The use of "fractals" in forex trading can inform the trader of potentially rewarding reversals in price movement. While the fractal indicator is not associated with the mathematical phenomenon of fractals, it nonetheless refers to recurring patterns that appear in the auction cycle of any trading vehicle. When looking at past price charts, the presence of fractals at key turning points is obvious. They consist of five price bars with the highest point in the middle and lower highs on each side. Identifying these patterns is easier in hindsight than in real-time trading. In combination with other indicators, it is possible to predict when a fractal may appear.
Things You'll Need
- Forex charting software
Load a forex chart of any currency pair. The fractal indicator is a basic chart pattern that applies to any investment instrument on any time frame. Configure the chart for the currencies you wish to trade.
Educate yourself on the characteristics of a fractal pattern. A minimum of five bars is necessary and the middle bar must be the highest or lowest price point of the group. Adjacent bars to this extreme must exhibit a stairstep-like pattern where each bar further away from the middle is a lower high or a higher low.
Identify fractals in past price action. These are usually visible at turning points in an overall trend. When price reaches a high point and begins to fall back, a fractal pattern may form.
Add other indicators to the price chart. Fractals appear in oversold or overbought conditions, leading to a reversal. A fractal on its own can indicate a turning point only after the reversal has occurred and the pattern played out. Additional indicators can prepare the trader for the upcoming appearance of a fractal pattern by identifying the conditions that often cause this pattern. A popular indicator for this purpose is the "Alligator" study. Many traders only follow a fractal pattern that occurs in conjunction with conditions of the Alligator. This study is comprised of three moving averages. A fractal outside these bands is more valid due to the extreme conditions necessary for price to trace to these areas. When price is trading outside the Alligator, fractals are more likely and predictable.
Draw a trend line of price action. By joining the highs or lows of previous fractals, it is possible to visualize price points in the future where a new fractal formation will materialize. Fractals that form along a trend line are often very strong signals.
Tips & Warnings
- Always test a new trading strategy in real time before committing real capital to the trades. Patterns are often deceivingly simple in hindsight. Forex trading is a risky endeavor and must be approached with great caution until a strategy proves itself consistently profitable.
- Photo Credit Jupiterimages/Pixland/Getty Images
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