Definition of Fractals
When traders think of fractals they think of chaos theory and abstract mathematics but most traders see them in a simpler way which is a they are simply recurring price patterns which can predict reversals among larger and more chaotic price movements.
Bill Williams Fractal Indicator
"Fractal — it is price behaviour change. It means if fractal has appeared - price will change it direction. Fractal is a five bars sequence, where the central bar has higher maximum or lower minimum. The fractal arrow shows central bar position." Bill Williams - "Trading Chaos"
The Fractal trading indicator comes as a standard indicator on many charting programs such as Metatrader and Tradestation. The indicator consists of three moving averages with different parameters (5,8,13) and colors (blue, red, green). A fractal outside of these bands is considered more valid.
The Fractal Trading Indicator therefore, consists of a series of at least five successive bars, with the highest high in the middle, and two lower highs on either side of it. The reversal set up is a series of at least five successive bars, with the lowest low in the middle, and two higher Lows either side of it which creates to the sell fractal. The fractals high and low values and are simply indicated with an up and down arrow.
A bearish signal occurs when there is a pattern with the highest high in the middle and two lower highs on each side.
A bullish trading signal occurs when there is a pattern with the lowest low in the middle and two higher lows on each side.
Fractals and Bill Williams Alligator Indicator
Bill Williams Alligator indicator is a way of filtering signals for bigger profits and he likened it to a compass for navigating the markets and helping you get in on the best moves. The purpose of the The Alligator is to help traders spot valid trends and stay out of range-bound markets, which normally result in losses.
The indicator is a lagging indicator and a common way to apply it is with the Bill William's Alligator indicator. This technical indicator is used to filter trading signals. When using the Alligator indicator, all buy signals are only valid if below the "alligator's teeth" (the centre moving average), and all sell signals are only valid if they are above the alligator's teeth.
A fractal outside these bands is more valid due to the extreme conditions necessary for price to trace to these areas. When price is trading outside the Alligator, fractals are more likely and predictable.
The "Alligator indicator" is the most common way of using fractals for Forex traders but they can be used in other ways as we have seen. There obvious limitation is they are Lagging indicators so they need to be combined with other indicators and are seen as useful to confirm a reversal in the market really did take place and fractals confirm this.
The longer the time period a traders uses (i.e. the number of bars required for a fractal), the more reliable the reversal will tend to be. Fractals can be used in multiple time frames and long-term fractals can be used to confirm short term fractals.
The fractal and Alligator indicators, I have tried but have really found they have not worked for me, combined with the indicators I normally use. As I have said in a previous article on Williams and Chaos theory the alligator and fractal indicators are nothing new and are really just renamed indicators based on moving averages and the MACD with tweaked parameters. Finally, as with all indicators, you need to try them for yourself and combine them with others, in your trading strategy and see if they work for you.