Fractals Forex Trading Strategy.
Trading with fractals is extensively used by the large market players and it is the best indicator of the fractals’ reliability. The combinations of fractals have such characteristics as self-similarity, scaling and memory of the «entry conditions», and, therefore, they can be used successfully for making price forecasts.
The French economist and the mathematician, the creator of fractal geometry Benoit Mandelbrot was the first person who had paid attention to the repeating price formations. The analysis of the prices for cotton for the period of more than 100 years had led to the creation of the effective trade technique for the first time mentioned in the well-known «Trading chaos» by Bill Williams. It was Williams who for the first time suggested that the market was chaotic, multiple-factor and self-regulating system and cancelled all linear models.
How to use fractals in Forex.
Fractal links of exchange prices and the repeating structures have been confirmed by the results of computer modeling.
The fractal (fr om Latin fractus ) means a steady scalable design of irregular shape emerging on any data. The trade fractal in the financial market is the candle pattern formed by at least 5 (or more) candles, max/min of the central candle of which exceeds the extremes of the neighboring candles.
Emergence of fractals means the beginning of a new price pyramid and is considered as a trading signal.
A fractal up (or a signal to enter to buy) is the set in which (at least) 5 consecutive bars form a pattern, wh ere the highest maximum is shown by an average candle.
A fractal down (or a signal for position to sell) is the reverse pattern made up by five (or more) consecutive candles, the average from which shows the lowest minimum.
What is the fractal analysis and what’s its value?
The aim of such analysis is «to notice» in time and correctly to treat fractal designs in conjunction with other market data regardless of whether they are fundamental and technical, volume and temporary. The set of the real fractals is very dynamic. It can vary depending on quantity and structure. For instance, emergence of max/min for a fractal need not be consecutive. The main thing is that one of the central bars has to show an obvious extreme. Therefore, non-standard combinations can also be used as fractals:
If the extremes have appeared at several bars of a pattern, then only the last will be taken into account as a trading signal. Current price movement 1 point higher the level of the fractal up is the breakthrough of the sellers, while if it is 1 point below the fractal down, it is a breakthrough of the buyers. The approximate scheme of an entry is shown below.
The fractal’s emergence means the strong turning impulse confirmed by preliminary movement at formation of the pattern. The strongest signal is just after its emergence, and the same group of candles can be used both for upper and for the lower fractals. Pointers of the appeared fractals are not redrawn.
The border of the upper fractal is the maximum, while the border of the lower is the minimum. In this case of fractal’s trading there shall be an entry in a direction opposite to the created fractal, stop is 1-5 points higher/lower than the border of key bar. In case of formation of an opposite fractal, the current trading signal is cancelled.
Conditions of the fractal’s use in Forex trading.
The emergence of two multidirectional fractals close to each other (sometimes in one candle) is called a fractal start: further the market is assumed to make the decision for the benefit of one of the directions.
When carrying out the fractal analysis we pay attention to the standard factors:
The longer the period of formation of fractal structure, the more reliable the trading signal given by it. The less timeframe, the more ‘false’ fractals and breakdowns will appear. Sometimes the expectation of the moment when the ‘correct’ fractal is created, leads to the omission of the good point of entry. In case of the emergence of several multidirectional fractals at some level with the subsequent breakdown of the level it is possible to expect a strong and long trend in the direction of breakdown. The fractal represents the beginning (or the end) of some pulse movement and, therefore, it can quite be considered as a wave structure. It is possible to apply fractals in the wave analysis only on the periods from the D and above. In case of the determination of ‘validity’ of breakthrough of a fractal it is important to carry out correctly the analysis of the candle structure on which this fractal was formed. If closing of a breakthrough candle happens far beyond the accumulation level, then it is possible to open in the direction of breakthrough on a smaller timeframe. If the candle design represents the pivoting model, then with a high probability it is possible to expect the emergence of the return fractal and transition in flat.
