A Trader’s Guide to Using Fractals

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A Trader’s Guide to Using Fractals

Prices, although seeming to be random, generate recurrent patterns and trends. Afractal is one of the most fundamental repeating patterns. Fractals are five-barrel reversal patterns. This article will describe fractals and how they may be used in your trading strategy.

Key Takeaways

  • The fractal markets theory examines the market’s daily unpredictability using technical analysis and candlestick charting.
  • It investigates investor horizons, the importance of liquidity, and the influence of information throughout the course of an economic cycle.
  • When investors with diverse investment horizons have access to the same information, the market is deemed stable.
  • When investing methods converge to shorter time horizons, crashes and crises occur.

Introduction to Fractals

When most people hear the term “fractal,” they immediately think of intricate mathematics. That is not what we are discussing about. Fractals are also a recurrent pattern that appears in the midst of broader, more chaotic price changes.

Fractals are made up of at least five bars. The following are the guidelines for recognizing fractals:

  • When there is a pattern with the highest high in the center and two lower highs on either side, this indicates a bearish turning point.
  • When there is a pattern with the lowest low in the center and two higher lows on either side, this is referred to be a bullish turning point.

Two instances of perfect patterns are provided below in the form of fractals. Many other less perfect patterns may arise, but this core pattern must be preserved for the fractal to be genuine.

Image by Julie Bang © Investopedia2020

The clear disadvantage in this case is that fractals are lagging indicators. Afractals cannot be drawn until the reversal has lasted two days. Most strong reversals, on the other hand, will persist for longer bars, favoring the trader. When the pattern appears, the price is likely to climb after a bullish fractal or decrease after a bearish fractal.

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Applying Fractals to Trading

Fractals are currently available as a trading indication on the majority of charting systems. This eliminates the need for traders to look for the pattern. When you apply the indicator to a chart, the program will highlight all of the patterns. Traders will immediately see a problem: this pattern happens regularly.

Fractals work best when combined with other indicators or types of analysis. The Alligator is a popular confirmation sign when working with fractals. It is a technique that was built by combining numerous moving averages. The chart below shows a long-term increase with the price mostly above the alligator’s fangs (middle moving average).Bullish signals might be utilized to produce purchase signals since the trend is up.

A bearish fractal, albeit relatively perplexing, is often depicted on a chart with an up arrow above it. A down arrow is drawn underneath bullish fractals. As a result, when employing fractals in an overall rise, seek for down fractalarrows (if using a fractal indicator provided in most charting platforms).Look for up fractal arrows while seeking for bearish fractals to trade in a bigger decline.

Switching to a larger time frame may limit the quantity of fractal signals, giving the chart a cleaner appearance and making it simpler to find trade opportunities.

This method gives entry, but it is the trader’s responsibility to manage risk. In the preceding example, the pattern is not identified until the price has begun to increase from a recent low. As a result, after a trade is entered, a stop loss might be put below a recent low. A stop loss might be put above the recent high if going short during a downturn. This is only one example of where a stop loss should be placed.

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Another approach is to use fractals with Fibonacci retracement levels. One of the difficulties with fractals is deciding which of the events to trade. One of the issues with Fibonacciretracement levels is determining which retracement level to utilize. By combining the two, the choices are narrowed since a Fibonacci level will only be traded if a fractal reversal happens off that level.

Traders also like to concentrate on trading at certain Fibonacci ratios. This may differ from trader to trader, but suppose a trader chooses to take long bets during a greater rise when the price drops down to the 61.8% retracement level. Fractals might be included into the system, with the trader only taking trades if a fractal reversal happens at the 61.8% retracement and all other requirements are fulfilled.

The graph below depicts this in action. The price is on an overall upswing before reversing. The price develops a bullish fractal reversal around the Fibonacciretracement tool’s 0.618 level. Once the fractal is apparent (two days after the bottom), a long trade in line with the longer-term uptrend is begun.

Profit taking may also entail the utilization of fractals. For example, if a trader goes long on a bullish fractal, he or she may exit the position once a bearish fractal arises. Profit objectives or a trailing stop loss might potentially be employed as exit strategies.

Further Considerations on Using Fractals

Here are a few things to remember when using fractals.

  • They are lagging indicators.
  • Because fractals are so ubiquitous, they work best in conjunction with other indicators or tactics. They should not be relied on in isolation.
  • The longer the chart’s time span, the more trustworthy the reversal. It’s also worth noting that the longer the time span, the less signals are created.
  • Plotting fractals in many time frames is recommended. Only trade short-term fractals in the direction of long-term fractals, for example. Focus on long trade signals during greater uptrends and short trade signals during larger downtrends, as previously indicated.
  • Fractals are now included in the indicator list of most charting programs.
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The Bottom Line

Fractals may be effective when combined with other indications and methodologies. Fractals may be applied in a variety of ways, and each trader may discover their own variant. One method is to use an Alligator indicator, while another is to use Fibonacci retracement levels. While some traders like fractals, others do not. They are not necessary for effective trading and should not be depended on alone.

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