Financial market believed to be unpredictable by those who do not know how to do the required analysis to make sense out of the random movement the market gives as every security and trading instrument tends to create a repeating pattern and move in trends. One of the most common and widely seen technical repeating patterns is a Fractal. Fractals are nothing more than a simple five-bar reversal candlestick patterns which form in the price movement of a financial trading and investment instrument. This blog we will give you all the details you need to know about fractals and how a trader can use them to make a highly rewarding financial trading strategy.
Introduction to Fractals
Fractals is a very simple five bar technical pattern, but usually, traders look at as a complex and tough mathematical analysis tool due to its complex name. Fractals are the patters which usually form in the movement and development of the push and pull between bulls and bears before giving a big movement in the security. These fractals appear commonly at the time of a reversal in the market movement as the candlesticks which form under the Fractals states a market sentiment of indecision which in turn indicates a turnaround in the price movement and trend.
To understand Fractals in a better way first we will try to understand how a Fractal is formed in a candlestick chart which can be identified by following few rules which makes a five or more bars pattern a fractal.
1. A bearish Fractal form at the turning point where the highest high or the formation form in the middle followed by two lower highs on each side before and after the highest candle.
2. A bullish Fractal form at the turning point where there is a pattern includes the lowest low in the middle followed by two higher lows on each side.
The example of the fractals shown below. However in real life situations other less perfect patterns can occur, but this basic formation of candlestick pattern should remain intact to be called as a fractal pattern.
Applying Fractals to Trading
Fractals are one of the most common and frequently accruing trading pattern and it usually appears in the price chart of a security which is in a strong be it bullish or bearish. Because of the frequency of this pattern, it is always advised to use Fractals with other indicators or forms of analysis to get a confirmation of the pattern at an early stage as fractals are a lagging pattern and it only completes after the two similar direction candles where a trade must be placed. A commonly used conformation indicator which is used with fractals is the Alligator indicator.
The Alligator indicator is an indicator which is made by the use of various combinations of different durational moving averages. On the chart below we can see a clearly visible long-term bullish trend with the price staying majorly above the alligator’s middle moving average which is called the teeth. As the major trend in this security is up, so bullish signals can be generated in this security.
As this type of formations is very commonly experienced trades usually switch to a longer time frame which will reduce the number fractal signals in a chart, allowing a clean looking chart, making it easier to spot a good trading opportunity.
This system can provide a strategically entry point, but it is up to the individual trader to get into a trade according to the risk-taking capacity. In the above-mentioned example we can see that the pattern isn’t clearly visible until the price has started to rise from the recent low. Therefore, a strategically stop loss and profit booking should be placed below recent lows and retracement levels.
Points to note when using Fractals
Here are a few important points to remember when using fractals.
• Fractals are a lagging indicator and candlestick pattern.
• Fractals should be used with a combination of other indicators or strategies to ensure a higher success rate.
• The longer the time frame of the chart is, the more reliable the reversal is and thus a higher time frame based fractal pattern give a higher success rate. The longer the time period, the lower the number of signals generated and higher the quality of the signals.
The Bottom Line
Fractals are very useful tools when it is used in combination with other indicators and technical analysis as they can be used in many different ways, and each individual trader should try to find their own variation and combination by hit and try method which can be used to determine the combination of another indicator which an individual trader believes to work with Fractals in order to increase the profitability of the trades and increase the value of the overall portfolio. However using an alligator indicator is a widely used option, and another popular tool which is used with Fractal is Fibonacci retracement levels. While a lot of traders like fractals and use them on a daily basis, others may not as Fractals have an obvious drawback that it is a lagging indicator which keeps a lot of traders away from fractals.