The true breakdown of a fractal on any timeframe shall be confirmed by certain volumes. A firm breakthrough candle but with the small volume appears to be an unstable signal. Also for an assessment of volumes it is recommended to use standard designs of Price Action.
Nowadays nobody looks for the trading fractals on a price chart manually. For these purposes a standard package of any trade platform includes the Fractals indicator. We will offer two popular trading strategies on its basis.
Strategy Alligator + Fractal.
Regular Fractals and Alligator indicators with standard settings are necessary for using this strategy. We trade all major currency and future assets: for the analysis and an entrance - M15, for maintenance – from H1 above (for futures - from D1 above).
The entry scheme for fractals Forex trading is shown below. Stop losses are on an opposite extreme from 2 last fractals: purchase is below the lowest, sale is slightly higher than the highest. We hold the transaction until the return fractal has been formed. In a flat we ignore all fractals.
While making the fractal market analysis using this technique, it is necessary to remember that:
it is impossible to trade against the direction of the Alligator; the first fractal after the Alligator exit from hibernation is the warning signal; in case of a long narrow flat it is possible to put the pending orders beyond the borders of small fractals; the red Alligator’s line is the line of dynamic stop; in case of stop closure the following entrance will be only after emergence of the next fractal.
Williams fractals trading strategy without additional indicators.
Any currency asset of a middle volatility subject to steady trends is traded: EUR/USD, AUDUSD, GBP/USD. The period for the analysis and entry is D1. Stops and profits are usually not put, at the end they are closed manually.
If there is a fractal up it is a sale, in case of the lower fractal there is a purchase. It is possible to enter by a market order, and also by the pending orders:
purchase - BuyStop is 2-5 points higher than a max of the second candle following a key candle of a fractal; sale - SellStop is 2-5 points lower than a min of the second candle following the key candle.
Shortcoming: the considerable part of the main movement passes by in the expectation of the ‘correct’ fractal.
Fractal trading is only one of the evaluation methods of the market which is effective during the periods of a stable trend, while in a wide flat can be unprofitable. It is necessary to understand that the fractals trade strategies were initially developed for the stock market which was less volatile and more predicted. Unusual market situations arising in Forex often cause failure in calculation of fractals construction, and also emergence of ‘false’ or difficult for recognition signals. However, fractals in conjunction with the trend instruments represent the powerful tool of a technical analysis and can be the basis of constructing the steadily profitable system.
A Trader's Guide to Using Fractals.
Many people believe that the markets are random. In fact, one of the most prominent investing books out there is "A Random Walk Down Wall Street" (1973) by Burton G. Malkiel, who argues that throwing darts at a dartboard is likely to yield results similar to those achieved by a fund manager (and Malkiel does have many valid points).
However, many others argue that although prices may appear to be random, they do in fact follow a pattern in the form of trends. One of the most basic ways in which traders can determine such trends is through the use of fractals. Fractals essentially break down larger trends into extremely simple and predictable reversal patterns. This article will explain what fractals are and how you might apply them to your trading to enhance your profits.
[Fractals are just one of many ways to interpret a stock's price movements. Investopedia's Technical Analysis Course provides an in-depth overview of many popular methods of analyzing stocks using both chart patterns and technical indicators. With over five hours of on-demand video, you'll not only learn these techniques, but see how to put them into action.]
What Are Fractals?
When many people think of fractals in the mathematical sense, they think of chaos theory and abstract mathematics. While these concepts do apply to the market (it being a nonlinear, dynamic system), most traders refer to fractals in a more literal sense. That is, as recurring patterns that can predict reversals among larger, more chaotic price movements.
These basic fractals are composed of five or more bars. The rules for identifying fractals are as follows:
A bearish turning point occurs when there is a pattern with the highest high in the middle and two lower highs on each side. A bullish turning point occurs when there is a pattern with the lowest low in the middle and two higher lows on each side.
