Fractal Chaos Bands

Fractal Chaos Bands – Strategy, Rules, Returns, Risk

While the movements of the financial markets seem very random and chaotic, they might actually follow a certain pattern if you can find it, and that is where the Fractal Chaos Bands come in. What do you know about this indicator?

In trading, the Fractal Chaos Bands are a technical indicator that plots a band above and below the price action based on price fractals. The upper fractal band is created by connecting the most prominent swing highs over a given period, while the lower fractal band connects the most prominent swing lows over the same period.

In this post, we will attempt to answer some questions you may have about the Fractal Chaos Bands in trading: what it means, how to calculate it, interpret it, and use it in trading. Read on!

Table of contents:

Key takeaways

  • Fractal Chaos Bands are a technical indicator that plots a band above and below the price action based on price fractals.
  • The upper fractal band is created by connecting the most prominent swing highs over a given period, while the lower fractal band connects the most prominent swing lows over the same period.
  • We provide you with a backtested Fractal Chaos Bands trading strategy.
  • This post is just one of the many trading indicators we have written about.

What are Fractal Chaos Bands in trading?

Fractal Chaos Bands

In trading, the Fractal Chaos Bands are a technical indicator that plots a band above and below the price action based on price fractals. The upper fractal band is created by connecting the most prominent swing highs over a given period, while the lower fractal band connects the most prominent swing lows over the same period.

Introduced by an Australian commodity trader and advisor, Edward William Dreiss, the indicator aims to provide insights into market trends by determining whether or not the market is trending. It helps to filter out minor price fluctuations (market noise), as it focuses solely on significant price fractals to reveal the distinctive pattern in price movements.

When the market is trending, the fractal bands slope in the direction of the trend, appearing like stairs. In an uptrend, they slope upward, and in a downtrend, they slope downward. On the other hand, when the market is choppy, moving sideways, or consolidating, the fractal bands are flat. The closer the bands are to each other, the smaller the price range and the tighter the consolidation.

An example of how Fractal Bands might look on a chart is shown below:

Fractal Chaos Bands
Fractal Chaos Bands

Fractal Chaos Bands trading strategy – trading rules, returns, performance

It’s time to put the indicator to the test. To do that, we make trading rules and backtest them. We do it systematically, with no anecdotal evidence!

We make the following trading rules:

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These simple trading rules have returned the following equity curve for the S&P 500 (SPY) from its inception until today:

Fractal Chaos Bands trading strategy
Fractal Chaos Bands trading strategy

Let’s look at the statistics and trading performance metrics:

Table of Key Statistics (Fractal Chaos Bands)

Statistics/Metrics/Key Data/PerformanceValue
Number of trades209
Average gain per trade1.3%
CAGR (Compound Annual Growth Rate)4.3%
Win rate79%
Average winning trade2.6%
Average losing trade-3.5%
Max drawdown-14%
Time invested in the market16%
Risk-adjusted return (CAGR divided by the time spent in the market)26%

We tried many different settings, but we were not able to improve the strategy significantly.

Fractal Chaos Bands – complete code

Here’s the complete code for the strategy:

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How do Fractal Chaos Bands help in trading?

The Fractal Chaos Bands helps in trading by providing insights into market trends. The indicator does this by filtering out minor price fluctuations (market noise) to reveal the distinctive pattern in price movements.

Traders can use it to check whether or not the market is trending. When the market is trending, the fractal bands slope in the direction of the trend, appearing like stairs. In an uptrend, they slope upward, and in a downtrend, they slope downward.

The more steep the slopes, the stronger the market trend. When the fractal chaos bands are flat, it means the market is choppy, moving sideways, or consolidating. The closer the bands are to each other, the smaller the price range, and the tighter the consolidation, which will soon be followed by a breakout.

What is a fractal in trading terms?

In trading terms, a fractal is a repeating geometric pattern of price swing points that represent the highest/lowest points in price swings. It is the repeating V or U (and the inverse) patterns that form the zigzag nature of price movements.

Thus, a fractal may signal a reversal from a swing low, forming a V or U pattern, or a reversal from a swing high, forming an inverted V or U pattern.

