Fractal Chaos Oscillator

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Introduction

Australian based trader Edward W. Dreiss was the first man who started to use fractal geometry for purpose of measuring the price movements of different securities. Widely used in mathematics, fractals are connected to chaos theory and abstract mathematics and are helpful when applied to the market, since the market itself is dynamic and nonlinear. In trading, fractals are referred to in their literal meaning, when used to divide larger trends into simple and predictable patterns, to predict reversals in the market development and determine repetitive samples that forecast 180 degrees turns among larger, more chaotic price spreads.

When looking at price movement charts, if the time scale is not given, sometimes it’s very hard to determine whether the bars in the chart are referring to hours, days or months. The chart always looks exactly the same regardless of its time resolution, with the only difference being the size. To examine these patterns the Fractal Chaos Oscillator can be used to determine what is happening in the current level of resolution. Fractal Chaos Oscillator is a great indicator to use in intra-day trading.

What Are Fractals?

By definition, fractals are mathematical objects that are self-similar irrespective of scale. To put it more clearly, the surface of a fractal has features on a large scale which are the same basic shape as smaller scale features, so when you look at a fractal and zoom in or out, it still basically looks the same.

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Applying Fractal Chaos Oscillator to Trading

In trading, fractals are called lagging indicators, that is they can form a graph with a certain lag, because a longer period of time is needed in order for a trend to be detected. Traders use fractals to determine reversals in market trends, and if a reversal is spotted, an important one that is, it will be spread on a high number of bars. If the trend change is negligible, then it is not worth taking into consideration and the trend will be unchanged.

Basic fractals have five bars or more. One can identify fractals as follows:

  • The highest value from a determined period of time, enclosed on both sides by lower high values is called a bearish turning point.
  • The lowest value on a determined time period, enclosed on both sides by higher low values is called a bullish turning point.

Fractal Chaos Oscillator Indicator or FCO “goes back in time” depending on the time interval selected by the trader and checks the choppiness of the market versus its trendiness and expresses it in the form of a numeric value. In choppy, variable markets, the indicator tends to return to 0. In markets that follow a trend, the graph of this indicator becomes abrupt and resembles the “alligator’s teeth” and essentially furthers itself from the 0 value, be it in a negative direction or a positive one.

Interpretation

The value of Fractal Chaos Oscillator is calculated as the difference between the most subtle movements of the market. In general, its value moves between -1.000 and 1.000. The higher the value of the Fractal Chaos Oscillator, the more one can say that it follows a certain trend – an increase in prices trend, or a decrease in prices trend.

Being an indicator expressed in a numeric value, traders say that this is an indicator that puts a value on the trendiness of the markets. When the FCO reaches a high value, they initiate the “buy” operation, contrarily when the FCO reaches a low value, they signal the “sell” action. This is an excellent indicator to use in intra-day trading.

Fractal Chaos Oscillator vs. Fractal Chaos Bands Indicator

Similar in name, the two indicators are relatively similar in their interpretation as well. They both reflect the trendiness of the markets, but in different ways. On a chart, the fractal chaos bands indicator resembles a band, comprised by the two lines that are plotted through the highest and lowest values of the market on that time period. The flatter the band is, the choppier the market. The more chaotic the band looks, the trendier the market is.

Conclusion

Fractals are extremely powerful tools when transformed into financial indicators or used for forecasting of price movements. The most common usage is with the "Alligator indicator"; however, derivative of this method are the Fractal Chaos Bands Indicator and the Fractal Chaos Oscillator. They both reproduce the predisposition of the market on a given time period, but the Bands indicator is a visual indicator, the trendiness of the market can be seen on a chart – and looks like an alligator’s teeth, whereas the Oscillator is a logical indicator, expressed through a numeric value. The results of the oscillator can be seen on a chart as well, but they have exact value correspondents. The trading rule is: buy when the numeric value of FCO is close to 1 and sell when it’s close to -1.