Fractals

In financial trading, fractals are a commonly used tool in technical analysis to help identify and confirm turning points for a particular asset.

Developed by the famous trader Bill Williams, a fractal appears above or below a candlestick. Traders routinely use fractals to ascertain which direction a price will develop.

A fractal will form when a particular price pattern happens on a chart.

The default fractal used by Bill Williams is based on a simple five bar pattern. In short, a bullish fractal appears below a candle when the two previous bars’ lows are higher, and when the two following bars’ lows are higher.

A bearish fractal appears above a candle, when the two previous bars’ highs are lower, and when the two following bars’ highs are lower.

This is why a trader needs to be careful with fractals.

Despite being attractive when viewing historical charts, in real time, you should know that the fractal arrow is always confirmed two bars back.

This means a fractal could disappear while the succeeding two candles don’t fulfill the conditions of a five-bar fractal setup.

How to Trade Fractals

Fractals are one of the few indicators that can be considered both leading and lagging. It’s a leading indicator in the sense it aims to predict when and where the market shall reverse.

By extension, it’s a lagging indicator because it is only produced after the reversal has partially developed, although before the potential trend is in full flow.

Despite the fact that a fractal is only confirmed after two candles into the reversal, it isn’t much of an issue.

This is of course due to the fact that most important reversals usually last for many candles, thereby allowing the trader to enter a buy or sell before the impending trend is established.

Of course, fractals, as with so many indicators, are best used combined with other technicals.

Bill Williams himself suggests using fractals with another of his indicators, called the Alligator indicator.

The Alligator is a series of three moving averages which are referred to as the “teeth”. The rules are simple, if the fractal appears above the Alligator’s teeth, this is considered a valid sell signal, and if the fractal appears below the Alligator’s teeth.

Overall, fractals are also used by traders who don’t actually base their entry decisions on them, but rather applied to charts as an assistant.