How are Fractal Chaos Bands calculated?

Fractal Chaos Bands are not calculated with any formula per se. Instead, they are plotted on the price chart by connecting the corresponding swing points in the price action over a given period to form an upper and lower band around the price.

The upper fractal band is plotted by drawing a line to connect the most prominent swing highs over a given period, while the lower fractal band is plotted by connecting the most prominent swing lows over the same period.

What does a Fractal Chaos Band look like on a chart?

On a Chart, a Fractal Chaos Band looks like an ascending or descending stair, depending on the direction it slopes, or a flat block if the market isn’t trending. In an uptrend, the Fractal Chaos Bands slope upward, and thus, look like an ascending stair. In a downtrend, the fractal bands slope downward, and thus, look like a descending stair.

On the other hand, when the market is choppy, moving sideways, or consolidating, the fractal bands are flat, and thus, look like a block or a rectangle.

What is the theory behind Fractal Chaos Bands?

The theory behind fractal chaos bands is that price fractals reveal orderly patterns in the seemingly chaotic market environment. That is, while the financial markets are chaotic, patterns emerge within that chaos, which are not random, and the fractal chaos bands can help reveal those patterns.

According to market experts, Robert F. Mulligan and Edgar E. Peters, those patterns can indicate psychological points where price trends are likely to reverse. This is based on the belief that market movements are influenced by traders’ reactions to price changes. And, these reactions tend to follow repetitive cycles in line with human nature and collective memory. This cyclical behavior creates repeating patterns that can be identified and used to predict market changes.

The fractal chaos bands only help to reveal those patterns for traders to make informed trading decisions.

How do Fractal Chaos Bands indicate a trend change?

Fractal chaos bands indicate a trend change by changing the direction of its slope to the direction of the emerging trend. However, this doesn’t happen abruptly most of the time — it is often preceded by a period of flat bands that indicate temporary price consolidation, as the market often moves from a trending phase to an accumulation or distribution phase before moving to another trending phase.

So, the fractal chaos bands may indicate a trend change by becoming flat for a while, and then the price breaks out of the flat range to initiate a new trend direction.

What are the key components of Fractal Chaos Bands?

The key components of fractal chaos bands include:

  • Price fractals: These are the repeating price swings that create swing highs and swing lows used in plotting the fractal chaos bands. The upper fractal band is formed by a line connecting the highest swing highs, while the lower fractal band is formed by a line connecting the lowest swing lows.
  • The chosen time period: This is the lookback period the indicator considers when picking the swing highs and lows to plot the bands.

How do Fractal Chaos Bands differ from Bollinger Bands?

The fractal chaos bands indicator differs from Bollinger Bands in that it plots its upper and lower bands across price fractal highs and lows respectively over a chosen period, while the Bollinger Bands indicator first obtains the price mean (a moving average) and then uses a specified number of standard deviations to plot its upper and lower bands.

In other words, the former makes use of price fractals, while the latter uses the statistical measure of central tendency and variation.

Can Fractal Chaos Bands predict price movements accurately?

Yes, fractal chaos bands can predict price movements accurately some of the time, but as with other technical analysis tools, it cannot give accurate predictions all the time since market conditions change from time to time.

To improve the predictive ability of the fractal chaos bands, you need to combine it with other indicators or price action analysis to have a clearer view of the market.

What types of assets can Fractal Chaos Bands be applied to?

Fractal chaos bands can be applied to different types of assets. In fact, it can be applied to any asset, as long as the asset’s price moves in fractals, and virtually all financial assets’ price movements are fractal-based.

Moreover, since the indicator is based solely on price data, it can be applied to any type of asset. The story will be different if it uses volume data in any way — in which case, it may not be suitable for the spot forex market where trading volume is not possible to obtain.

How do I set up Fractal Chaos Bands in trading software?

To set up fractal chaos bands in your trading software, you have to first check whether the software has a built-in indicator. If it doesn’t have it, you will need to get a custom-made indicator and install it in the software first.

After that, you can go to the indicator section of the platform and double-click on the indicator or simply grab it and attach it to your chart.

