Chart patterns are among the most important tools we can use to guess the next direction of markets, take a position and make some money. So far, I have talked about Triangles, Wedges, Flags, Pennants, Rectangles, Head and Shoulders, and Cup and Handle patterns. In this article, I will talk about some other kinds of patterns that are very important in predicting the market’s direction, specially when there is a possibility that the market changes its direction.
What Are Butterfly and Bat Patterns?
Butterfly and Bat patterns are also known as Harmonic patterns. Butterfly pattern, which is also known as W pattern, is an important reversal pattern that usually forms at the top of an uptrend. Of course, you have to notice that this pattern doesn’t always cause the market to reverse, and sometimes the trend will be continued after that. I will tell you what to do to stay away from taking wrong positions.
Bat pattern is so similar to Butterfly pattern. It is a reversal pattern too. In fact, Butterfly and Bat patterns are almost the same, but just their shape is a little different. Sometimes, it becomes hard to say if the pattern is a bat or butterfly pattern, but this doesn’t matter at all. The only thing we have to learn very well is that we understand that the market is going to go an indecision status for a while and it is possible that it reverses, so that we take a position and make some money.
Experience shows that Bat Pattern usually forms at the bottom of downtrends, but Butterfly pattern forms at the top of uptrends. Bat Pattern looks like a capital M, whereas Butterfly Pattern looks like a capital W.
Please let me show you some examples and then I will tell you how you can trade using these patterns.
This is a beautiful Butterfly Pattern formed at the top of a strong uptrend on GBP/USD daily chart:
And this is another Butterfly Pattern on the same chart:
And this is another Butterfly Pattern formed on EUR/USD four hours chart:
This is a Bat Pattern formed at the bottom of a downtrend on EUR/USD four hours chart. As you see, it really looks like a Bat and also capital M. Also, you can see that the downtrend reverses and goes up very strongly after this Bat Pattern:
How to Trade Butterfly or Bat Patterns?
Like all the other patterns, these patterns also have support and resistance lines. My strategy for trading these patterns is the same as my trading strategy with the other patterns. I consider the rules, but I always wait for a breakout. This is what I have always emphasized on.
For example, although it is said that Butterfly and Bat patterns are reversal patterns, I do not go against the trend when I see that these patterns are formed at the top of an uptrend. I wait for the market to break below a support line and then I go short.
Here below I am showing you an example. As you see, a strong Butterfly Pattern is formed on EUR/USD four hours chart, and finally it worked strongly as a reversal pattern and the price went down. However, in order to go short, we had to wait for the market to go down and break below the Butterfly support. The breakout occurs when a candlestick closes below the support line or above the resistance. The stop loss has to be placed above the candlestick which has broken below the support:
This is another example:
In case of a Bat Pattern that forms at the bottom of a downtrend, we have to wait for a resistance breakout to go long:
The same Bat Pattern resistance breakout in more details:
Like all other patterns, there will be cases that Butterfly and Bat Patterns cannot make the market reverse. So you have to be always careful and have a reasonable stop loss to get out if the trade setup doesn’t work as you expect it to. Also don’t forget to move your stop loss to breakeven if the market moves toward the target at least x1 or x2 of your stop loss size.
How Far Does the Price Move After a Butterfly or Bat Pattern Breakout?
I’ve already showed you some analysis about the size and direction of the market movement, in my Triangles, Head and Shoulders, and specially in my Cup and Handle articles. There are some methods to predict the size of the market movement after Butterfly and Bat Pattern breakouts too. However, I prefer not to talk about them here because experience shows that these techniques are not reliable in case of Butterfly and Bat patterns. I do not want to make your trading too complicated with these techniques.
The truth that you should never forget is that, markets pay no attention to our analysis. They move on their own way. All we can do is that we locate the trade setups, take the positions, set the stop loss and target orders, and then wait to see what will happen.
Therefore, like all the other patterns, in case of Butterfly and Bat Patterns’ breakouts, I recommend you to set a reasonable stop loss as it was instructed above, and set a target order which is at least x3 of your stop loss size. An optimum and proper entry helps you have a reasonable stop loss which is not too wide. So your target will not be too wide too, and can be hit by the price easily. Also, don’t forget to move your stop loss to breakeven when it is the time to.
