​Fractals and Time Patterns when Trading the Forex Market

February 19, 2017 08:00

custom fractal.png

Dear Traders,

Regular readers of our blog articles already know why the Fractal Indicator is critical for trading purposes. In case you're not sure, please read our first article which explains the benefits.

This second article promises to address two other critical aspects of the Fractal concept and indicator:

  1. What is the best Fractal value for the Forex market?
  2. What is time factor and how does it impact the markets?

Make sure to grab a tea or coffee – it's now time for a new way of analysing the charts.

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What is the best Fractal value for the Forex market?

It's important to realise that the inventor of the Fractal indicator, Bill Williams, tested the Fractal concept on daily charts in the commodity markets. His research came to the conclusion that the best Fractal value was found via the number two.

This is why Fractals appear on the chart when two candles to the left and two candles to the right are lower or higher than the candle with the Fractal. You can read more info.

Generally speaking, I think that this particular setting has value for all time frames and financial instruments. However, after many years of research, I started to notice that the best Fractal value for the Forex market was 5 or 6 (for the rest of the article I will refer to 6) and 13.

The Fractal value of 6 is especially beneficial for intra-day charts of the Forex market, but is equally useful for long-term charts too. The value of 13 will be explained in a later article.

The MT4 charts do not allow traders to change the Fractal indicator so I asked a programmer to make a custom Fractal indicator for my own trading. You can receive a free copy by writing us here (please add a reference to this article).

What is the benefit of your custom-designed Fractal?

Intraday charts move rather quickly compared to daily charts. Using a Fractal of 2 makes sense on slow-moving charts but not when price moves quickly and impulsively. Why?

A Fractal value of 2 will have less importance in the Forex market because the support and resistance (S&R) levels break quite easily. Only when 6 candles fail to break the most recent high or low do the odds change and will the S&R most likely hold (at least for a while). That is why a Fractal value of 6 has more relevance for the Forex market and lower timeframes.

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Once a Fractal of 6 occurs, I feel more comfortable to conclude that the momentum swing is probably completed for a while. At this point, the market will most likely show a reversal or correction (more explained in next week's article).

The 6 Fractal value is a key part (but not the only aspect) of what I call the "time factor" pattern. Why this name?

The reason is simple: I am actually counting the number candles from a each new candle high or low. Whereas other patterns rely on candles, chart formation, and Fibonacci levels, this particular pattern is a mixture of price and time.

I call it a pattern and not a Fractal trading system because it's a set of loose rules that are used in a discretionary method. Of course, it is possible to build a trading system based on these time factor ideas but it requires more detailed rules.

How does time factor pattern impact the market?

The time factor pattern offers very important information because traders are able to know the phase of the market cycle – either impulsive price action (momentum) or corrective price action (correction).

Based on time factor patterns, traders can judge the correct cycle of the current price action:

  1. momentum
  2. end of momentum
  3. start of correction
  4. continuation of correction
  5. end of correction
  6. start of new momentum
  7. continuation of momentum.

In this particular article, I will focus on how the time factor pattern impacts point 1 and 2 but in the future articles (later this month and quarter), I will explain how time factor patterns can help identify all phases of the market cycle.

Do time factor patterns identify the end of momentum?

Yes, that is correct.

Once 6 candles fail to break for a new higher high or lower low, the time factor pattern indicates that the momentum swing has most likely been concluded and finished.

Take a look at the below.

  1. Price is in a momentum (blue arrows)
  2. Price pauses for few candles (purple box)
  3. Price however still pushes for a new high within 6 candles so the momentum is still alive (green arrow)
  4. Price fails to post a new high within 5-6 candles, which means that price action swing is over and that the momentum is pausing or finished (red box)
  5. Price builds a reversal or correction (orange); in below image below it's a correction.

custom fractal 3.png

With that said, please not that I use the time factor as an extra tool of analysis. A tool of confluence. I always perform my analysis first and do not use this concept yourself before testing it in more detail.

Although I use the tool for confluence, the time factor pattern for momentum completion does offer me enormous advantages:

  1. Trend traders can make a decent estimate when the trend is taking a pause, which offers them a method to take profits near the extreme point of price. The advantage is that traders clearly wait for the momentum to finish before exiting the trade setup.
  2. Reversal traders can feel more at ease that the momentum into the opposite direction has died down and that they are entering at a time when price action is not heavily pushing against their trade direction.

In the upcoming weeks, I will share more of my research on time factor patterns. That article will review how time factor patterns impact other phases of the market cycle as well.

Cheers and safe trading,

Chris

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