Fractal trading strategy offers a simple yet effective way to find opportunities in the market. Here's a complete guide on how to apply it.

Fractal Trading Strategy

At first glance, market prices may look random and confusing. The truth is, if you pay enough attention, you will see that those prices actually create repeating patterns and trends that can help you win trades. Therefore, the ability to find these repetitive patterns and use them in a trade is one of the main keys to successful trading.

Fairly speaking, there are perhaps hundreds of different repetitive patterns to use in a trading strategy. However, not all of them are equally effective since humans and markets are always evolving. Some patterns may not be relevant anymore, while some others become stronger than ever. In this case, one of the most basic repeating patterns to use is fractal.

 

Understanding Fractal in Trading

When you hear the term "fractal", the first thing that might pop up in your mind is about complex mathematics. But in trading, a fractal is simply a repetitive price pattern that occurs in seemingly chaotic price charts. A fractal consists of five or more bars that align in a distinctive manner, where the middle candlestick should either be the highest or the lowest point. Fractals can either be bullish or bearish depending on the shape of the pattern.

There are two basic rules to identify fractals:

  • A bearish or down fractal occurs when there's a pattern with the highest high in the middle and two lower highs on each side.
  • A bullish or up fractal occurs when there's a pattern with the lowest low in the middle and two higher lows on each side.

Fractal Patterns

Before we continue, keep in mind that fractals are lagging. That means a fractal can't complete until we are at least two days into the reversal. However, most significant reversals will continue for more bars, benefiting the trader. Once the pattern appears, the price is expected to rise following the bullish fractal or fall following a bearish fractal.

 

Bill Williams' Indicators for Fractal Trading Strategy

To identify fractals, you can now use a trading indicator so that you don't have to manually search for the pattern in the chart. Bill Williams, an expert in stocks, commodities, and forex markets had developed a fractal indicator that can detect fractal patterns in a price chart. He also created several other brilliant indicators like the Accelerator/Decelerator Oscillator, Alligator, Awesome Oscillator, Gator Oscillator, and Market Facilitation.

Further, Bill's fractal indicator can be found in various trading platforms, including the famous MetaTrader 4. Simply add the indicator to the chart and the software will automatically highlight all of the fractal patterns for you.

The indicator basically displays an arrow above or below the middle candlestick of the fractal pattern, which aims to signal swing lows and swing highs in the market:

  • A fractal swing high is shown with a green arrow pointing upwards and is placed above the middle candlestick, where the fractal pattern must consist of at least five candlesticks. In this case, the low of the pattern can signal a potential support.
  • A fractal swing low is shown with a red arrow pointing downwards and is placed below the middle candlestick, where the fractal pattern must consist of at least five candlesticks with the middle candle being the lowest point of the pattern. In this case, the high of the pattern can signal a potential resistance.

Here's how the indicator looks like:

Fractal indicator

 

How to Use Fractal in a Trading Strategy

In addition to fractal indicator, another indicator that we're going to use in this strategy is the alligator indicator, which basically consists of 3 specific Moving Averages that serve different purposes:

  1. The 13-MA as the Jaw.
  2. The 8-MA as the teeth.
  3. The 5-MA as the lips.

To utilize fractal and alligator indicators, the first thing to do is obviously apply both indicators on your charts. Once applied, your chart would look more or less like this:

Fractal and alligator indicator

Fractals are shown in tiny upwards and downwards pointing arrows. However, just because an up or a down fractal is formed, it does not mean that these are valid signals to buy on bullish fractals or sell after the appearance of bearish fractals. In this case, you need to use the alligator indicator as a confirmation, especially the alligator's teeth, which is the line in the middle.

Fractal Trading Strategy

The signal can only be considered valid if there's an up fractal forming above the alligator's teeth or if there's a down fractal forming below the alligator's teeth. Therefore, we can also say that any up fractal located below the alligator's teeth and any down fractal above the alligator's teeth are not valid.

 

Wait Until 5 Consecutive Candles

Technically, fractals are used to signal short-term price reversals. Hence, the easiest way to use fractals is to sell on up arrows and buy on down arrows. But in reality, when a fractal appears, the price action is still rather "flat". It means there has not been a real breakout in the short term.

That being said, there's still a possibility that there might be a pullback, reversal, or if the price action is still consolidating in the flat market. Meanwhile, if you're using fractals as entry signals, you would want a big upward bullish move for buy orders and a significant bearish move for sell orders. That is why the best thing to do is to wait for at least five consecutive candles to form after the arrow before entering the market.

Fractal strategy step 3

 

Wait for a Breakout

Once you figure out that the 5 consecutive candles did not make any drastic move and stay in between the high/low of the fractal pattern and the alligator's teeth, then wait until the price breaks the high/low of the fractal pattern.

Fractal breakout

There are two conditions that could invalidate a buy signal. If one of these conditions happens, then we should forego the signal and look for other opportunities. These conditions can trigger a long bearish trend, which can't be good for your long position.

  1. If a down fractal appears below the alligator's teeth line before a position is opened.
  2. If any of the alligator's lines cross each other after a fractal pattern is identified.

 

What about the Exit Strategy?

Protective stop loss should be placed either above the up arrow for sell signals or below the down arrow for buy signals. You can also use a trailing stop loss to lock in profits.

Fractal Stop Loss

Alternatively, you can wait until 2 alligator lines cross each other because it most likely means the price action will either move to the other way or consolidate.

We can see that Bill Williams' fractal indicator offers a simple yet powerful technique to earn easy profit. Fractals can be used in various different ways, so it is suitable for almost any type of trader. The fact that most trading platforms now include fractals in their indicator list also adds to the benefit of using this indicator. However, it's important to understand that while this indicator is easy to use on its own, but it tends to generate false signals since it is a lagging indicator. Thus, it's highly recommended to combine it with other indicators, and alligator is one example that you can use according to the abovementioned strategy.