Fractals

Fractals

Fractals

Some people believe that markets are random. However, others argue that although prices may appear to be random, they 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. Although it can seem like some complicated and abstract mathematical term, fractals have a very real application in trading: they break down bigger trends into simple reversal patterns. In this article we will explain what fractals actually are and how you can use them to improve your trading success. Stay with us!

Fractals | Definition

Fractals are basically recurring patterns that can predict reversals among larger, more chaotic price movements. Basic fractals are composed of five or more bars and there are some rules for identifying them. A bearish turning points occurs when there’s a pattern with the highest high the middle and two lower highs on each side. On the other hand, a bullish turning point occurs when there’s a pattern with the lowest low in the middle and two higher lows on each side. It’s important to know that the fractals are lagging indicators. In other words, it cannot be drawn until we are about two days into the reversal.

Fractals | How to Use Them

Like other trading indicators, these tools are best used in combination with other indicators or forms of analysis. You can combine them with Oscillators or Fibonacci Numbers, for example. They are also commonly used with moving averages when they form the so-called Alligator indicator. The rule is that all buy rules are only valid if below the „Alligator’s teeth“ (the center average), and all sell rules are valid only if above the teeth.

Even though they are quite simple to use, there are still some things every trader should be aware of when using fractals. Firstly, as they are lagging indicators, they are best used to confirm that a reversal took place. Secondly, the longer the time period, the more reliable the reversal becomes because you have more data to work with and you can see the pattern more clearly. Also, it is always useful to plot them in multiple time frames and use them in conjunction with one another.

Fractals | Conclusion

As you can see, fractals can be very powerful tools, especially if they are combined with other indicators and techniques. For example, you can use them with moving averages to form the so called Alligator indicator, or with Fibonacci numbers. Always keep in mind that they are more reliable if your time period is longer, but don’t use just them and only them in your analysis. Perhaps the best way to use them is if you’re looking for a confirmation that a trend reversal took place. Then you can rely on them with a fairly high degree of certainty, but remember to take a sufficiently big time span into consideration.

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FURTHER READING:

1. Patterns of Investment Strategy and Behavior Among Individual Investors (Wilbur G. Lewellen, Ronald C. Lease and Gary G. Schlarbaum-1977)
2. The Ascent Of Money: A Financial History Of The World (N. Ferguson, 2008)
3. Responsible Excellence Pays! (Fussler, Claude-2004)
4. A Random Walk Down Wall Street (B. Malkiel, 1999)
5. Market Wizards (J. D. Schwager, 1989)

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Author: Ben Prescott
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