There’s no denying traders look for ways and strategies to navigate the wild price swings of digital assets. They’re constantly searching for reliable methods to forecast market movements and improve their trading strategies to avoid massive losses. Enter fractal trading, a sophisticated approach that uses repeating patterns found in crypto price charts.
In this guide, we’ll discuss what a fractal pattern is, how to identify and trade fractals, and the formula to calculate fractals. We’ll also weigh the pros and cons of this trading strategy.
What is a fractal?
A fractal is a repeating pattern occurring within price charts at different scales or sizes. Crypto traders use it to predict potential market movements by identifying reversal points, continuation patterns, or key support and resistance levels. They identify fractal patterns by their characteristic shape and structure, which remain consistent regardless of the time frame.
A basic fractal pattern typically consists of a minimum of five consecutive bars, with the middle bar representing the highest (in a bullish fractal) or the lowest (in a bearish fractal) price point of the pattern. Bullish fractals suggest a potential upward movement in prices, while bearish fractals indicate a possible downward trend. These patterns are based on the principle that market behavior is self-similar across different time scales, allowing traders to apply fractal analysis to various time frames, from short-term minutes to long-term days or weeks, to make informed trading decisions.
The formulas for fractals
Crypto traders use two distinct formulas—bearish and bullish—to determine a fractal pattern. But to use these formulas, they must first identify the high or low cryptocurrency price, which can be deciphered using the moniker “N.”
For example, in a bearish fractal formula, traders look at the current price high (N) and determine if it’s greater than N minus two or one, meaning it’s greater than the high on the price bar two or one period to the left of N. Next, they check if the high is greater than N plus two or one, meaning it’s greater than the high on the price bar two or one period to the right of N.
Here’s what a bearish formula looks like:
High (N) > High (N-2) and
High (N) > High (N-1) and
High (N) > High (N+1) and
High (N) > High (N+2).
Conversely, traders view the opposite metrics in the bullish formula. They start by examining the current price low (again labeled as N) and see if it’s less than N minus two or one period to the left of N. From there, they see if the low is less than N plus two or one (either two or one period to the right of N on the price bar).
Here’s what the bullish formula looks like:
Low (N) < Low (N-2) and
Low (N) < Low (N-1) and
Low (N) < Low (N+1) and
Low (N) < Low (N+2).
How to identify fractals on a crypto chart
Identifying fractals on a crypto chart involves looking for specific patterns that signal the possibility of a market turning point. Here's how to spot these fractals:
Understand the basic fractal pattern
Fractal patterns move up or down. A bullish one suggests the cryptocurrency price’s lows are ending, and highs will ensue. In a bullish pattern, five candles form, with the third marking the cryptocurrency’s lowest point. The first two and final two candles show higher lows.
A bearish fractal assumes the opposite form. Five candles form on a chart again, but instead of the lowest low, the third candle features the cryptocurrency’s highest point, while candles one, two, four, and five are lower. The fractals show the price moving in a diagonal line, though when the pattern is bullish, that line goes down, then up. If it’s bearish, the line moves up, then down.
Look for the patterns at key levels
Fractals are more significant when they occur at support and resistance levels or near other important indicators like moving averages or Fibonacci retracement levels. A fractal’s presence at such levels may indicate a stronger market reversal or continuation potential.
Practice and experience
Like any trading strategy, identifying fractals effectively comes with practice and experience. Spend time analyzing historical charts to see how fractal patterns play out and combine them with other analysis methods to develop a comprehensive trading strategy.
How to use fractals in crypto trading
By identifying these fractal patterns, traders can fine-tune their entry and exit points, improve their risk management, and enhance their overall trading strategies. While fractals can be powerful, they’re most effective when combined with other technical analysis tools. Here are two of the most effective trading strategies:
RSI and fractal trading strategy
This strategy combines the relative strength index (RSI) with fractal indicators to pinpoint potential entry and exit points. The RSI is a momentum oscillator that measures the speed and change of price movements, typically over 14 days, to identify overbought or oversold conditions.
For example, if a cryptocurrency is oversold, a trader likely enters the market following the formation of the fifth candle. The digital asset has probably endured the peak of its descent and is about to start moving up.
Conversely, if there’s opposite movement, the trend is likely bearish, with the trader placing a stop-loss order on the crypto when it reaches overbought status, thus exiting the market and cashing in before dips occur.
