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October 30th, 2020

Fractals

Being a successful investor or trader begins within our own psychology.

Have you ever noticed beautiful patterns that are random yet eerily similar to one another?

From seashells and spiral galaxies to the structure of human lungs, these inexplicable patterns are all around us. These patterns are called fractals.

Fractals are patterns formed from chaotic equations and contain self-similar patterns of complexity increasing with magnification. If you divide a fractal pattern into parts you get a nearly identical reduced-size copy of the whole.

The mathematical beauty of fractals is that as complexity increases to infinity, they’re consistently formed with relatively simple equations. By iterating or repeating fractal-generating equations many times, random outputs create beautiful patterns that are unique, yet recognizable. A very popular mathematical concept called the Fibonacci Sequence is also considered a fractal.

The term fractal was coined by Polish-born mathematician Benoit Mandelbrot, rooted in the Latin word “fractus,” which means “broken glass,” the reference being to broken lines. In the 1980s while working at IBM, Mandelbrot arose as a singular pioneer into the fractal universe, publishing the seminal work The Fractal Geometry of Nature.

This publication laid the mathematical and philosophical foundation for fractal theories that have since been adopted by analysts, scientists, and theoreticians of all disciplines – from art to astrophysics, economics to the natural sciences, social media to medicine, and climatology to human psychology.

Since fractal theories have been adopted by so many disciplines, how does this relate to the financial world or the stock market?

From the original concept of fractals, the fractal indicator was born. The fractal indicator is based on a simple price pattern that’s frequently seen in financial markets.

The fractal indicates the possibility of a trend change because it essentially shows a "U-shape" in price. The indicator isolates potential turning points on a price chart and then draws arrows to indicate the existence of a pattern. There are generally two types of financial fractal patterns:

  1. A bullish fractal is marked by a down arrow and signals that the price could move higher. It has the price moving down and then moving upward, forming a U.
  2. A bearish fractal is marked by an up arrow and signals the price could move lower. It has the price moving upward and then moving downward, forming an upside-down U.

The main problem with fractals is that there are so many of them. They occur frequently and trying to trade all of them will rapidly deplete a trading account due to losing trades. These are called false signals or whipsaws.

Since fractals occur so frequently, and many of the signals aren't reliable entry points, fractals are typically filtered using some other form of technical analysis. By combining fractals with trend analysis, an investor may decide to only trade bullish fractal signals while the price trend is up. For example, if the trend is down, they may take only short trades on bearish fractal signals.

Therefore, next time you use these fractals to determine the performance of a stock, make sure to combine or filter the signals with some other indicator or form of analysis.

vig.io Fractals
TagsPsychologyBehavioral FinanceRisk Management Asset Management MPTDeep Learning AlgorithmsGeneral InvestingFractals
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