Traders are always looking to integrate new techniques into their market analysis in order to get an edge.
This article is going to explore a relatively new way of recognising price patterns and discuss an indicator that instantly flags up the patterns on a chart for you. These patterns are fractal patterns, and the Forex fractal indicator is the tool that identifies them.
So first things first,
A fractal pattern is a repeating pattern in which the same configuration occurs throughout the structure, on a variety of different scales.
In nature, we see fractal patterns in the growth of crystals, the branching of twigs on trees and the structure of snowflakes, to name just a few. These exhibit the properties of being recursive and self-similar.
Fractal patterns are recursive because no matter how complex the whole, it is built from many repetitions of the same process. They are self-similar, in that if you look at a small section of the pattern, it is no different than a much larger section of the pattern or the whole.
How does this apply to the financial markets, though?
Well, we can draw some kind of analogy between fractals and the behaviour of the financial markets. When we look at price movements in the market as a whole, it is clearly very complex and it also appears to be random.
The fractal theory, though, as propounded by well-known trader and analyst Bill Williams, suggests this complexity is built up from self-similar patterns of trader behaviour. It follows, therefore, that there is ultimately a non-random structure to the whole that we can fathom.
Williams argued that the Elliott Wave was the underlying structure of the market and that the structure of the Elliott wave is fractal. If trades are the results of a behavioural fractal, Williams reasoned, then the aggregate behaviour also follows a fractal pattern.
In short, recognising the behavioural fractal pattern of the overall mass of traders offers a way to potentially profit from the market.
Williams said that a fractal pattern on a bar chart was made up of a minimum of five consecutive bars. An initiating fractal must have a middle bar that has a higher high or lower low than the two preceding bars and the two following bars.
Examples of classic fractal patterns with five bars are shown below:
As you can see, a fractal is like a mini-reversal. It highlights a potentially significant high or low.
Do not let the up and down names confuse you — some label these patterns as bearish or bullish, but the truth is they are neither inherently bearish nor bullish.
Their significance is contextual. That is to say, it only becomes bullish or bearish if the market behaves a certain way.
Though Williams maintained that these fractal patterns were simple and easy to recognise, the reality is slightly different. Trying to visually pinpoint sequences of these patterns on a chart is an irksome process.
Here's the good news: the Bill Williams fractals indicator is one of the standard tools that come packaged with MetaTrader 4. Handily, there is no need to make a separate fractals indicator download.
So having familiarised ourselves with the basics of fractal patterns, let's take a look at the MT4 fractals indicator itself.
You will find the fractals indicator in the Bill Williams folder in MT4's Navigator.
Clicking on Fractals launches the dialogue window for the fractals indicator, as shown in the image above.
Now, the purpose of the fractal indicator is simply to recognise the standard, recurring patterns defined by Bill Williams. This means there are no variables to set when you launch the tool.
As you can see, the only choice relates to the cosmetics for the indicator — a choice of how large to make the markings for the MT4 fractals and in which colour they should appear.
The image below shows MT4 fractals marked on an hourly EUR/USD chart, using the default settings for colour and line-thickness:
The MetaTrader fractals indicator here has done all the work of identifying the Forex fractals in our chart for us.
When it comes to making trading decisions, though, this is only part of the job. We need to look at sequences of fractal Forex patterns together in order to identify trends and thereby decide on a trade.
Using the fractals indicator meaningfully requires a bit of knowledge of Bill Williams trading rules. Let's run through them briefly and see how we can apply them.
Williams' original rules for fractal trading involve looking for certain formations that signal a trade. Specifically, we first want two adjacent MetaTrader 4 fractals that are pointing in the opposite direction to each other.
This will constitute what Williams called a fractal start and a fractal signal. The fractal start is simply any fractal followed by a fractal in the opposite direction. The signal is the direction of the second of these two fractals.
With an up fractal, we are only concerned with the level of the highest bar. In a down fractal, we are only concerned with the level of the lowest bar. Most important of all, we only trade on the signal if the market moves beyond the high or low of the fractal signal.
Another term Williams defined was the fractal stop, which is the furthest point from either of the previous two fractals that are in the opposite direction to the signal. When trading on a fractal signal, he recommended putting a stop just beyond the fractal stop.
The rudimentary trading rules are:
Williams, who was trading with futures contracts, recommended that the stop be one tick beyond the fractal stop.
This is illustrated in the diagram below:
So these are the basic trading rules given by Bill Williams.
Are there any drawbacks?
There are, of course. No indicator is perfect and the fractals indicator is no exception.
For example, the indicator provides a large number of fractal signals and plenty of these will be false. Indiscriminately trading on all of these will yield poor results.
The best fractal indicator performance will come when you combine it with other trading tools in order to tighten up its trading signals. The most obvious way is to combine the Forex fractal indicator with another one of Bill Williams' inventions, the Alligator Indicator.
A potential method would be to only open a trade when both the fractals indicator and the Alligator indicator agreed on a trend direction. One of the strengths of the Alligator indicator is in helping you maintain a position while the market is still trending in your favour.
Another combinatory use, therefore, might be to keep a position open as long as the jaws of the alligator are open and it is still feeding.
If you're looking for a wider selection of indicators than are available with the standard version of MT4, why not consider downloading MetaTrader 4 Supreme Edition? It's a custom plugin with a cutting-edge set of additional trading tools chosen by industry professionals.
Fractals trading is designed to align you with the trend. The fractals indicator quickly identifies fractal highs and lows that may be of significance and from these we obtain signals designed to align us with the directional flow of the market.
Bear in mind, the standard fractals indicator in MT4 is not the only game in town — there are other custom indicators available. For example, there are reversal fractal indicators that focus on identifying price reversals.
There are even reversal fractal indicators with alert notifications that you can customise to let you know when key patterns are forming.
It's always a sensible piece of advice to not rely too heavily on one indicator in isolation. As we said previously, you can improve the performance of the fractals indicator if you combine it with another.
You may find, for example, that fractals are more effective as a way to confirm or support your decision making rather than as a primary signal for initiating a trade.
There's a long list of available combinations. Which one works best is for you to decide — a good way to discover effective combinations is experimenting in the risk-free environment of a demo trading account.
Once you've seen what works, you can trade confidently for real. We wish you the best of luck.