The fractals shown in Figure 1 are two examples of perfect patterns. Note that many other less perfect patterns can occur, but the basic pattern should remain intact for the fractal to be valid.
The obvious drawback here is that fractals are lagging indicators – that is, a fractal can't be drawn until we are two days into the reversal. While this may be true, most significant reversals last many more bars, so most of the trend will remain intact (as we will see in the example below).
Applying Fractals to Trading.
Like many trading indicators, fractals are best used in conjunction with other indicators or forms of analysis. Perhaps the most common confirmation indicator used with fractals is the "Alligator indicator," a tool that is created by using moving averages that factor in the use of fractal geometry. The standard rule states that all buy rules are only valid if below the "alligator's teeth" (the center average), and all sell rules are only valid if above the alligator's teeth.
Figure 2 is an example of such a setup:
As you can see, the primary drawback to this system is the large swings that take place. Notice, for example, that the latest fractal had a drawdown of over 100 pips and still has not hit an exit point. However, there are countless other techniques that can be applied in conjunction with fractals to produce profitable trading systems.
Figure 3 shows a forex trading setup that uses a combination of fractals (multiple time frames), Fibonacci-based moving averages (placed at 89, 144, 233, 377 and their inverses) and a momentum indicator. Let's look at a recent trade setup for the GBP/USD currency pair to see how fractals can help:
Here is a basic rule setup that is used when using a chart with a four-hour time frame:
Initiate a position when the price has hit the farthest Fibonacci band, but only after a daily (D1) fractal takes place. Exit a position after a daily (D1) fractal reversal takes place.
Notice how the fractals pinpoint meaningful tops and bottoms? This helps to take the guesswork out of deciding at which Fibonacci level to trade – all we have to do is check to see if the daily fractal occurred. We should also note that the trend strength began increasing at the sell fractal, and topped at the buy fractal. Although we lose some pips with the confirmation, it saves us from losing out on mere market noise – 139 pips certainly isn't bad for three days!
Here are a few things to remember when using fractals:
They are lagging indicators. They are best used as confirmation indicators to help confirm that a reversal did take place. Real-time tops and bottoms can be surmised with other techniques. The longer the time period (i. e. the number of bars required for a fractal), the more reliable the reversal. However, you should also remember that the longer the time period, the lower the number of signals generated. It is best to plot fractals in multiple time frames and use them in conjunction with one another. For example, only trade short-term fractals in the direction of the long-term ones. Along these same lines, long-term fractals are more reliable than short-term fractals. Always use fractals in conjunction with other indicators or systems. They work best as decision support tools, not as indicators on their own.
The Bottom Line.
As you can see, fractals can be extremely powerful tools when used in conjunction with other indicators and techniques, especially when used to confirm reversals. The most common usage is with the "Alligator indicator"; however, there are other uses too, as we've seen here. Overall, fractals make excellent decision support tools for any trading method.
These are the two main charting packages that contain fractals:
If you want to know more about chaos theory and its applications in the marketplace, an excellent book on the topic is "Profiting From Chaos" (1994) by Tonis Vaga.
Fractals in Forex Trading.
Fractals indicate natural resistance and support levels, which helps to identify good entry points and locate stop-loss points. Most importantly, fractals help me identify trends and ranges.
Fractals can be used effectively in forex trading, especially with the power of a mechanical trading system. Focusing on the EUR/USD and GBP/USD currency pairs gives the best results.
A fractal is a repetitive natural pattern.
A fractal is a geometric shape or set of self-similar mathematical patterns found in nature. When broken into smaller pieces, fractal shapes exhibit the same shape or characteristics of the larger object.
In nature, fractal shapes and patterns may be observed in things such as broccoli and many other types of plants, where the smallest florets still have the same overall shape as the largest “head” of broccoli. Likewise, many mineral and crystal forms exhibit similar patterns on both large and small scales.
