Fractal Chaos Bands

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Introduction

Australian commodity trading adviser Edward William Dreiss was the first who started to use fractal geometry as a way to measure price movements of different securities. Fractals are mathematical tools that essentially divide large trends into extremely facile and predictable patterns. For most traders fractals are considered to be recurring patterns that can predict reversals in chaotic stock price movements.

When looking at price movement charts, sometimes it’s difficult to observe whether the bars in the chart are referring to hours, days or months, if the time scale is not given. The charts look the same, regardless of its time resolution, with the only difference being the size. To examine these patterns the Fractal Chaos Band Indicator can be used to determine what is happening in the current level of resolution. Fractal Chaos Band is an excellent 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.

Applying Fractal Chaos Bands Indicator to Trading

Stock market moves in a highly chaotic way, but at a larger scale, the movements follow a certain pattern that can be applied to shorter or longer periods of time and we can use Fractal Chaos Bands Indicator to identify those patterns. Basically, the Fractal Chaos Bands Indicator helps us to identify whether the stock market is trending or not. When a market is trending, the bands will have a slope and if market is not trending the bands will flatten out. As the slope of the bands decreases, it signifies that the market is choppy, insecure and variable. As the graph becomes more and more abrupt, be it going up or down, the significance is that the market becomes trendy, or stable. Fractal Chaos Bands Indicator is used similarly to other bands-indicator (Bollinger bands for instance), offering trading opportunities when price moves above or under the fractal lines.

The FCB indicator looks back in time depending on the number of time periods trader selected to plot the indicator. The upper fractal line is made by plotting stock price highs and the lower fractal line is made by plotting stock price lows. Essentially, the Fractal Chaos Bands show an overall panorama of the price movement, as they filter out the insignificant fluctuations of the stock price.

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Examples

Figure 1
Fractal Chaos Bands example

Figure 2
Fractal Chaos Bands example

In figure 1, the fractal chaos bands have slopes that are not extremely abrupt. In trading, this relates to a capricious, volatile market, on that certain period of time (1 hour). In figure 2, the market becomes trendier, as slopes increase. Trendiness in investing means that from that point on, the market is following a certain pattern and it’s easier for traders to make assumptions about the direction the market is heading to.

Conclusion

Fractals are extremely powerful tools when used together or transformed into financial indicators and forecasting techniques. The most common usage is with the "Alligator indicator"; however, derivative of this method is the Fractal Chaos Bands Indicator, a tool that connects the highest and lowest value points on an interval with two lines, and creates an actual band. The mentioned band is extremely easy to interpret, the flatter it is, the choppier the market. The more the band resembles an alligator’s teeth, the trendier the market is and easier to forecast. Overall, fractals make excellent decision support tools for any trading method. Similar to numberless mathematical instruments, fractals are used in trading to forecast trends, to determine time resolution etc., and are extremely practical when trying to determine a safer way to address the stock market. However, mathematics does not apply 100% to the trading market, but all the mathematical devices that are turned into financial indicators help traders a great deal when “playing” with securities.