In 1975, a Polish mathematician living in the United States and working for IBM named Benoit Mandelbrot coined the word “fractal” to describe geometrical shapes that appear equally rough at all scales. This was the basis for fractal geometry. Simply stated, fractal geometry maintains that some geometric shapes remain rough regardless of scale. A famous example is that of a rocky coastline, which will look equally jagged whether viewed from a few feet or from hundreds of miles in space.
Mention this coastline image of fractal roughness to a trader, and he or she will immediately recognize the uncanny similarity between the shape of a rocky coastline and that of a price chart depicting the price fluctuations of financial instruments.
Mandelbrot applied his concept to financial markets, such as cotton futures, and many traders employ a fractal strategy in predicting future prices in many markets, one of the primary ones being the Forex currency markets.
The basis of the fractal strategy is that currency prices will fluctuate in a pattern that can be observed on price charts displaying many different time frames. A trader well versed in the strategy can observe historical patterns over longer time frames and trade accordingly when a similar pattern of prices begins to form on shorter time frames.
In currency trading, traders seek fractal signals by observing a price series containing five or more bars or candles, attempting to predict when price reversals will take place. A selling signal based on an ideal fractal formation would occur when the highest high of the series is in the middle of the bars with two lower highs on either side. For a buying signal, the exact opposite conditions apply, those being a lowest low in the middle with two higher lows on each side. It should be noted that in real world trading, fractal patterns are seldom perfect due to the chaotic nature of financial instrument prices.
The weakness of fractal strategies is that they fall into the category of lagging indicators. If a trader were using it on a daily chart, by the time the signal appeared it would be two days into the reversal, which can be an eternity in the currency markets, causing a trader to miss most or all of a trend. The same is true for shorter time frames as well. Also, no trading strategy is perfect and all of them, including fractal strategies, must be combined with other indicators to achieve confirmation of validity. Trader experience plays a key role as well.
Even though the time delay inherent in fractal signals might cause a trader to miss a market reversal, there is an equal probability that when they do signal a reversal, that reversal will last many more than the two price bars or candles that first generated the signal, giving the trade adequate time to profit from a trend.
Since the math involved in fractal geometry frequently describes roughness found in nature, many traders will combine fractals with another indicator that is based on natural science, the Fibonacci sequence. They will often use the Fibonacci overlay indicator to predict exit points of maximum profit where the likelihood of prices stagnating or reversing after initiating a trade based on a fractal setup.
Forex brokers, such as AlfaTrade, offer traders of all experience levels expert educational resources that show traders how to find fractal signals on price charts representing all time frames and how to combine those signals with other indicators to gain a trading edge.