Fractals enjoy a special place in the field of mathematics, and have delighted mathematicians and lay-people alike with their captivating patterns and colors. In the investing world, a fractal does not refer to these specific formulaic structures. As a chart pattern on forex charts, a fractal is a simple method of identifying turning points in a trend. Traders use these fractals to participate in price reversals for a profit.
Look at a candlestick or bar chart in any trading platform or other charting software. Identify any areas where price reversed to the up-side or down-side.
Compare these turning points with two bars on each side of the reversal. A down fractal pattern exists if it presents a high point in the middle of the pattern with two lower highs on both sides. Similarly, a five-bar pattern with the lowest point in the middle and higher lows on each side represents a bullish fractal with an expected reversal to the up-side.
Combine the implication of the fractal pattern with another technical indicator for verification. Investopedia notes the popularity of the "Alligator indicator" for use with fractal patterns. This tool is based on a set of three moving averages. Fractal signals which occur above or below the center line in this system are considered valid, while other fractal signals are ignored. For example, a bullish turning point that displays below the "alligator's teeth" (the center line) carries more weight than one which does not coincide with this additional signal.
Implement an additional technical indicator to provide the most valid confirmation of the fractal pattern. A common indicator which works well in fractal analysis is the Fibonacci tool. This chart study applies ratio analysis to determine extreme price swings. When a bearish fractal turning point appears at a high Fibonacci extreme, the implication is particularly powerful. Some traders use both moving averages and Fibonacci levels with fractals to offer fewer, but more reliable, trading signals.
Draw a trend line between fractal pattern centers to analyze overall market structure. The traditional "Dow Theory" introduced by Charles Dow in the 19th century simply states that an uptrend is characterized by higher highs and higher lows. By only using highs and lows that are generated by true five-bar fractal patterns, the clarity of a trend line is more obvious This makes it particularly easy to identify the strength of a trend and when the trend may slow or stop due to a break in the line.
Always study a new chart pattern and technique extensively before committing real money to any strategy. It is important to gain experience with these patterns as they develop in real-time so there are no surprises in their behavior.
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