue in the
direction of the initial XA leg. Traders often use additional technical analysis tools, such as support
and resistance levels, trendlines, and indicators, to validate the Butterfly pattern and make informed
trading decisions.

As with other harmonic patterns, not all Butterfly patterns will lead to successful trades. Traders
should employ proper risk management techniques and implement appropriate stop-loss and take-
profit levels to protect their capital and optimize trade outcomes. Additionally, combining the
Butterfly pattern with other technical analysis methods can enhance the accuracy and reliability of
trading signals.