Fractals have a multipurpose use when
applied to trading; the amount of trading systems based around this
one indicator are too numerous to list.
To understand the “Daily Fractal
Trading System” first we need to understand how a fractal is
generated. A fractal calculates the series of candlesticks over the
last 5 days. A bullish fractal occurs when the lowest low of any
trading day is represented by the middle candle, with two
successively higher trading days on each side. This is seen as a buy
signal.
Bull Fractal
A
bearish fractal occurs when the highest high of the five days is
represented by the middle candle, with two successively lower trading
days on each side. This is seen as a sell signal.
Bear Fractal
The middle
candlestick of the series of 5 is the central point of the Fractal,
but this is not known until the 5th candlestick starts. When you use
the Meta Trader 4 platform or other, the “Bill Williams Fractal” indicator
comes as standard.
As soon as the 5th
candlestick starts, the indicator produces an arrow either above or
below the central candlestick depending on whether it`s a bull or
bear fractal. Now, when you add the Bill Williams fractals indicator
to your chosen price chart it produces lots of arrows, both bullish
and bearish, in fact so many you wonder if it is possible to make a
valid entry signal out of them at all. We mentioned earlier that the
fractal indicator is used in a multitude of different trading
systems, either as an entry point or as a trailing stop to maximise
profits. The way the “Daily Fractal Trading System” works is to
eliminate most of the signals generated and only trade the ones with
the highest potential and highest probability of being correct. Take
a look at the screenshot below.
The
fractals highlighted in yellow are the signals we are going to
ignore, and those highlighted in green are valid entry points. Out of
the 14 fractals on this daily price chart of the GBP/USD, 9 have been
discarded, just leaving 5 to be traded. Out of the 5 valid
trading signals all of them offered a chance to make money depending
on the exit strategy employed with this system. Before we go on with
the different exit strategies that can be used with this system, we
need to establish how to identify the good from the bad. A valid
entry signal The central candlestick is the key to selecting the good
trades, and this is dependent on the size of the central candle.
Remember, this is a series of 5 candlesticks and the central
candlestick is number 3 in the series. What we need to do is identify
the size of the 4th candlestick compared to the 3rd candlestick. If
the extreme points of the 4th candlestick are within the extreme
points of the 3rd candlestick then we have a valid signal. This is
commonly known as an “Inside Day”
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