Trading Idea #021 – Just Fractals 1

This idea is based on the concept of Fractal indicator, popularized by Bill Williams in his books Trading Chaos and New Trading Dimensions.  This is the second fractal indicator system I have featured here on Systematic Algo Trader.  The first one, SAT2021-07 Fractals 1, was successful, but it used different exit criteria.  I call this one Just Fractals, because I use the fractal indicator signal for entries and reversals.  Plus, my wife came up with that name for one of her fractal systems and I like it.  It amuses me.

If you are a mathematician, the word fractal in this respect probably makes your hair bristle, so let me get this out of the way.  Fractals, as described by Bill Williams, are not mathematical fractals.  He had to call these something, so he picked fractals.  Market data is considered fractal: we are measuring the same thing, but with different levels of granularity and detail.  A more accurate term for what we are doing here is pivot, but the fractal indicator term has embedded itself in the minds and hearts of market technicians high and low, so ‘fractal’ it is.

[This explanation of a fractal indicator is a repeat of SAT2021-07, so you can skip to Step 1 if you want.  I won’t be offended.]

A fractal high occurs when the highest high of five bars is on the third, or middle, bar.  A fractal low occurs when the lowest low of five bars is on the third bar.

A high fractal looks like this:

• First bar High < Third bar High
• Second bar High < Third bar High
• Fourth bar High < Third bar High
• Fifth bar High < Third bar High

This is a high fractal:

A fractal low would be the opposite:

• First bar Low > Third bar Low
• Second bar Low > Third bar Low
• Fourth bar Low > Third bar Low
• Fifth bar Low > Third bar Low

Fractals can be very confusing and deceiving.  If you use them on a chart, do not fall for the illusion that they can predict the future.  The fractal will appear only after that fifth bar has closed and the conditions for the fractal have been met.

Fractal indicator signals can be used several ways.  This idea uses the fractal high as a resistance level and fractal low as a support level.  When we break through resistance or support, we go long or short, respectively.  Below is an example of how this is used for support and resistance (Chart: daily Euro FX futures):

This is pure counter-trend trading.  Scary, but can be rewarding.  There are no exits, only reversals.  I will use a 1 ATR stop loss.

Phase 1: Plan & Design

The idea is simple:

• Buy at market when if the Close is greater than the latest Fractal High
• Sell short at market if the Close is less than the latest Fractal Low
• Reverse our position if we receive a buy or sell short signal
• Profit Target: None
• Stop Loss: 1 ATR (20 period)

2. System Definition

Position Sizing:

• Futures:  1 contract

Input Parameters:

No inputs for this system, which means no optimization later.

Variables:

Entry:

• Long:
• If Close > FractalHigh, then buy next bar at market
• Short:
• If Close < FractalLow, then sell short next bar at market

Stop Loss:

• Stop Loss = ATR * Full Contract Size

Challenges:

• None.

3. Performance Objectives

The system will meet the following objectives:

4. Market Selection

Markets:

Instruments:

Chart Type, Timeframe, Session, Time Zone:

5. Manual Test

I have done so much work using fractals, I am confident that this is a good idea.  In this case, I have manually tested this idea hundreds of times and am confident in continuing to the Build step.

6. Build

Process Diagram

Nothing spectacular here.

7. Unit Test

The unit test was fine. Simple systems are the best, in this respect. Below is a screenshot of the system on a gasoline futures (RBOB) chart. The blue dots indicate fractal lows; the red dots indicate fractal highs.

Complete?

Note: Unit Test verifies that the system is executing the trading rules correctly.  It is, essentially, quality control.

8. Optimization

No optimization here.  I could have optimized fractal strength, which is the number of bars we evaluate, but since this is called Just Fractals, I’ll be a purist and go with the classic 5-bar fractal.

9. Walk-Forward Analysis

I tested over nearly a 10 year period, from January 2011 to November 2020. All instruments failed spectacularly. This does not require a ton of analysis mainly because the best profit factor we saw 1.09, Crude Light futures (CL). Heating Oil, predictably, was very close to CL. I will explain some reasons why this failed in the Notes and Commentary section.

10. Monte Carlo Simulation

We did not make it this far.

11. Incubation

We did not make it this far.

Phase 4: Deploy

We did not make it this far.

Notes and Commentary

Fractals, as implemented here, identify some spectacular breakouts through support or resistance, but they also give plenty of false signals. Just by themselves, fractal indicators are too simple and too obvious to trade alone. I am actually struggling here to think of improvements, but that may just be fatigue speaking.

Ideas for Future Systems

• Do not stop and reverse and use Average True Range (ATR) exits only
• Use a trend filter,, such as a simple moving average or Kaufman’s adaptive moving average KAMA)
• Use the Alligator (three moving averages), as suggested by Bill Williams, as a confirmation

That is about it. This system idea seems kind of lame in retrospect, though I find a fractal indicator, both the trading and mathematical kinds, fascinating. I have written dozens of fractal systems, most failures (as most ideas are), a couple of winners, and a couple in incubation. I will continue to explore this idea to see if I can make it work.

Sources/References

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