Price movements in marketplaces are often thought to be random and chaotic. Yet, as with other seemingly-random forms found in nature, fractal patterns can be observed in price charts of forex pairs and other assets. Forex price movements show certain repetitive fractal patterns which can be profitably traded.
Fractals used in forex trading may show the same form at every size scale, or they may show nearly the same form at different scales. Stated simply, in forex trading a fractal is a detailed, self-similar pattern that repeats itself, often many times over.
It’s important to note that these fractal patterns aren’t the regular, geometrically-square figures found in man-made structures; they don’t have sides with even-integer factors. The distinguishing characteristic of fractals in forex trading and elsewhere is their natural organic scaling when contrasted with ordinary geometric figures.
For example, doubling the length of one side of an ordinary geometric square will scale the area of that figure by four, since the square has 2 sides, and 2 2 equals four. Or, when a geometric sphere’s radius is doubled, the volume scales to eight, because the sphere has three dimensions, and 2 3 = 8.
In contrast, when the one-dimensional lengths of a fractal are doubled, the space contained within that fractal scales up by a number that is not a whole integer.
Leaving aside the mathematical and technical description of fractals — In essence, I use them in forex trading so that my mechanical trading system can break down larger “cluttered” price movements into very simple and highly predictable views of trends and reversals.
Once these trends are visible, it’s easy for my automated trading system to take advantage of them. In particular, I’ve found that fractal signals based on smoothed moving averages (SMMAs) are very valuable for trading when I use them together with momentum indicators.
How do fractals help with forex trading?
Fractals predict reversals in current trends. When viewed as a set of price bars on a chart, the most basic fractal pattern contains five bars or candlesticks with these characteristics:
1. When the lowest bar is positioned at the middle of a pattern, and two bars that have successively higher lows are located on each side of it, this signals the change from a downward trend to an upward trend;
2. When the highest bar is positioned at the middle of a pattern, and two bars that have successively lower highs are located on each side of it, this signals the change from an upward trend to a downward trend;
Stated differently, when the forex fractal pattern shows the highest high at the center, and there are 2 lower highs positioned at each side, it signals a bearish turning point. And, when the pattern has the lowest low at the center, and there are 2 higher lows positioned at each side, it signals a bullish turning point.
Fractals are lagging indicators, so a mechanical trading system can’t act on them until they’re a couple of bars into the reversal. Still, since most of the significant reversals last for multiple bars, the trend usually continues long enough for me to trade it.
Fractals work best for forex trading when used together with a momentum indicator. Along with fractal indicators, I also use an oscillator such as the CCI indicator to facilitate entering a forex trading position as early and safely as I can.
Fractal Alligator indicators.
My favorite fractal tool is the “Alligator indicator,” which is a moving-average tool that relies on fractal geometry and SMMAs. This indicator with a fancy name was introduced by senior trader Bill Williams around 1995, and it’s commonly available in MetaTrader software.
If you’re using MetaTrader, you should be able to easily add this fractal indicator by clicking on the menu tabs “Insert,” then “Indicators,” “Bill Williams,” and “Fractals.”
Alligator indicator lines confirm the direction and presence of a trend. Specifically, the Alligator indicator consists of 3 smoothed moving averages. Overlaid on pricing charts, these balance lines represent the metaphorical “jaw,” “teeth” and “lips” of the Alligator.
Carrying the metaphor further, it can be said that when the 3 balance lines are intertwined or converged, the Alligator is asleep with its mouth is closed. This indicates that particular forex market is trading in a sideways range.
Once a trend forms, the Alligator awakens and it begins to “eat.” The Alligator isn’t a picky eater; it can feast on either a bull or a bear. Once satisfied, the Alligator’s mouth closes and the creature returns to sleep.
The Alligator fractal indicator shows trends in the following way: When the price is trading above the mouth of the Alligator, i. e. the green balance line is over the red line which is over the blue line, and all three are aligned and pointing upward, yet still below the price line, this indicator signals a clear uptrend.
