Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a forex trader!
Today we are going to be looking at fractals and their application in the Forex market.
Although at times, the forex market seems to be unpredictable, candlesticks and price actually create a series of repeating patterns and trends. To the untrained eye, it can be hard to discern these patterns, but with the help of this channel, we hope to provide you with the skills necessary to identify them.
One of the more basic repeating patterns is a fractal. Fractals are very simple five-bar reversal patterns. Let’s now take a look at how we may apply fractals to our trading strategy after first identifying what exactly are.
Fractals are a recurring pattern that occur amongst a larger, more chaotic series of price movements. Fractals are composed of five or more bars. As always, we have a set of rules for identifying fractals, and they are as follows.
Firstly a bearish turning point occurs when there is a pattern with the highest high in the middle and two lower highs on each side.
Secondly, a bullish turning point occurs when there is a pattern with the lowest low in the middle and two higher lows on each side.
The fractals shown here are perfect examples of the bullish and bearish patterns. Generally, you’re going to see less perfect versions of these when looking for them in the market, but the rules remain the same. If when analysing the market for fractals, the pattern doesn’t follow the rules, then we don’t follow it as an indicator.
Now as always fractals are essentially a lagging indicator and provide us with a delayed signal to enter the market. The fractal can’t be successfully identified until after the move; however, most significant reversals will continue on for an extended period of time. Once the pattern presents itself, the price is expected to rise following a bullish fractal or fall following a bearish fractal.
Most charting platforms available provide fractals as a trading indicator, or you can find them freely available for download online. This can save us a great deal of time as we don’t have to manually scan through charts identifying the patterns. An immediate concern after the application is that you will notice this pattern occurs frequently.
In order to reduce the number of trades we take and increase the probability of taking a correct reversal signal provided by fractals, It is probably best to use fractals in conjunction with other indicators. If we incorporate moving averages such as the 200 MA into our charts, we can now look for trade setups surrounding bounces from the MA in the direction of the trend while using fractal patterns as a confirmation of reversal.
It is important to remember this as it is slightly confusing, but a bearish fractal is typically drawn on a chart with an up arrow above it by most indicators. Bullish fractals are drawn with a down arrow below them. So if we are using fractals in an overall uptrend as previously discussed, look for the down fractal arrows. Likewise, If you are looking for bearish fractals in a larger downtrend look for up fractal arrows.
Let’s now set our fractals to a higher time frame so that we may have fewer but higher probability signals.
Fractals provide us with entries. However, that does not mean we take every opportunity as we must reduce the risk. In order to reduce the risk, we discussed earlier using additional indicators to limit the number of trades we take in favour of higher probability setups.
Another way we can control the risk is by using our stop losses effectively. After entry, we will want to place a stop-loss in this example below the established low of our fractal signal as this is in an uptrend and we are buying. Considering that we want good risk to reward ratios such as a 1 to 2 then if our entry to our stop-loss is 100 pips we want to take profit to be around 200 pips. If you Precalculate your potential loss surrounding the pair and lot size you will know what percentage of the account will be risked.
We can increase our chances of entering higher probability trade setups by nullifying the weaknesses of indicators with the strengths of others. Take the Fibonacci retracement, for example, the issue we have with Fibonacci is which retracement level is it going to bounce off. Usually, we know it will be one of three levels, but sometimes opportunities are missed. Similarly with fractals, sometimes it’s hard to know which pattern will yield the greatest movement.
By combining the two, we narrow down the possibilities as when we are seeing reversal fractal formations along with key Fibonacci levels they are more likely to go in our favour.
The chart here shows this exact trade set up in action. The price is in an overall uptrend and then retraces. The price forms a bullish fractal reversal near a key level of the Fibonacci tool, And there is our signal to buy the market.
In summary Fractals can be useful tools when used in conjunction with other indicators and techniques. We discussed strategies invoking moving averages and another using the Fibonacci retracement levels, but the main take away to consider is finding converging indicators that cancel out the weaknesses of each other to find stronger trade signals. Where is we never use one indicator or even 2 to base an entire strategy on you can see how using fractals within your strategy can aid in your trading decisions.
Thank you for taking the time to watch our educational video today, and I hope you have learnt a lot. Please open up your charts and start to review what you have learnt here today. Please contemplate the use of fractals within trading remember contemplation is the key to learning.