The Butterfly Pattern uses the identification of quantified structures on a chart that has specific and sequential Fibonacci ratio alignments that show harmonic patterns. These patterns calculate and measure the Fibonacci aspects of the price action structures to signal reversal points with good odds of success. Traders using harmonic patterns as a trading method believe that these types of patterns or chart and market cycles repeat over time. The key to profitably using the butterfly pattern is to identify the favorable risk/reward set up on extensions in price, betting on a reversal and to enter a trade based on a high probability that the same repeating swings will occur.
The Bearish Butterfly Pattern is a reversal pattern with four distinct swings in price or ‘legs’ , it is similar to both the Bullish Gartley and Bullish Bat Patterns but this example is bearish.
The butterfly pattern tries to identify when a current price swing in progress is probably getting near its end. This is a reversal chart pattern with traders trying to enter a trade on the chart as the price action reverses its current direction.
This is what the bearish butterfly chart pattern looks like.
The first swing down is created when the price drops from the starting point X to the ending point A.
The A to B swing up in price is a reversal in direction and retraces approximately 78.6% of the price move of the X to A drop.
The B to C swing back down is the next directional change and price falls back down with a retracement of between 38.2% to 88.6% of the price swing of the A to B upswing.
The C to D upswing and breakout is the last part of the butterfly pattern and is important for confirmation and completion. This harmonic pattern has close to a AB=CD price structure, but the C to D upswing frequently breaks out creating a 127%, 161.8%, or even a 224% price extension of the A to B upswing. Traders commonly use the point D price level at the end of the pattern to sell short seeing it as a good risk/reward ratio after the overbought move.
The Bearish Butterfly Pattern is a reversal chart pattern that can show technical traders a high probability price level to sell short at a very overbought reading after a long move and extension in price from the mean creates a high probability for a retracement and swing back down.