The stock market has a certain reputation. Stereotypically, it’s viewed as a place for businessmen instead of businesswomen, and in May 2018, the BBC did a story on the only full-time female floor trader to work on the New York Stock Exchange. Aside from that, the terminology around the stock market is often rather macho thanks to phrases like “bear market” and “bull market”. The butterfly trading pattern offers a bit of a break from all those other testosterone-laden symbols of Wall Street. Let’s take a closer look at this pattern and how it works.
Harmonic patterns and Fibonacci numbers
The butterfly pattern is what’s known as a harmonic pattern. Harmonic price patterns are more complicated than other geometric patterns like the triangle or flag. That’s largely because they mix geometry with Fibonacci numbers. You’re aware of geometry if you took high school math, but Fibonacci numbers aren’t as well known unless you hang out with either math or stock market enthusiasts.
Fibonacci numbers are what’s known as technical indicators. They were developed by Italian mathematician Leonardo Fibonacci during the Middle Ages, and the start of the Fibonacci sequence goes like this: 0, 1, 1, 2, 3, 5, 8, 13, 21. If you can’t recognize the pattern right away, that’s okay. Each number (starting after the first two) is created by adding the two previous numbers together. This sequence is important because they follow something called the golden ratio. The golden ratio is 1.618, so all numbers in the sequence are roughly 1.618 times the number before it.
That may feel like a lot of math, but the Fibonacci sequence gets easier the more you work with it. For now, know that stock traders are obsessed with the golden ratio and associated percentages, including 38.2 percent, 50 percent, and 61.8 percent.
The butterfly pattern
The math behind some of these patterns can get complicated, but the butterfly pattern is pretty easy to spot visually, because it looks like either a butterfly or two side-by-side triangles when you see it on a pricing chart. It also resembles another harmonic pattern known as the Gartley, which means you’ll sometimes hear it referred to as a Gartley butterfly. This is a reversal trading pattern, which means it helps you spot a trend that is reversing itself rather than a trend that is just going to continue the same way it’s already going.
Remember those golden ratios mentioned earlier? They’re going to appear on a butterfly pattern pricing chart. For instance, the ratio between point A and point B might be 0.382 or 0.618. The pricing points will go through retracements, or temporary reversals, before rising again, but one thing that stays consistent is those ratios. It can take some time to memorize the ratios, because this is intense stuff. If possible, find a local butterfly trading expert who can work with you to point out instances where the butterfly pattern shows up. This isn’t the kind of thing that’s easy for beginners to pick up right away, so don’t put too much pressure on yourself to understand it all right away. You wouldn’t expect yourself to speak fluent Spanish in the first month of a foreign language class, so give yourself a break with the butterfly pattern as well.
By the way, the butterfly pattern has nothing to do with the butterfly effect that you hear about in movies and books. The butterfly effect is about unpredictable outcomes, whereas the butterfly pattern is used to predict the stock market.