Fibonacci retracement and fractal trading strategy
This strategy uses Fibonacci retracement levels with fractals to identify potential support and resistance levels, offering traders strategic points for entries and exits.
For this method, traders must first understand a cryptocurrency’s trend. Lower lows and highs suggest it’s traveling south, while higher highs and lows mean it’s growing in value. If the trend moves downward, they should draw the Fibonacci retracement confluence starting at the highest point and ending at the lowest on the chart. If the featured pattern retests former Fibonacci retracement levels, they should potentially enter the market and open a position following the fifth candle’s close.
In situations like these, it’s recommended to short-sell positions––like placing a stop-loss order above the fractal to hold the position. So if the signal is bearish, the swing low on the chart should be the profit target; otherwise, it’s the swing high if the signal’s bullish.
Benefits of fractal trading
Fractal trading enables a deeper understanding of market trends and potential reversal points. Here are a few key benefits of employing fractal trading strategies:
- Enhanced market timing: By spotting fractal patterns, traders can improve their timing for entering and exiting trades, potentially increasing profitability by catching the beginnings or reversals of significant price movements.
- Multi-timeframe analysis: Fractal trading is applicable across different time frames, offering flexibility and a comprehensive view of market dynamics. This multi-timeframe approach confirms trends and signals, increasing the robustness of trading decisions.
- Risk management: The clear patterns identified by fractals can aid in setting more precise stop-loss and take-profit levels, improving the overall risk management of trading activities.
- Clear support and resistance levels: Fractals help traders pinpoint crucial support and resistance levels, providing insights into potential barriers that might influence future price movements.
Limitations of fractal trading
While fractal trading offers insightful perspectives into market dynamics and potential trading opportunities, it's not without its limitations. Below are a few notable cons associated with fractal trading:
- Late signals: Fractals require a complete pattern formation before providing a trading signal, which may result in delayed entries or exits. This delay can sometimes cause traders to miss the most advantageous positions.
- Subjectivity: Identifying fractal patterns can sometimes be subjective, with different traders interpreting the patterns in varying ways. This subjectivity can lead to inconsistent trading decisions.
- Market noise sensitivity: Fractal patterns can be sensitive to market noise, especially in lower time frames, leading to identifying patterns that don’t result in significant market movements.
Learn more about crypto trading with dYdX Academy
Looking for beginner-friendly content on trading, technical analysis, and crypto? Look no further than dYdX Academy. Our education hub features dozens of guides on all things blockchain.
dYdX also offers eligible traders access to many contracts and tokens through our decentralized exchange. Find out more details about our platform and products on our official blog, and start trading on dYdX today.
Disclosures
The content of this article (the “Article”) is provided for general informational purposes only. Reference to any specific strategy, technique, product, service, or entity does not constitute an endorsement or recommendation by dYdX Trading Inc., or any affiliate, agent, or representative thereof (“dYdX”). Use of strategies, techniques, products or services referenced in this Article may involve material risks, including the risk of financial losses arising from the volatility, operational loss, or nonconsensual liquidation of digital assets. The content of this Article does not constitute, and should not be considered, construed, or relied upon as, financial advice, legal advice, tax advice, investment advice, or advice of any other nature; and the content of this Article is not an offer, solicitation or call to action to make any investment, or purchase any crypto asset, of any kind. dYdX makes no representation, assurance or guarantee as to the accuracy, completeness, timeliness, suitability, or validity of any information in this Article or any third-party website that may be linked to it. You are solely responsible for conducting independent research, performing due diligence, and/or seeking advice from a professional advisor prior to taking any financial, tax, legal, or investment action.
You may only use the dYdX Services in compliance with the dYdX Terms of Use available here, including the geographic restrictions therein.
Any applicable sponsorship in connection with this Article will be disclosed, and any reference to a sponsor in this Article is for disclosure purposes, or informational in nature, and in any event is not a call to action to make an investment, acquire a service or product, or purchase crypto assets. This Article does not offer the purchase or sale of any financial instruments or related services.
By accessing this Article and taking any action in connection with the information contained in this Article, you agree that dYdX is not responsible, directly or indirectly, for any errors, omissions, or delays related to this Article, or any damage, injury, or loss incurred in connection with use of or reliance on the content of this Article, including any specific strategy, technique, product, service, or entity that may be referenced in the Article.