Technical Indicator

Some people believe that markets are random. However, 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. 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, thus making it much easier for traders to conduct their analysis and make a prediction.

Fractals are basically recurring patterns that can predict reversals among larger, more chaotic price movements. They are a nice way for traders to simplify large chunks of charts by breaking them down into simpler and more recognizable pieces. To put it very simply, everything revolves around the moment in which the trend changes and the way the market behaves after that.

Basic fractals are composed of five or more bars, and there are some rules for identifying them. A bearish turning point occurs when there’s a pattern with the highest high in 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. So, you essentially get a sort of an arrow composed of the bars on your chart pointing upwards (in the first case) and downwards (in the second). You can also think of it as a kind of “V” (second case) or an upside-down “V” (first case). It’s important to know, however, that fractals belong to the group of so-called lagging indicators. In other words, they cannot be drawn until the reversal has been lasting at least a couple of days. Yes, that is a drawback, but given that these processes often last much longer, this may not pose such a significant problem if you can react quickly enough.

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 (more on both of those topics later), 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. Using them as the sole basis for making your decision is not recommended – they work best as support tools.

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