While prices appear random, they follow predictable patterns and trends. A fractal is one of the most fundamental repeating patterns. Fractals are simple reversal patterns comprised of five bars. This post will discuss fractals and how they can be used to improve your trading strategy.
Fractals: An Introduction
When people hear the term “fractal,” they frequently conjure up images of intricate mathematics. That is not the case here. Fractals are also used to describe a regular pattern that occurs in more chaotic price changes.
Fractals are made up of at least five bars. The following rules apply for identifying fractals:
- A bearish turning point happens when a pattern with the highest high in the middle and two lower highs on either side arises.
- A bullish turning point happens when a pattern is produced with the lowest low in the middle and two higher lows on either side.
Two instances of perfect patterns are the fractals displayed above. It should be noted that many other less perfect patterns can exist. But this basic pattern must be preserved for the fractal to be genuine. The clear disadvantage, in this case, is that fractals are lagging indicators. We won’t be able to draw a fractal until the reversal has lasted two days. Most significant reversals will persist for adding bars, favoring the trader. When the pattern appears, the price’s likely to climb following a bullish fractal or decrease following a bearish fractal.
The formula for the Fractal Indicator
The formula for the fractal indicator comprises multiple if statements.
How is the Fractal Indicator Calculated?
Calculating fractals is more visual than mathematical.
- Select a high/low (N) point on the chart.
- A pattern exists if there are two lower highs or two higher lows (N-2 and N-1) to the left of the high. Two more bars on the right will confirm the pattern.
- A bearish fractal (N+1 and N+2) is complete if two lower highs occur after the high. A bullish fractal is absolute if two higher lows occur.
Bill Williams’ Fractal Trading Strategy Indicators
You may now use a trading indicator to locate fractals instead of manually searching for the pattern in the chart. Bill Williams, a stock, commodity, and currency chart expert created a fractal indicator to detect fractal patterns in price charts. He also invented the Accelerator/Decelerator Oscillator, Alligator, Awesome Oscillator, Gator Oscillator, and Market Facilitation, among other brilliant indicators. Bill’s fractal indicator is also available on various trading platforms, including the well-known MetaTrader 4. Simply drag the indicator onto the chart, and the software will highlight all fractal patterns for you.
The indicator simply shows an arrow above or below the fractal pattern’s middle candlestick, indicating swing lows and swing highs in the market:
- A green arrow pointing upwards indicates a fractal swing high, positioned above the middle candlestick in a fractal pattern that must have at least five candlesticks. The pattern’s low may signal a potential support level.
- A fractal swing low is depicted by a red arrow pointing downwards below the middle candlestick, with the middle candlestick being the pattern’s lowest point. In this situation, the pattern’s peak may signal resistance.
How Do You Use Fractal in a Trading Strategy?
In addition to the fractal indicator, we’ll employ the alligator indicator, which comprises three Moving Averages that serve diverse purposes:
- The Jaw is played by 13-MA.
- The 8-MA serves as the teeth.
- The 5-MA serves as the lips.
To use fractal and alligator indicators, apply both indicators first to your charts. After application, your chart should resemble this:
Fractal Indicator and Chart Patterns: What’s the Difference?
The fractal indicator is unusual: it recognizes and marks a price pattern on the chart. Fractals are five-bar patterns with particular properties. Chart patterns, which are not limited to five price bars, can also be drawn on the chart. Triangles, rectangles, and wedges are just a few of the shapes that can be seen in chart patterns. While some tools can mark chart patterns on a chart, most chartists locate and isolate chart patterns by hand.
Advantages and Disadvantages of Indicators
Indicators like the fractal indicator provide traders with easy-to-see market entry objectives (at the close of the fifth candlestick in the pattern), such as stop-loss price points. A trader selling short a bearish fractal pattern may set a stop-loss order right above the fractal pattern’s highest high. In a bullish fractal pattern, a trader buys at the fifth candlestick’s close and places their stop-loss order right below the fractal’s lowest low.
The fact that fractal patterns frequently appear in price action movement means that the indicator is prone to give traders misleading signals. Few traders rely solely on the fractal indicator for trading signals rather than in combination with other technical indicators.
Another disadvantage of using the fractal pattern for trading is that it presents less-than-ideal market entry points. Initiating a buy trade at the close of the fifth candlestick in a bullish fractal pattern, for example, might result in a trader buying into the market at a far higher price level than the market low. Furthermore, placing a stop-loss order below the fractal pattern’s low point may result in a high potential loss.
Additional Considerations Regarding the Use of Fractals
Here are a few things to keep in mind when working with fractals:
- They are considered to be lagging indicators.
- Because fractals are so frequent, they work the best in conjunction with other indicators or strategies. They should not be used in isolation.
- The longer the chart’s period, the more trustworthy the reversal. It’s also worth noting that the longer the period, the fewer signals are generated.
- Plotting fractals in many time frames are recommended. Only trade short-term fractals in the direction of long-term ones, for example. During higher uptrends, focus on long trade signals, while during larger downtrends, focus on short trade signals.
- Fractals are now included in the indicator list on most charting platforms.
These easy fractal trading strategies should point you in the right direction if you’ve been looking for a great strategy to apply with these indicators. You can use a combination of strategies with these indicators and try this one with the Bill Williams indicators. The fractals can be beneficial when combined with other indicators and strategies. Many people believe that every indicator is lagging, and the profitable entries are rare. The Fractal Trading Strategy applies a mix of price action and other indicators to supplement these powerful indicators.