Fractal Indicators: What They Are, How to Use Them, and Real-Life Examples

Last updated 03/19/2024 by

Edited by

Fact checked by

Summary:

Fractals in finance are recurring geometric patterns used as indicators in trading. Bullish and bearish fractals signal potential price movements. This article delves into the concept of fractals, their formulas, how to calculate them, and their practical application in trading.

What is a fractal indicator?

In financial markets, the fractal indicator is a vital tool based on recurring geometric patterns. These patterns exist on all time frames and serve as a key element in technical analysis. A bullish fractal appears when there’s a low point surrounded by two higher low bars or candles on each side. Conversely, a bearish fractal forms when there’s a high point with two lower high bars or candles on each side. To make it more intuitive, bullish fractals are marked by down arrows, while bearish fractals are marked by up arrows.

Formulas for fractals

Fractals can be identified using specific formulas. Let’s explore these formulas to understand the mathematics behind these patterns:

Bearish fractal formula

For a bearish fractal to occur, the following conditions must be met:

The high of the current price bar (N) must be greater than the high of the price bar two periods to the left of N (N-2).
The high of the current price bar (N) must be greater than the high of the price bar one period to the left of N (N-1).
The high of the current price bar (N) must be greater than the high of the price bar one period to the right of N (N+1).
The high of the current price bar (N) must be greater than the high of the price bar two periods to the right of N (N+2).

Bullish fractal formula

For a bullish fractal to occur, the following conditions must be met:

The low of the current price bar (N) must be less than the low of the price bar two periods to the left of N (N-2).
The low of the current price bar (N) must be less than the low of the price bar one period to the left of N (N-1).
The low of the current price bar (N) must be less than the low of the price bar one period to the right of N (N+1).
The low of the current price bar (N) must be less than the low of the price bar two periods to the right of N (N+2).

These formulas provide a mathematical basis for identifying fractals and using them in trading strategies. Understanding the calculations is essential for traders.

How to calculate the fractal indicator

Calculating fractals relies more on visual acuity than complex mathematics. Here’s a simplified way to calculate fractals:

Isolate a high/low point (N) on the price chart.
If there are two lower highs to the left of the high or two higher lows to the left of the low (N-2 and N-1), a possible pattern may be forming. However, the pattern still requires confirmation from two more bars on the right.
If two lower highs occur after the high (N+1 and N+2), a bearish fractal is complete. If two higher lows occur after the low, a bullish fractal is formed.

This simplified approach allows traders to identify potential fractals without extensive mathematical calculations. It’s essential to remember that fractals are more about pattern recognition than complex equations.

What the fractal indicator tells you

The fractal indicator generates signals frequently, but the mere existence of a fractal isn’t always significant due to its common occurrence. Fractals indicate the possibility of a trend change by depicting a “U-shape” in price. A bearish fractal represents an upward and then downward movement, forming an inverted U shape. In contrast, a bullish fractal occurs when the price moves down and then starts moving up, forming a U shape.

Since fractals occur frequently, they are often filtered using other technical analysis tools. For example, combining fractals with trend analysis allows traders to make more informed decisions. If the price trend is upward, traders may consider trading only bullish fractals, and vice versa for bearish fractals.

Fractals can also be used in conjunction with other indicators such as pivot points or Fibonacci retracement levels. In such cases, a trader may act on a fractal signal only when it aligns with other technical indicators and supports the longer-term price direction.

The difference between the fractal indicator and chart patterns

While the fractal indicator identifies specific five-bar patterns, chart patterns are more varied and encompass a broader range of formations. Chart patterns include wedges, flags, head and shoulders, and more. While some software can automatically detect chart patterns, many chartists prefer to identify and isolate them manually.

Limitations of using the fractal indicator

The primary limitation of fractals is their frequency. They occur often, and attempting to trade all of them can lead to substantial losses due to false signals or whipsaws. Traders typically filter fractal signals using other indicators or technical analysis methods.

Furthermore, the arrows in the indicator are typically drawn over the high or low point, which is the middle of the fractal, not where the fractal completes. This visual aspect can be misleading. Since the pattern actually completes two bars to the right of the arrow, the first available entry point after seeing an arrow is the opening price of the third bar to the right of the arrow.

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and the drawbacks to consider.

Pros

Clear Explanation: The article provides a clear and concise explanation of what fractal indicators are and how they work, making it accessible to both beginners and experienced traders.
Practical Application: It offers insights into how fractals can be practically applied in trading strategies, highlighting their potential in identifying trend changes.
Informative Formulas: The article breaks down the mathematical formulas for bearish and bullish fractals, enhancing readers’ understanding of the calculations involved.
Combination with Other Tools: It emphasizes the importance of combining fractals with other technical analysis tools, providing a comprehensive approach to trading.

Cons

Frequent Signals: The article mentions that fractals generate signals frequently, which can lead to confusion for traders. It could provide more guidance on how to filter and prioritize these signals.
Arrow Misleading: The discussion about arrows being drawn over the high or low point, rather than where the fractal completes, could be confusing without visual aids. Adding illustrations might improve clarity.
Lack of Real-World Examples: While the article explains the concept well, it could benefit from real-world trading examples to illustrate how traders can use fractals effectively in different scenarios.

Frequently asked questions

How frequently do fractals appear in financial markets?

Fractals occur frequently in financial markets due to the repetitive nature of price movements. However, not all fractals are reliable signals, so traders often filter them using other indicators or technical analysis.

Can fractals be used as standalone trading signals?

Fractals can be used as standalone signals, but they are often combined with other technical analysis tools to increase their reliability. Traders may also consider the overall trend when acting on fractal signals.

Key takeaways

Fractals are recurring geometric patterns used as indicators in trading.
They signal potential price movements, with bullish and bearish fractals indicating different directions.
Formulas are used to calculate fractals, and the process relies more on visual recognition than complex mathematics.
Fractals can be used in conjunction with other technical analysis tools and indicators to enhance their reliability.
It’s important to filter fractal signals, as not all are reliable, and trading all of them can lead to losses.

Share this post: