Fractals are a mathematical vocabulary term, but they’ve been turned into technical trading tools, as well. In forex, trading platforms like Metatrader 4 and TradeStation keep traders from having to explore fully the mathematics of the indicator. Rather, traders simply need to know how fractals work, and how they can be used in profitable forex strategies.
Fractals occur as a function of 5 trading bars. There are two types of fractals, buy and sell fractals:
- Buying Fractals – A buy fractal forms at the highest bar of a set of five trading bars. On each side of the fractal you should find two lower bars.
- Selling fractals – A selling fractal forms at the lowest bar of a set of five trading bars. On each side of the fractal you should find two higher bars.
Fractals: Their Use in Forex Trades
Because fractals are a mathematical finding, there is no explicit method for using fractals in forex trading. Bill Williams outlined several techniques for using fractals in your trading strategy, and any one of the following fractal uses are quite profitable and popular with traders.
Fractals for Trendlines and Horizontal Support or Resistance
One method to employ fractals in your trading strategy is to use each fractal point as a point of reference for horizontal support and resistance lines, as well as diagonal trend lines.
- Support lines – Support lines can be made by drawing a trend line through several different forex fractals that appear on the chart.
- Resistance lines – Resistance trend lines can be made by drawing a line through several different forex buy fractals on a chart.
Fractals Confirm Forex Trends
We can use a derivative of our trend line studies to confirm market sentiment, or momentum. When the market is in a strong bear market move, there will be several more broken sell fractals than buying fractals. When the market is in a strong bull market, there will be several more broken buy fractals than selling fractals.
Furthermore, we can see ahead of time the end of a trend. If a forex pair fails to push through the previous high or low fractal, the trend is consolidating. (If we were to use the fractal indicator with another Williams Indicator, the Market Facilitation Index, we would most likely see a pink bar forming.)
Fractal-based Forex Trading Strategy
Bill Williams knew that fractals could be powerful as trading indicators, but only when a trader could successfully include or disclude fractals to make trading decisions. Williams eventually paired the fractals indicator with the Alligator indicator to form a very basic trading strategy.
Traders still use this trading strategy today with success.
In the fractal and Alligator trading strategy, traders should:
- Buy – Place a buy order when a fractal appears above the Alligator’s teeth. Williams would recommend you use a limit order to place such a trade only if the market moves slightly above the last fractal. Thus, if the last fractal on a EUR/USD chart were to appear at 1.3500, you might place a limit buy order at 1.3505.
- Sell – Place a sell order when a fractal appears below the Alligator’s teeth. Williams said sell orders should also be placed as a limit order, so as to enter a trade only when the price fell below the last sell fractal. So, if the last fractal on a chart of GBP/USD appeared at 1.4900, you might wish to enter a limit order at 1.4895, five pips below the last sell fractal location.
Naturally, traders should never hold a buy or sell position when the Alligator’s teeth run opposite to the trading rules above. Hold long positions only if the buy fractals are above the teeth. Hold short positions only if the sell fractals are below the teeth. Simple enough, right?
Finally, a limit buy or sell order should remain in play only until it is placed in the market, or until a new fractal is formed. Once a new fractal is formed, it’s time to adjust your limited entry points around the new fractal formation. Traders can double down on a trend by adding another position to their short or long trades when several buy or sell fractals occur in a row.