Conversely, when the price moves below the Alligator’s mouth, and the blue line is over the red line which is over the green one, and all three of the balance lines are above the price line, then the indicator signals a downtrend.
Finally, once the fractal forex trading Alligator has sated itself, the green, red and blue balance lines once again converge and cross over, signaling the end of the trend. At that point, my mechanical trading system takes profits, and then begins to watch for the next fractal forex trading opportunity.
In short, my mechanical trading system filters fractal signals by stating that the buy rules are confirmed only if they signal a value below the “alligator’s teeth” in the pattern, which means the center average.
Likewise, my sell rules are only confirmed if they signal above the alligator’s teeth. As well, I double-confirm the validity of Alligator signals by using the CCI oscillator.
The fractal Alligator formula.
The Alligator’s jaw, often depicted as a blue line, shows a Smoothed Moving Average containing 13 periods; this line is then moved 8 bars into the future;
The teeth, depicted with a red line, shows a Smoothed Moving Average containing 8 periods, moved 5 bars into the future;
The lips, depicted as a green line, shows a Smoothed Moving Average containing 5 periods, moved 3 bars into the future.
To reiterate, when the red and green balance lines cross over the blue line, it signals my mechanical trading system to “sell.” Conversely, when the red and green lines cross under the blue line, it signals a “buy.”
For purposes of programming a mechanical trading system for fractal forex trading:
n is the number of periods High(n) is the highest price during period n Low(n) is the lowest price during period n SMMA(ABC) is a Smoothed Moving Average in which A is the data being smoothed, B is the period being smoothed, and C is the shift in time-period.
The mechanical trading system calculates the balance lines:
[Low(n) + High(n)] / 2 SMMA (Median price n, 13, 8) = Alligator jaw (the blue line) SMM (Median price n, 8, 5) = Alligator teeth (the red line) SMM (Median price n, 5, 3) = Alligator lips (the green line)
Forex markets show many false trends. That is, often a “trend” may appear to begin, yet the price action soon settles back into a sideways range.
When using fractals, my strategy correctly identifies real trends and then follows them. Fractal forex tools such as the Alligator help my mechanical trading system reach through price clutter and focus on finding and trading the real trends.
My fractal trading method based on Alligator indicators.
Here’s the simplest form of my fractal trading system based on Alligator indicators:
• Determine the entry point according to when the Alligator balance lines are intertwined, i. e. the Alligator is “sleeping” and when the CCI oscillator is indicating an overbought price condition;
• Execute new orders with 2% of the account equity;
• Places a stop-loss order at exactly 20 pips below the entry point;
• Sets an exit order to be triggered when more than two of the Alligator balance lines cross the candlesticks and/or when the CCI oscillator indicates an overbought condition.
Other ways to use fractals.
Fractals are an easy way to see or confirm trends on any time frame. I program my mechanical trading system to check and see whether the fractals are showing lower lows and lower highs, or higher highs and higher lows. For my typical forex trading, I use fractals based on one-day, one-week, and one-month time frames.
The longer the time frame used to generate the fractal, the greater the reliability of the signals it produces. Also, the longer the time frame, the fewer the signals.
Also, I program my mechanical trading system to calculate fractals in order to set trailing stops. Since fractals show changes in trends, they work well to trigger my mechanical trading system to exit from trades when very-short-term reversals threaten to eat up the profits from a trade.
Trading with fractals and Fibonaccis.
Beyond using the fractal Alligator indicator, fractal tools offer a great way to confirm Fibonacci signals. I’ve found that fractal forex trading works well when used for Fibonacci retracement levels.
I program my mechanical trading system to draw Fibonacci bands and calculate the fractals using daily time frames in forex markets such as EUR/USD and GBP/USD.
Then, I open a position when the price touches the most-distant Fibonacci band, yet only after my mechanical trading system sees that a daily (D1) fractal signal has occurred. The mechanical trading system exits the trade when a D1 fractal reversal occurs.
