Fractal Indicator

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21 Aug, 2024

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A Fractal Indicator, in technical analysis, is a market indicator with recurring geometric patterns indicating a trend reversal in the financial markets. The primary purpose of this indicator is to identify trend reversals that can book profits for the trader.

The fractal indicator strategy consists of 5 candlesticks or bars. These candlesticks are further represented by arrows (upwards and downwards). On that basis, bearish and bullish trends can be recognized. Plus, the trader can use it to identify trade signals. However, these indicators can predict wrong trends as they occur frequently.

What Is Fractal Indicator?

A fractal indicator is an analytical tool used in the financial market that determines trend reversals through geometric patterns.
Bills Williams was the first trader to develop this indicator in 1995. It consists of 5-candlesticks forming a fractal in the chart.
A bullish fractal has a U-shaped formation along with a downward arrow. Likewise, a bearish fractal forms an inverted U and contains an upward curve.
It has the highest low and high as the third candle. There will be a descending trend till the third and a rise in the bullish fractal. It goes the same for a bearish fractal.

How Does Fractal Indicator Work?

A fractal indicator is a simple yet popular tool used in financial markets by traders to identify trends using geometric patterns on five candlesticks or bars. Famous trader Bill M. Williams first developed this indicator in the book Trading Chaos published in 1995. However, the first use of the fractal dates back to the 1970s. The Polish mathematician Benoit Mandelbrot applied it to understanding geometric figures.

The fractal indicator strategy has wide acceptance in technical analysis. However, to understand its workings, it is vital to learn its components. These fractals are based on some patterns that are quite repeating. Therefore, Williams's fractal indicator considers five candles at a time. Each will indicate either a bullish (upward-moving) or bearish (downward-moving) trend. And in the middle of this pattern will be a candle that represents the highest or lowest price. For example, if five candles form a fractal, the third candle will be either bullish or extremely bearish.

Types

In contrast, identifying the fractal pattern is a must to predict a trend. Following are the listed methods that will help to predict the fractal pattern easily:

#1 - Bullish Fractal Pattern

The first two candles will have the highest lows. However, the third (or middle) candle's price will be lower than the first two. And the last two price bars will surpass the middle candle. In short, the first three candles will have a descending volume (red), and the last two will rise in a bullish trend.

#2 - Bearish Fractal Pattern

In this case, the first two candles will have lower highs than the middle candle. Here, the fractal pattern will witness a rising volume (green) till the third candle. But the other two will see a descending (or falling) volume.

How To Determine?

Let us look at the Willams fractal indicator formula for determining the trend reversal patterns:

Bullish Fractal Indicator = Low(N)<Low(N−2) and

Low(N)<Low(N−1) and

Low(N)<Low(N+1) and

Low(N)<Low(N+2)

Bearish Fractal Indicator = High (N) > High (N-2)

High (N) > High (N-1)

High (N) > High (N+1)

High (N) > High (N+2)

Where

N refers to the High or Low of the current (third) price candle.

(N-2) refers to the previous two candles on the left side of the third candle. Likewise, N-1 is the high or low of the second candle.

N+1 is the fourth candle on the right side of the fractal. And lastly, N+2 are the fractal's last two candles (4th and 5th).

Examples

Let us look at some examples of fractal indicators to comprehend the concept better:

Example #1

Let us look at the following Bitcoin/US Dollar perpetual inverse swap contract chart with a fractal indicator applied to it.

The upward arrows represent the possibility of a downward trend, while the downward arrows denote a potential downtrend.

As one can observe, the fractals in essence, are demonstrating a U-shape with regard to price. The formation of bullish fractals takes place in case the price is dropping but then begins to move upward, forming a U shape. On the other hand, bearish fractals form an upside-down U, as the price first moves up and then down.

To look at more such charts and develop a comprehensive understanding of this concept, individuals can visit the TradingView platform.

Example #2

According to the recent updates as of October 2023, the popular analyst Rekt Capital has expected a level break at $31,000 in the Bitcoin price. If it does happen, it will lead to a bearish fractal. Until now, the Bitcoin price has been around $41,000. However, the Bitcoin analysis does suggest a price correction, and it may occur after gaining more key-level strength. Only when the required resistance is developed the bearish fractal may exist.

Interpretation

Each bearish/bullish fractal consists of arrows above or below it. Yet, there is a way to identify the arrows. Let us look at them:

● Bullish fractal = U-shape = Downward arrow

● Bearish fractal = Inverted U-shape = Upward arrow

If the trader witnesses a downward trend (or bearish fractal), they can put a stop-loss. As a result, it acts as price support. Likewise, a bullish fractal acts as a resistance to the price levels.

How To Use?

The trader can apply the fractal indicator formula on the chart to predict a trend reversal. It is possible with the help of trading platforms or analytical tools on the software. However, the software will highlight many patterns within a certain timeframe. Therefore, it is necessary to select the right time. If a person is a beginner, they can choose a smaller chart timeframe.

For example, 1 hour, 15 minutes, or 30 minutes can be feasible for them. Likewise, experienced professionals can perform daily or weekly.

Traders can also use other tools along with the fractal indicator. One of the popular ones includes the Alligator indicator given by Bill Williams. The latter suggested using both indicators together. Here, the trader must place an order above the teeth formation. But there must be 13-day moving averages evenly distributed. Other rules are listed below. Let us look at them:

● Bullish fractal above teeth = Placing an order above it

● Bearish fractal below teeth = Placing an order below it

● Bullish fractal below teeth = Ignoring it.

● Bearish fractal above teeth = Ignore it

However, traders can use other tools like pivot points and Fibonacci retracement level with fractal indicator calculation. It will help in better identification of trends.

Frequently Asked Questions (FAQs)

1. What are fractal indicators in forex?

The application of fractal indicators in the forex markets remains the same as in the stock market. Here, traders can easily use them to identify whether a particular currency will notice an appreciation or depreciation. For instance, the EUR/USD currently has a downward arrow or bullish fractal. Thus, in a few days, it might witness a bullish trend.

2. Does the fractal indicator repaint?

Repainting in the forex market refers to the situation where the indicator may repaint itself due to new prices. Fractal indicators might do the same. As a result, it might change the fractal and the trend.

3. What are the pros and cons of a fractal indicator?

Fractal indicator, as per trader, is the easiest tool to apply in technical analysis. It helps in identifying reversal points for a trend change. In addition, traders can easily use other indicators simultaneously at different timeframes. However, some limitations include false signals as it lags and uses past data. Also, it is not suitable for all market conditions.