Bulkowski's Bullish Butterfly

Written by and copyright © 2005-2018 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information.

WARNING: I believe this article contains incorrect information (the ratios are wrong, for example). I'll correct it as soon as I finish new research. Posted 1/18/2018

This butterfly pattern has nothing to do with options. The bullish butterfly pattern was coined by Larry Pesavento, if you believe the Internet. It's a variation of the Gartley (or Gartley 222) chart pattern. I review it here.

Important Results Identification Guidelines Trading Tips Testing Methodology Performance Statistics Trading Example See Also

Bullish Butterfly

Bullish Butterfly Identification Guidelines

See the below figure. It's called a butterfly because if you connect XB and BD with lines, it looks like the wings of a butterfly.

I did not find any sources that identified how the pattern is constructed except to say that the AD move (not CD) should be longer than XA by 1.272 to 1.618 times. However, they hinted that it's a bullish Gartley with a long move (AD), using similar Fibonacci ratios. I assumed the ratios of the Butterfly were the same as the Gartley, but that could be wrong. I tested a loose version of the butterfly with more relaxed ratios as well as the strict variation.

Characteristic Discussion XA Price rises from X (see figure on the right, not drawn to scale) to peak at A. This is typically a large upward move to accommodate the retraces that follow. AB Price retraces from peak A to valley B. The retrace should be near 61.8% of the XA move. For testing, I used a range of 61% to 62.6% (0.8 around 61.8%) BC After bottoming at B, price climbs to C. The BC move retraces between 61.8% to 78.6% of the AB drop. For testing, I chose to interpret this as a range of acceptable values. CD and AD The final leg of the pattern sees price drop from peak C to the valley at D. The AD move is sometimes 127% or 161.8% of the XA move. Rise Point D must be below X.

The Bullish Butterfly Retraces

Bullish Butterfly Trading Tips

Trading Tactic Explanation Buy Once price turns at D, buy. AD should be 1.27 or 1.62 times as long as XA. Be flexible since this will rarely occur. Stop I chose a close below D as the stop location. Measure Rule The target price zone is between valley X and peak A. The associated figure shows how often price reaches those targets. For an explanation of the measure rule, refer to the figure on the right. I tested the pattern and measured the rise from the low at D to either a 20% trend change (price drops 20% from a peak) or drops below D. I found that 94% of the patterns I looked at reached X, 42% made it to A, 64% made it to B, and 45% reached C. Six percent failed to reach X (the start of the X-A target area).

The Measure Rule

Notice that many of the patterns stop in what's called the corrective phase of the measured move down (BC). This is a congestion region that often stops price. See "Completion" in the trading tactics table of the measured move down for more information.

Bullish Butterfly Testing Methodology

To test the performance of the bullish Butterfly, I programmed my computer to find all peaks and valleys within 5 days. In other words, I looked for the highest high (peak) from 5 days before to 5 days after (11 days total) the peak. I did the same for valleys.

Then it was just a matter of finding turns that fit the Butterfly profile.

Since finding an AB retrace of exactly 61.8% would make the pattern too rare, I used a range of 61% to 62.6% (that is, plus or minus 0.8 around the 61.8% value).

Using daily price data from January 1990 to April 1, 2013, I found 104 stocks with butterflies (but I used over 1,000 stocks in the search). That gave me 110 individual patterns.

I did not split performance into bull or bear markets.

Bullish Butterfly Performance Statistics

I show the "strict" butterfly retraces in the figure for reference. The loose interpretation allows more flexibility in the ratios. AB retrace of XA for the strict version is 61% to 62.6%. The loose version uses a range of 50% to 78.6%. The BC/AB retrace widens to 50% - 78.6%, too. For both the strict and loose versions, AD (not CD) must be at least as long as XA.

I show the performance results of tests on both types in Table 1.

The table shows how often price, after turning at D, reaches X, A, B, and C for the strict and loose interpretations (the "measure rule" lines). The numbers are similar with the strict interpretation outperforming the loose variation.

Failures differed slightly. The break even failure rate represents moves up from D that fail to rise at least 5% before dropping. This is different than the 6% that fail to reach X.

Bullish Butterfly Trading Example

Let's take a look at a trading example.

I show the Butterfly on the daily chart of Arch Capital. X is at 11.83, A is at 13.38, B is at 12.43, C is 13.04 and D is 11.67.

The AB retrace of XA is 61%. The BC/AB climb is 64%. The AD/XA move is 110%, below the low end of the 127% to 161.8% range (which I felt is fine as long as it's more than 100%.

After D, the stock moved up and rounded over but not shown is that the gain before it collapsed was 130% (at the "ultimate high," see the glossary).

-- Thomas Bulkowski

Written by and copyright © 2005-2018 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Disk space: The final frontier!