Fractal Indicator: Finding Turning Points In Forex Trends – Fractals can be found all around us, both in the natural environment and in the financial markets. Here we present the concept of fractals and their practical applications in the world of trading. You will learn how to recognize a basic fractal pattern on a price chart and how to combine it with specific technical tools to build a consistent trading strategy.
Fractals are self-similar patterns that repeat at varying degrees of scale. The fractal was discovered in 1975 by Benoit Mandelbrot, a famous mathematician working at IBM. A fractal can be thought of as irregular geometric shapes that have recursive properties and can last indefinitely.
Fractal Indicator: Finding Turning Points In Forex Trends
In the natural world, we can see examples of fractals all around us. For example, trees, shells, fern leaves, sunflowers, and even galaxies have fractal characteristics. Fractals cannot be explained using traditional Euclidean models. This means that irregularities in fractal structures cannot be measured by linear mathematical models. Let’s look at an example of a fractal in our natural universe. Below you will find a photo of the tree.
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Notice how each branch, starting from the trunk of the tree, branches out into smaller and smaller branches. Each extension or branch is similar in appearance to its larger structure. Note the recursive process as larger branches lead to smaller and smaller branches that are similar in appearance.
And another example? Look at the fern leaf below. Can you see how each leaf is made up of many other smaller leaves? Additionally, note that each smaller leaf has similar visual characteristics to its larger leaf.
They are similar in shape and appearance, however, they represent different scales in the larger fern leaf. Larger leaves lead to smaller leaves, which in turn lead to even smaller leaves. All of which have self-similar characteristics on ever-smaller scales.
Financial markets operate within fractals. If you view the chart on a five-minute timeframe, an hourly timeframe, a daily timeframe or a weekly timeframe, you won’t be able to tell one from the other. This means that the price action on the charts has fractal characteristics as we can see self-similar patterns at different time frequencies.
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Fractal market theory provides an explanation of market movements through the lens of fractal geometry. In short, it provides insight into the financial markets as consisting of recursive geometric patterns that occur from the highest degree of trend to the smallest degree of trend.
This is in line with technical analysis tenants who say all public market information is digested as part of price action. As such, the best form of market analysis is based on a thorough understanding of the recurring price patterns that form in all markets and on all time frames. The basic concept is that price movements in liquid, freely traded markets create patterns that repeat continuously.
Now, while there is obvious market cyclicality, the periodicity and amplitude seen in price structures can vary greatly. This makes fractal app-based market analysis a bit tricky, but not entirely elusive. A trained analyst can, by carefully studying price action patterns, cycles and chaos theory, gain a deeper understanding and advantage regarding trading the markets.
Fractal market analysis aims to discover and exploit the seemingly random nature of price movements to the advantage of financial speculation. Thus, in a sense, the market must be seen as a non-linear system where there is a higher hidden order that is hidden in the seemingly random market movements.
Williams Fractal Indicator: Full Guide
Now let’s start moving from theory to practical application. Many practical applications of market fractals were developed and popularized by Bill Williams. He is a leading expert in market fractals and chaos theory. He is the author of the book “Trading Chaos”, in which he describes the fractal pattern in detail. Basically, the market fractal is the basic building block of up and down price movements in the market. Let’s take a look at up and down fractal patterns.
The fractal consists of five bars. In an upward fractal, the middle bar will have a higher maximum than both bars on either side of it. Similarly, in a downward fractal, the middle bar will have lower lows than both bars on either side of it. Below you can see the up and down fractal structure. Upward fractals are also referred to as bearish fractals and downward fractals are also referred to as bullish fractals. They are referred to as such because an upward fractal has a bearish implication while a downward fractal has a bullish implication.
Notice in the illustration above that the middle bar in the upward fractal has the highest peak of the entire five-bar structure, and that each of the two bars preceding and following it has a lower peak. This creates a level of resistance in the market and the price is expected to continue falling until the next downtrend fractal in the market.
On the other hand, if you refer to the middle bar within the fractal downwards, you will see that it has the lowest lows of the entire five-bar structure, and that each of the two bars immediately before and after it has higher lows. This creates a level of support in the market and the expectation that the price will go up until the next fractal in the price action.
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As you can see, the structure and implications of market fractals are quite easy to understand. We can build many different rules and trading models around the concept of fractals that can help us in our decision-making process.
Today, most trading apps include the fractal indicator as described above as a default study in their indicator library. As a result, you can simply apply the fractal indicator to your charts. This should automatically print the notation each time the fractal is completed. Most fractal indicators will mark the middle bar of a fractal trading pattern after completing the fifth and final bar in the fractal pattern.
You should now have a pretty good understanding of the theory behind fractals and the proper fractal formation as seen in the price chart. There are many ways to use the fractal indicator as part of our overall trading program. We will look at the fractal based trading strategy in the following, but for now we just want to outline some of the basic ways to use the fractal indicator.
The fractal indicator can help you assess the potential direction of price movement. For example, if a downward fractal has recently appeared on the price chart and the overall trend is higher, we can reasonably expect the price to move higher. By the same token, if an upward fractal has recently been broken by a new price leg that is moving higher, then an upward breakout may indicate that there may be a continuation of higher price momentum.
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Another practical application of the fractal indicator is to use it to build trend lines and parallel channels. Most technical analysts do not have clear rules for constructing diagonal support and resistance lines. Instead, they usually use very loose guidelines when drawing trend lines and channels. This can result in a very random process where a distinct edge is missing. Fractal indicators are great for drawing objective trend lines based on market support and resistance levels.
The same can be said about drawing channels. For example, you can draw an upward sloping trendline by connecting fractals down below price action. Similarly, you can draw a clear downward trendline by connecting upward fractals above price action. This removes most of the discretion associated with trendline analysis and more importantly allows you to plot the most appropriate diagonal support and resistance levels.
Fractals can also be used in the trade management process. We know that an upward fractal can serve as resistance during an uptrend and a downward fractal can serve as support during a downturn. As such, we can use these important market levels to place stoploss or take profit orders. These are just a few uses of the fractal indicator, but they should certainly give you some ideas to start thinking about.
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The alligator indicator is a complementary study that works well in conjunction with the fractal indicator. The alligator indicator was also created by Bill Williams. It basically consists of three lines, called jaw, teeth and lips. It helps in identifying the trend and potential future movement
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