Fractals

Charting Indicators — November 10, 2010 at 5:05

One of the main problems with trading the markets is accuracy. While trading may be profitable, it’s finding a system that produces consistent gains that is usually the hard part. One way to increase your trading accuracy is not to trade against the market, but to trade with it, by following the trends that the market is demonstrating.

One basic signal that you can use to identify trends is fractals. Fractals are points where reversals occur, and can lead you to enter a trend just as it begins. The drawback is that there are false positives, or times when the reversal does not follow through. Therefore, a good system of exiting, money management, and further confirmation signals should also be used.

The definition of a fractal is a pattern that consists of at least 5 bars, and follow these rules:

• Up fractal: This pattern will show the highest high in the middle, and at least 2 lower lows, on each side.
• Down fractal: This pattern will show the lowest low in the middle, and at least 2 higher highs, on each side.

A few examples of valid fractals are shown below:

An example of fractals on an actual chart can be seen below, where we analyse China Animal Healthcare. We can see that on all the points labeled “1″, are examples of up fractals. Similarly, all the points labeled “2″ are examples of down fractals.

Fractals are great indicators as you can see, but the problem with fractals, is that they are a lagging indicator, and as such, are better used as confirmation indicators. Stay tuned for future articles where we talk about trading strategies regarding fractals.

Tags: 5 bars, animal healthcare, false positives, Fractals, lagging indicator, middle, reversals, signal, trend, way