What is a Fractal Breakout Strategy?

What is a Fractal Breakout Strategy?

If you are looking for a good price action strategy, you might have already come across the Fractal Breakout Strategy. We will look at what fractals are, how the Fractal Breakout Strategy works, and many more.

What is the Fractal Breakout Strategy- Fractal breakout Strategy

What is a Fractal in Trading? 

Before anything else, you first need to understand what a Fractal is. It might sound close to the mathematical term fraction, but it's not related to that. Fractals refer to recurring patterns that happen in the middle of a large and highly chaotic price movement.

Fractals are made of 5 or more bars. These can be identified using the following rules:

  • A bearish turning point happens when there's a pattern that has the highest high in the middle then each side has two lower highs.

  • A bullish turning point is when there is a pattern that shows the lowest low in the middle; then each side has two higher lows.

The main reason why traders utilize fractals is that it can help them figure out where the price will go next.

However, the problem with it is that it is a lagging indicator. It can only be drawn after two days into the reversal.

What Does a Fractal Indicator Mean in Trading?

Fractal indicators generate signals frequently. However, a fractal is not really significant because the pattern is recurrent.

Moreover, the Fractal indicates a possible change in trend. This is mostly because it shows a "u-shape" in pricing.

A bearish fractal has the price moving in an upward direction then downward, creating an upside down U.

Meanwhile, a bullish fractal happens when the price moves downward but begins to move upward, creating a U shape.

Since fractals happen frequently, the signals are not always reliable entry points. This is why facts are typically used to filter other forms of technical analysis instead of just using it as a standalone.

What is the Fractal Breakout Strategy- Fractal Indicator

Steps on How to Calculate the Fractal Indicator

Calculating a fractal indicator is easier than you think. Here are the general steps that you should follow:

  1. Determine a high or low point based on the chart.
  2. There is a possible pattern if two lower highs are to the left. This is also the same case when there are two higher lows on the left of the low. However, the pattern still needs confirmation using two more bars.
  3. If there are two lower highs following the high, then it's a complete bearish fractal. However, if there are two higher lows after the low, then it's a complete bullish fractal.
What is a Fractal Breakout Strategy-HOW ARE FRACTALS USED IN TRADING

How are Fractals Used in Trading? 

Nowadays, many trading chart platforms offer the option of using fractals as a trading indicator. This means that traders don't have to figure out the pattern on their own, which is very convenient.

All they have to do is use Fractal as the indicator for the chart, and the software will automatically reveal the pattern without much effort.

The benefits of fractals can be maximized when used along with other forms of analysis or indicators. A common confirmation indicator used along fractals is Alligator. It can also be used together with the Fibonacci retracement method.

Bill Williams invented the Alligator indicator to isolate trends. When used with fractal indicators, the user can decide whether to only trade based on bullish fractal signals while the price moves up.

On the contrary, users might only choose to take bearish fractal signals if the trend moves down.

Understanding the Fractal Breakout Strategy

Now that you have a good idea of what fractals are, let's discuss the Fractal Breakout Strategy.

The Fractal Breakout Strategy involves determining the price of the last fractal top then enter a trade once the price breaks over the last fractal top. 

The last fractal top average price is also calculated with this strategy to get a clear direction of the trend.

Once the average of the fractal top begins falling, that's when the exit strategy for this begins. The user then manually sets a time delay based on this exit condition. By default, a long exit strategy involves 3 bars after the appearance of the long entry condition.

Take note that only a breakout position with a Commodity Channel Index (CCI) cycle higher or less than 0 can be taken.

For example, it is necessary to wait until the CCI changes during a trend prior to re-entering with a breakout. This increases the chances of entering winning trades.

You can read about the double CCI trading strategy here.

This type of strategy works best on weekly or monthly time frames. It can also work on daily and other time frames, but you might not get the same results compared to when you use it on higher time frames.

The downside to Using Fractal Indicators in Trading Strategies

The main limitation with using fractals is that it's very common; there are so many of them. It occurs very frequently, and trying to trade based on one of them will quickly deplete trading accounts because of lost trades.

The term used to describe this scenario is whipsaws. This is why it's highly recommended to use another form of analysis or indicator to filter out the signals to prevent losses.

The indicator arrows are typically drawn over the high or low. This is not where the fractals complete but its middle point. This makes the arrows a bit deceiving.

In addition, since the arrow points to completing two bars from its right, the primary available entry point after that refers to the third bar’s opening price, which is located on the right side of the arrow.

Final Words

All trading strategies have risk involved, and the Fractal Breakout Strategy is not an exception. On top of that, the past performance of the strategy does not indicate that it will consistently yield the same results. This is why it's important to assess your risks first before attempting it.

You might also interested in What is Time Warp Trading? and A Short Breakdown of the Bear Call Ladder Strategy

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