The Basics of Fractal Patterns - Locate Patterns That Reveal Trends
Traders are always aiming to integrate new techniques into their market analysis in order to get an edge. This article is going to explore a relatively new way of recognising price patterns, discussing an indicator that instantly flags up the patterns on a chart for you. These patterns are known as fractal patterns, and the Forex fractal indicator is the tool that identifies them.
What is a Fractal Pattern?
A fractal pattern is a repeating pattern in which the same configuration occurs throughout the structure, on a variety of different scales.
In nature, we see fractal patterns in the growth of crystals, the branching of twigs on trees, and the structure of snowflakes, to name just a few. These exhibit the properties of being recursive and self-similar. Fractal patterns are recursive because no matter how complex the whole, it is built from many repetitions of the same process. They are self-similar, in that if you look at a small section of the pattern, it is no different to a much larger section of the pattern, or even the whole.
How does this apply to the financial markets though?
Well, we can draw some kind of analogy between fractals and the behaviour of the financial markets. When we look at price movements in the market as a whole, it is clearly very complex, and it also appears to be random. The fractal theory, as propounded by well-known trader and analyst Bill Williams, suggests that this complexity is built up from self-similar patterns of trader behaviour. It follows, therefore, that there is ultimately a non-random structure to the whole that we can fathom.
Williams argued that the Elliott Wave was the underlying structure of the market, and that the structure of the Elliott wave is fractal. If trades are the results of a behavioural fractal, Williams reasoned, then the aggregate behaviour also follows a fractal pattern. In short, recognising the behavioural fractal pattern of the overall mass of traders offers a way to potentially profit from the market.
The Basics of Fractal Patterns
Williams stated that a fractal pattern on a bar chart was made up of a minimum of five consecutive bars. An initiating fractal must have a middle bar that has a higher high or lower low, compared with the two preceding bars, and the two following bars. Some examples of classic fractal patterns with five bars are shown in the image below:
As you can see from the image above, a fractal is like a mini-reversal. It highlights a potentially significant high or low. Do not let the up and down names confuse you — some label these patterns as bearish or bullish, but the truth is that they are neither inherently bearish or bullish. Their significance is contextual. That is to say, it only becomes bullish or bearish if the market behaves a certain way.
Though Williams maintained that these fractal patterns were simple and easy to recognise, the reality is slightly different. Trying to visually pinpoint sequences of these patterns on a chart is an irksome process. Here's the good news: the Bill Williams fractals indicator is one of the standard tools that come packaged with the MetaTrader 4 trading platform. Handily, there is no need to perform a separate fractals indicator download. So having familiarised ourselves with the basics of fractal patterns, let's take a look at the MT4 fractals indicator itself.
Using the Forex Fractals Indicator in MetaTrader 4
You can locate the fractals indicator within the 'Bill Williams' folder in MT4's 'Navigator' tab. The screenshot still shown below demonstrates how to find it:
Source: MetaTrader 4 - Navigator tab - Locating the fractals indicator
Clicking on 'Fractals' launches the dialogue window for the fractals indicator (as shown in the image above). Now, the purpose of the fractal indicator is simply to recognise the standard, recurring patterns defined by Bill Williams. This means there are no variables to set when you launch the tool.
As you can see, the only choice relates to the cosmetics for the indicator — i.e. a choice of how large to make the markings for the MT4 fractals, and in which colour they should appear. The image featured below shows MT4 fractals marked on an hourly EUR/USD chart, using the default settings for colour and line-thickness:
Depicted: MetaTrader 4 - EUR/USD Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
The MetaTrader fractals indicator here has completed all the work in regards to identifying the Forex fractals in our chart for us. When it comes to making trading decisions however, this is only part of the job. We need to look at the sequences of fractal Forex patterns together, in order to identify trends, and then subsequently decide on a trade to make thereafter. Using the fractals indicator meaningfully requires a bit of knowledge of Bill Williams' trading rules. Let's run through them briefly and see how we can apply them:
Rules for Trading with the Forex Fractals Indicator
Williams' original rules for fractal trading involve searching for certain formations that signal a trade. Specifically, we want two adjacent MetaTrader 4 fractals that are pointing in the opposite direction to each other. This will constitute what Williams referred to as a fractal start and a fractal signal. The fractal start is simply any fractal followed by a fractal in the opposite direction. The signal is the direction of the second of these two fractals.
With an up fractal, we are only concerned with the level of the highest bar. In a down fractal, we are only concerned with the level of the lowest bar. Most important of all, we only trade on the signal if the market moves beyond the high or the low of the fractal signal. Another term Williams defined was the fractal stop, which is the furthest point from either of the previous two fractals, that are in the opposite direction to the signal. When trading on a fractal signal, Williams recommended putting a stop just beyond the fractal stop.
The rudimentary trading rules include:
- To trade in the direction of the fractal signal after a fractal start
- But only if the market subsequently resumes in the signal direction, and then breaks beyond the level of the fractal signal
- To place a stop-loss to close this trade, guided by the level of the fractal stop
Williams, who was trading with futures contracts, recommended that the stop be one tick beyond the fractal stop. This is illustrated in the diagram below:
Depicted: MetaTrader 4 - EUR/USD Daily Chart - Placing a stop-loss - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
So these are the basic trading rules provided by Bill Williams, but are there any drawbacks? There are, of course. No indicator is perfect and the fractals indicator is no exception. For example, the indicator provides a large number of fractal signals, and plenty of these will be false. Indiscriminately trading on all of these will yield poor results. The best fractal indicator performance will come when you combine it with other trading tools, in order to tighten up trading signals.
The most obvious way is to combine the Forex fractal indicator with another one of Bill Williams' inventions, the Alligator Indicator.
For example, a potential method would be to only open a trade when both the fractals indicator, and the Alligator indicator, agreed on a trend direction. One of the strengths of the Alligator indicator is that it helps you to maintain a position while the market is still trending in your favour. Another combinatory use, therefore, might be to keep a position open as long as the 'jaws of the alligator are open and it is still feeding'.
If you're looking for a wider selection of indicators than are available with the standard version of MT4, why not consider downloading the MetaTrader 4 Supreme Edition add-on? It's a custom plugin with a cutting-edge set of additional trading tools, chosen by industry professionals.
Fractals Indicator Forex Trading — A Conclusion
Fractals trading is designed to align you with the trend. The fractals indicator quickly identifies fractal highs and lows that may be of significance, and from these we obtain signals designed to align us with the directional flow of the market. Bear in mind, the standard fractals indicator in MT4 is not the only game in town — there are other custom indicators available as well. For instance, there are reversal fractal indicators that focus on identifying price reversals.
There are even reversal fractal indicators with alert notifications that you can customise, to let you know when key patterns are forming. It's sensible not to rely too heavily on one indicator in isolation. As we mentioned earlier in this article, you can improve the performance of the fractals indicator, if you combine it with another indicator.
You may find, for example, that fractals are more effective as a way to confirm or support your decision making, rather than as a primary signal for initiating a trade. There's a long list of available combinations. Which one works best is for you to decide — a good way to discover effective combinations is by experimenting in the risk-free environment offered with a demo trading account. Once you've seen what works for you, you can make a transition to the live markets, and see if the strategies lead to success!
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.