The fractal nature of market structure is based on the idea that prices create repeating patterns and trends that can be identified by price movement. This theory was first presented by William Williams in the late 1970s, and it has since become a popular concept among traders. Fractals are self-similar patterns in which the high and low of one candle are greater than the high/low of the neighboring candle. Fractals are considered stable market structures, which show the same patterns and trends in different time frames.
The hypothesis is based on the fact that financial prices exhibit fractal properties due to the interactions of many agents, which are inherently unstable. The fractal structure of markets can result in a crash when everyone is trading based on the same information. Further, fractal market structures are believed to be a good starting point for new paradigms in financial economics. The fractal market hypothesis is a test of whether particular investment horizons are dominant during turbulent periods.
A fractal market structure is stabilized when there is sufficient liquidity in different horizons. Diversification is one of the best ways to take advantage of this fact, although it is important to remember that fractals are not a standalone indicator. They should be used in combination with other indicators to identify trends and signals. The Alligator indicator is a popular confirmation of fractal patterns. This tool uses multiple moving averages to identify a long-term uptrend. As long as the price remains above the Alligator’s teeth, the signal is bullish.
The Fibonacci numbers and fractals go hand in hand with wave analysis. Fibonacci is a fractal shape in its own right. The 0.618 number is repeated many times and forms a golden spiral. In addition to the Fibonacci pattern, Fibonacci patterns are used in both market structure and wave theory to understand the psychology of Fractals. Fibonacci provides practical levels to identify when Waves begin and end.
Fractals are also useful to combine with Fibonacci retracement levels. For example, traders often focus on trading opportunities that correspond to certain Fibonacci ratios. However, their preferences may vary from person to person. For example, a trader may prefer to take long trades only during larger uptrends and the 61.8% retracement level. Fractals aren’t a guaranteed reversal, and there must be other conditions for a trade to work.
Fractals also influence the efficiency of a market. Studies of the fractal features of stock markets reveal that developed markets are more efficient than their emerging counterparts. In turn, this can help us optimize our decision-making process and curtail speculative tendencies in the stock market. This is a fascinating topic that we will continue to explore in future articles. The fractal nature of market structure is a fundamental concept that should be understood and implemented by all investors.