Why Fractal Indicator Is Critical for Trading
Perhaps you have already come across charts with funny-looking triangles or arrows above or below candlesticks. You probably wondered what these objects actually represent. Luckily, you've come to the right place.
The brilliant indicator we're focusing on today is called the Fractal indicator, and it provides a wide range of benefits. Mainly, it helps identify support and resistance, understand the trend, and find entries.
Before we dive deeper, let me first explain the Fractal itself and how to add the indicator to the chart. Then we can actually discuss how this may help improve your trading.
So what is a fractal?
A fractal is a mathematical set that exhibits a repeating pattern displayed at every scale. This might sound complicated, so let's break it down.
Firstly, think of a fractal as a curve or geometrical figure. An object is fractal if the same pattern occurs at every size. In essence, fractal explains natural objects and chaotic phenomena such as snowflakes, crystals, and even galaxy formations.
Fractals are connected to the "chaos theory", which is a branch of mathematics focused on the behavior of dynamical systems such as weather, climate and other natural and even artificial (i.e. road traffic) systems.
Okay, now that we understand fractals a bit better, how exactly do they tie in with the markets?
Fractals in financial markets
Many traders see the financial markets—such as Forex, CFD and commodities markets—as fractal because the behavior of the markets is like a dynamical system that repeats on all time frames.
Simply said, I think that most traders will agree that market patterns are continuously repeated:
- on all scales (timeframes)
- in a curve shape—price is moving up and down and forward in time
- with various speed (momentum) and movement (corrections).
Chart patterns, candlestick patterns, wave patterns and many more patterns repeat themselves regularly and confirm their Fractal nature. Legendary trader Bill Williams took the fractal and chaos concepts and transformed them into a Fractal indicator which can actually be applied directly on a chart.
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.
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 do I place Fractal indicator on charts?
Good question. For MT4 and MT4 Supreme Edition users, you can add the indicator by going to "Insert" -> "Indicators" -> "Bill Williams" -> "Fractals". The Fractal indicator is a support and resistance indicator. The standard MT4 Fractal indicator "formula" is based on 5 candles and occurs in the following cases:
- Support Fractal: it appears on the chart when 1 candle has a low which is lower than 2 candles to its left and to its right.
- Resistance Fractal: it appears on the chart when 1 candle has a high which is high than 2 candles to its left and to its right.
The two candles to the left and right is a minimum, but there is no maximum. A fractal will appear and stay on the chart even if there are 100 candles to the left and 50 candles to the right that are higher or lower.
How to use the Fractal indicator?
The Fractal indicator offers multiple advantages. Let's overview 3 simple reasons why you should use this indicator.
The first benefit is the simplicity in viewing and digesting the charts. The fractals provide me with an immediate overview of the major support and resistance (S&R) levels.
This is effortless because the Fractal indicator is an indicator which is automatically updated. The S&R levels can also be used for filtering out a trade setup and for spotting major bounce or break spots.
The second benefit is that I like to connect trend lines with fractals. This also helps to identify the trend by checking the sequence of fractals (higher highs and lows or lower lows and highs). It is also possible to place a Fibonacci tool from fractal to fractal but make sure to see the presence of a trend or momentum.
The third benefit is for trade entries and trade management. The break of fractals can be used for potential entry setups as price breaks through support or resistance (but make sure to test this within a clear trading system).
Fractals can also be used for placing a stop-loss (SL) below the closest or the second-closest fractal. A long setup would have a SL below the fractal support, whereas a short setup would go with a SL above fractal resistance. The same logic can be applied for a trail SL that would use newly formed fractals to reduce the risk or lock in profit.
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:
- momentum
- end of momentum
- start of correction
- continuation of correction
- end of correction
- start of new momentum
- 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.
- Price is in a momentum (blue arrows)
- Price pauses for few candles (purple box)
- Price however still pushes for a new high within 6 candles so the momentum is still alive (green arrow)
- 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)
- Price builds a reversal or correction (orange); in below image below it's a correction.
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:
- 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.
- 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.
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