When using Fibonacci tools, fractals help pinpoint tops and bottoms with great accuracy. This gives me the confidence to trade at the right Fibonacci level. It’s easy – My mechanical trading system simply looks for the daily fractal parameter.
General considerations when using fractals.
In order to double-check the signals generated from fractal indicators, my mechanical trading system uses other indicators such as the CCI oscillator to confirm fractal signals before trading. And, as with any type of trading method, use appropriate risk management measures to ensure that drawdowns are reasonable.
Fractals can be plotted in multiple time frames and used to confirm each other. One simple rule is to only trade short-term fractal signals in the direction of long-term fractal signals, since long-term fractals are the most reliable. Use another indicator for safety such as the CCI oscillator to confirm the signal.
The Alligator and other fractal tools help.
Fractals offer a set of powerful tools that you can use to strengthen your profits. Since mechanical trading systems are able to calculate fractal values and act on them quickly, there are plenty of fractal-based trading opportunities.
My own personal favorite is the Alligator indicator, yet fractals also work well with Fibonacci indicators and other trading strategies. In fact, fractal tools enjoy a relatively small yet devoted following among successful traders.
There are plenty of articles about fractals, as well as trader discussions about the basis for fractal forex trading success if you’d like to explore the topic further.
How do you use fractals in your trading? Share your thoughts on fractals below.
Shaun, I am a little confused over the entry rules.
If I use an example for a LONG trade is this right ………
Use the daily chart.
Wait for the 5 MA to cross the 8MA and the 8MA to cross the 13 MA.
See that the cross of the alligator happens after the pivot (pivot low) which would be at least 2 bars later.
Check that CCI (Using a 20 period CCI) has moved from oversold back up indicating momentum is towards the long side.
Enter on the close of the bar where the 8MA crosses over the 13MA.
Forex Fractals trading strategy.
Forex Fractals is an indicator used in the Forex technical analysis. It shows the highest high and lowest low of price movement on a chart. Fractals in Forex provide free Forex trading signals.
Description of Fractals.
Image 1. Mandelbrot's Fractal.
Forex Fractals represent the pattern reflected in the form of house above or under a candle. They are formed by the combination of five Japanese candles (bars). Upon that, a median candle must have the highest (among the High) High or the lowest (among the Low) Low against two neighbor candles to the right and two candles to the left (Img. 2).
Image 2. Fractals Indicators.
Bill Williams is considered to be an author of the Forex Fractals. He mentioned that there are some variations of this indicator, for example, that it is possible to set more or less than five candles. Highs (or Lows) of bars must not necessarily descend from the central by degrees, but can simply be below (or above). If Highs (or Lows) of two (central and right) bars are equal, then the right High (or Low) is not taken into account.
Application of Forex Fractal Trading Strategy.
Forex Fractals show Low and High of the price on a chart and is applied in a "breaking" strategy when the price leaves frames of Fractal. In order to get trading signals, Forex Fractals trading system as a rule should be combined with Alligator Indicator which was also developed by Bill Williams. Here are the basic rules according to his theory:
Fractals is effective as Forex signals, if they are formed beyond Alligator's jaws.
A Forex signal for buying is the Fractal formed above “Alligator's teeth”, exit should be made according to the price of the highest maximum of five previous bars (Img. 3)
Image 3. Fractals Indicators, the Forex signal for buying.
Image 4. Fractals Indicators, the Forex signal for sale.
While trading with Fractals, a trader should take into account the following factors:
Fractals provide free anticipating signals in Forex;
A trader always should open a position towards the Fractal;
Fractal Forex trading system gives just a signal to enter the market, therefore, a trader needs to wait for its confirmation, using other methods of technical analysis;
A trader using the Fractal Indicator strategy, should remember that Fractals are not used to define points for leaving the market.
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