What Is a Fractal?
The fractal indicator is based on a simple price pattern frequently observed in financial markets. Outside of trading, a fractal is a recurring geometric pattern repeated over various time frames. Leveraging this concept, the fractal indicator was created to pinpoint potential inflection points on price charts through visual signals.
A bullish fractal pattern indicates a prospective rise in price, while a bearish fractal signals a potential decline. Bullish fractals are marked by a down arrow, and bearish fractals are marked by an up arrow.
Key Takeaways
- Bullish Fractal: Occurs when there is a low point with two higher low bars/candles on each side.
- Bearish Fractal: Happens when there is a high point with two lower high bars/candles on each side.
- Indicators: Up arrows signal bearish fractals, while down arrows signal bullish fractals.
- Entry Points: This can only be acted on at the open price of the third bar following the arrow formation.
- Pattern Completion: Arrows are illustrated above or below the central bar (either high or low point) even though the complete pattern involves five bars.
The Mathematical Foundation of Fractals
Bearish Fractal Formula:
Bearish Fractal = High ( N ) > High ( N−2 ) and High ( N ) > High ( N−1 ) and High ( N ) > High ( N+1 ) and High ( N ) > High ( N+2 )
Bullish Fractal Formula:
Bullish Fractal = Low ( N ) < Low ( N−2 ) and Low ( N ) < Low ( N−1 ) and Low ( N ) < Low ( N+1 ) and Low ( N ) < Low ( N+2 )
Where ‼️:_
- N: High/low of the current price bar
- N-2: High/low of price bar two periods to the left of N
- N-1: High/low of price bar one period to the left of N
- N+1: High/low of price bar one period to the right of N
- N+2: High/low of price bar two periods to the right of N
How to Calculate the Fractal Indicator
This process relies more on visual identification than complex mathematics:
- Identify a High/Low (N): Pinpoint a peak or trough on the price chart.
- Left Side Confirmation: If, to the left, you find two lower highs (for highs) or higher lows (for lows), you’re on the verge of identifying a pattern. It remains to be confirmed.
- Right Side Confirmation: Once two lower highs appear following the detected high—or two higher lows follow the identified low—a full bearish or bullish fractal is confirmed.
Insights From the Fractal Indicator
Due to the prevalence of fractals, the sheer existence of a fractal pattern may not hold significant weight. What it denotes is a potential trend shift. Bearish fractals suggest initial upward followed by downward movement (an inverted U-shape), while bullish fractals indicate a reversal from a decline to an ascent (a normal U-shape).
Given the commonality of these fractals and the possibility of generating unreliable signals, refining fractal usage with other technical analysis tools is usually the practice. An example includes combining them with Bill Williams’ Alligator Indicator, trend analysis, pivot points, or Fibonacci retracement levels.
Comparing the Fractal Indicator and Chart Patterns
The fractal indicator’s uniqueness lies in its ability to highlight and mark specific five-bar patterns. Traditional chart patterns, such as wedges, flags, and head and shoulders, are broader and don’t adhere to a specific number of price bars. While software can automatically identify these patterns, manual chartism remains a prevalent method.
Limitations of Fractal Indicators
The frequent manifestation of fractal patterns is their primary flaw. Attempting to trade each one without ample filtration can drain a trading account due to false signals. Typically, the indicator’s arrows are above or below the high or low point of a fractal, visually misleading observers into thinking they can trade right away. The arrows do not indicate completion, as fractal patterns finalize at the third bar to the right, positioning trades at the open price of the fourth bar following the high/low marked by the arrow.
Related Terms: alligator indicator, pivot points, Fibonacci retracement, trend analysis, chart patterns.
