How to apply Fractal in trading

The fractal indicator is a simple price pattern commonly found in financial markets. Outside of the trading realm, a fractal is a geometric pattern that repeats itself on all timeframes. From this concept, the fractal indicator has been established. The indicator separates potential turning points on the price chart. Then, draw arrows to indicate the model. A bullish fractal pattern signals a possible move higher. On the contrary, a bearish fractal signals a possible decline. A bullish fractal is marked with a down arrow and a bearish fractal is marked with an up arrow.


Source: Tradingview

What does the fractal indicator say?

The fractal indicator generates frequent signals. The existence of the fractal is not necessarily that important because this pattern is very common.

Fractal shows the ability to change trend. This is because fractal is essentially showing the “U-shaped” price. A bearish fractal has price moving up and then down, forming a U. A bullish fractal occurs when the price falls but then begins to rise, forming a U.

Because fractals happen so often and many signals are not a reliable entry point, fractals are often selected using some other form of technical analysis. Bill Williams also invented the Alligator indicator that helps separate trends. By combining fractal with trend analysis, traders can decide to only trade on bullish fractal signals while the price trend is up. If the trend is bearish, they can only do short trades based on bearish fractal signals.

Fractals can also be used with other indicators, such as the pivot point or the decreasing Fibonacci level. Fractal is only triggered if it matches one of these indicators and is likely a long-term price trend. For example, let’s say a crypto tends to go higher. The price is falling back and reaching the Fibonacci of 50%. Since the trend is up and the price is close to the downside Fibonacci, the trader will enter a trade if a bullish fractal forms.

Difference between fractal indicator and chart pattern

The fractal indicator is unique in that it identifies the price pattern and marks it on the chart. Fractal is a specific five-bar model. Patterns can also be plotted on charts, though they’re not limited to five price bars. They also include many different shapes, such as triangles, rectangles, and wedges. While some software will mark the pattern on the chart, most charters will find and split the chart template manually.

Limitations of using fractal indicators

The main problem with fractals is that they come out too much. They happen often and if we try to trade all of them they will quickly run out of trading accounts due to loss of trades. These are called false or ‘jagged’ (whipsaw) signals. Therefore, filter signals with some other indicator or form of analysis.

The indicator arrows are usually drawn on the top, bottom, or midpoint of the fractal, not where the fractal completes. Therefore, arrows can deceive vision. Since the pattern is actually completing two bars to the right of the arrow, the first available entry point after seeing the arrow is the opening price of the third bar to the right of the arrow.

How and model of Fractal application in trading?

There are 2 forms of unrelated fractal analysis commonly recognized by traders:

  • Reversing fractal pattern
  • Fractal: Analyze multiple timeframes

Fractal reversal pattern

Fractal in technical analysis terms is a five-bar / candlestick trend reversal pattern. For a bullish reversal fractal pattern:

  • The third candle in a series of five candles will be marked as having the lowest low
  • The first two candles in the pattern have a higher low than the middle candle

The chart below shows a bullish fractal pattern:

The bullish reversal fractal pattern shows the end of the short-term downtrend and the start of a new uptrend. Traders can use this pattern as either a long entry signal or a signal to exit an existing short position.


The fractal pattern reverses in price

Many traders will use fractal signals in combination with oscillators such as the Stochastic indicator or the relative strength index (RSI) to confirm bullish buy signals. In this respect, a buy fractal signal will be considered to be of higher value when accompanied by an oversold signal.


The fractal pattern reverses in price

For a bearish reversal fractal pattern:

  • The third candle in a series of five candles will be marked as having the highest high
  • The first two candles in the pattern have a lower high than the middle candle
  • The last two candles in the pattern will have a lower high than the middle candle

The chart below shows a bearish reversal fractal pattern:

A bearish reversal fractal pattern shows the end of the short-term uptrend and the start of a new downtrend. Traders can use this pattern as either a short entry signal or an exit signal to an existing long position.

The fractal pattern reverses price

Traders often use fractal signals in combination with oscillators like Stochastic or RSI to confirm bearish signals. In this regard, fractal sell signals will be considered to have higher value when accompanied by an overbought signal.


The fractal pattern reverses price

Fractal: Analyze multiple timeframes

Another unrelated interpretation of fractal analysis in trading is analyzing multiple timeframes. In this regard, traders can use the timeframe of their analysis to provide predictive views and trading ideas.

For example, a trader can use a daily or weekly timeframe to get a better overview of the market he wants to trade. Then, traders look at smaller timeframes like 1 hour or 15 minute charts to help correct entry and exit points.

You can refer to a simple fractal trading strategy like this:

1. Identify the main trend on the daily chart
2. Use the 1-hour chart to identify market entry and exit points
3. Input signals on the 1 hour time frame are considered only if they match the trend derived from the daily chart.
4. The anti-trend signals identified on the daily timeframe are not signals for trading against the trend but a hint to exit current positions.

Summary

There are 2 common trading concepts in fractal technical analysis: a reversal fractal pattern and a fractal that analyzes multiple timeframes.

Fractal reversal pattern:

  • The bullish fractal implies the end of the downtrend and a possible new uptrend
  • The bullish fractal is considered a signal to exit a short position or the signal to enter a long position
  • These patterns are made up of five bars or candles
  • The middle candle in a pattern has a lower low than the previous and next candles
  • The first two candles in the pattern have a higher low than the middle candle
  • The last two candles in the pattern also have a higher low than the middle candle
  • Oversold signals are often used to confirm bullish fractal patterns
  • A bearish fractal implies that the uptrend is over and a new downtrend may be followed
  • A bearish fractal signal is considered a long exit or a short entry signal
  • These patterns are made up of five bars or candles
  • The middle candle in a pattern has a higher high than the previous and following candles
  • The first two candles in the pattern have a lower high than the middle candle
  • Overbought signals are often used to confirm bearish fractal patterns

Fractal: Analyze multiple timeframes

  • Fractal can use multiple timeframes in transactions
  • Traders can look at the larger chart timeframe for a better view, i.e. a measure of the long-term trend.
  • Traders can then look at the smaller chart’s timeframe to reach those entry and exit trigger points

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