Table Of Contents
What Is Fractal Dimension Index?
The fractal dimension index or FDI refers to a technical analysis indicator that measures the current volatility of any market. The main objective of this indicator is to serve as a filter to figure out if the market is in any trading range or is trending.
You are free to use this image on your website, templates, etc.. Please provide us with an attribution link.
The FDI value always ranges from 1 to measuring the fractal dimension of a financial instrument’s price series. If a value is lower than 1.5, it indicates a persistent price series or a trending market. On the other hand, a value over 1.5 suggests the market is within a trading range, acting randomly.
Key Takeaways
- Fractal dimension index refers to a technical indicator that helps in gauging the price volatility of financial instruments.
- Traders can use this tool to determine whether a security is trending or trading within a specific range. Accordingly, they can decide whether to enter or exit a position.
- An FDI value of 1.55 indicates the potential start of a new trend, and the lower this value, the greater the strength of the trend.
- Determining a trend’s direction is not this tool’s intended purpose.
Fractal Dimension Index Explained
The fractal dimension index refers to a technical indicator that gauges the irregularity or convolution of a market. Traders can utilize it to determine if a certain market is trending or whether it is in a trading range. This indicator does not demonstrate the direction of a trend. Individuals may try to check if it can serve as a trend-following technical analysis indicator. However, it is not this tool’s intended use.
One may look at security prices ranging or trending. When a strong rally happens, a financial instrument’s prices trend sharply, and sometimes they approach a straight line that is one-dimensional. If individuals believe that the price movements should be more like a ragged fractal pattern, they would be under the assumption that the nearly straight movement should cease to exist. This might be predictable with adequate accuracy for making a good trade.
Post-trending, in many cases, security prices trade within a certain price range for some time prior to the commencement of another trend. To understand better, consider the price movement taking place within a rectangle pattern, moving upward and downward over identical points, leading to the formation of a planar pattern having two dimensions.
Taking into account that both a plane and a straight line are not fractals, one can anticipate a breakout to materialize with regard to the asset prices, and following that, the price movements may get back to bearing a resemblance to a fractal.
Thus, the fractal dimensional index is a tool that allocates a number ranging from 1-2 to a line on the financial instrument’s price chart. The closer the asset’s price movements resemble a straight line that is one-directional, the closer the indicator value moves toward 1. On the flip side, the closer the price movements seem to line a plane that is two-dimensional, the nearer the values move toward 2.
One must note that the lower the FDI values, the stronger the trend is likely to be, and as the value moves away from 1.5, the possibility of the trader earning financial gains increases proportionately to how much deviation takes place. Also, individuals need to remember that when the FDI value reaches 1.55, it signals the start of another trend.
Chart
Let us look at the following fractal dimension index chart published on TradingView to understand the concept better:
The above Euro/British Pound chart shows that the FDI indicator is red when the market is trending. On the other hand, when there is high volatility, and the market is erratic, the indicator turns blue from red. Usually, the blue periods last for a short timeframe and precede a new trend. This means that individuals should seek trend-following signals when FDI is blue.
In contrast, traders must avoid any trend-following signal when the indicator is red, as it signals a non-trending or ranging market. Also, they must avoid such signals as the indicator may signal a trend in the market that started long back.
Examples
Let us look at a few fractal dimension index examples to understand the concept better.
Example #1
Suppose Sam is a trader who is tracking the price movements of Stock XYZ. He identified that the security was in an uptrend and confirmed using the fractal dimension index that it was a trending market. To benefit from the price rise, Sam purchased the shares of the company when the FDI value was 1.1, indicating a strong trend.
After a few trading sessions, he noticed that the price chart started to show lower highs and lower lows. He checked the FDI indicator and found out that the value was approaching 1.9, signaling a weakening trend. So, he decided to sell his shares when the value was 1.8. Thus, with the help of this indicator, he could make significant gains.
Example #2
Suppose XYZ stock was trading within a range. The fractal dimension index value moved to 1.55 and signaled that a new trend was on the horizon. John, an experienced trader who was looking to make short-term profits, noticed the indicator value and observed the formation of a bullish marubozu accompanied by high trading volume in the price chart. He predicted that the price would increase, and an uptrend was on the horizon. Accordingly, he entered a long position. The new trend actually materialized as the price increased significantly, and the stock went into an uptrend.
After that, when FDI increased to 1.75, signaling that the trend’s end was likely close, he closed his position, bagging significant gains.
Frequently Asked Questions (FAQs)
Is the fractal dimension index effective?
What is the disadvantage of using the fractal dimension index?
Can I use the fractal dimension index with the relative strength index?
What does a fractal dimension index value of 1.9 mean?