What time frames work best with Fractal Chaos Bands?

The time frames that work best with fractal chaos bands would depend on your trading style. If you are a day trader, you may want to try out the hourly, 30-minute, or 15-minute time frame.

If you are a swing trader, the 4-hourly or daily time frame may be more suitable for you. Position trading may even require a higher time frame.

However, the only way to know the best timeframe for whatever style of trading you apply is to backtest the various time frames to know the one that works best for the indicator.

Are Fractal Chaos Bands useful in day trading?

Yes, fractal chaos bands can be useful in day trading if used on a suitable timeframe, and your backtesting result shows that your strategy is profitable. For day trading, you can use the indicator on the 15-minute, 30-minute, or hourly timeframe — the best timeframe to use would depend on your findings from backtesting.

As long as the market trends on an intraday timeframe, fractal chaos bands can be used. Ensure you backtest your strategy to be sure it has a positive expectancy.

How do Fractal Chaos Bands interact with other indicators?

How fractal chaos bands interact with other indicators will depend on whether those indicators can complement it or not. Any indicator that complements the signals from fractal chaos bands can make the signals better.

For example, a moving average indicator can help you identify the direction of the main trend faster so you can trade a fractal chaos breakout in that direction and avoid a breakout in the opposite direction, which may not work so well.

Can Fractal Chaos Bands be used for stop loss placement?

Yes, fractal chaos bands can be used to guide your stop-loss level, especially if you are trading a breakout in the direction of the existing trend. The bands often track the swing highs and swing lows, so they are good guides for stop-loss levels.

If you have a buy signal, your stop loss can be below the lower band. Likewise, if you have a sell signal, your stop-loss order can be above the upper band. Interestingly, you can use these bands to also guide your trailing-stop orders.

What are the limitations of using Fractal Chaos Bands?

The limitations of using fractal chaos bands are as follows:

  • The indicator lags, just like most other indicators that use previous price action in their calculations.
  • It is prone to whipsaws in a very choppy market, with many false breakouts.
  • It cannot be relied on as a standalone strategy — you must combine it with other analysis tools to create a strategy and then backtest it for profitability.

How do market conditions affect Fractal Chaos Bands’ effectiveness?

Market conditions can affect fractal chaos bands’ effectiveness, as the indicator functions well only in trending markets and does poorly in very choppy markets.

In a trending market, the indicator bands slope in the direction of the trend, and when breakouts occur after short consolidations, the price moves in one direction, making it easy to trade. however, in a very choppy market, there are multiple false breakouts in both directions, leading to conflicting signals and many losses if traded blindly.

What strategies can be built around Fractal Chaos Bands?

The strategies that can be built around fractal chaos bands are mostly breakout strategies, which aim to capture a new trend or the continuation of the old trend after a temporary price consolidation. It is often best to use a moving average indicator to confirm the breakout signals when trading.

Another strategy that can be built around fractal chaos bands is a mean-reversion strategy if the market is in a broad range — a fake out at the upper band could be a sell signal while a fake out at the lower band could be a buy signal.

Are Fractal Chaos Bands suitable for novice traders?

Yes, fractal chaos bands can be suitable for novice traders if they can create a simple breakout strategy with the indicator and backtest it to be sure it is profitable. Breakout strategies are one of the simplest strategies in trading, so novice traders can easily master them if they put in the effort.

How do traders interpret the spacing between Fractal Chaos Bands?

Traders interpret the spacing between fractal chaos bands as a measure of the price range over the time period used for the indicator. For instance, if the period chosen for the indicator is 20 days or 20 hours, then the spacing between the bands is the price range over the last 20 days or 20 hours.

What do narrowing or widening bands suggest in Fractal Chaos Bands?

In fractal chaos bands, narrowing or widening bands suggest a decrease or increase in the size of price swings over the chosen period for the indicator. The closer the bands are to each other, the smaller the price range and the tighter the consolidation.

On the other hand, the wider the bands, the more likely the price is moving in one direction — trending.

How can Fractal Chaos Bands improve trading decisions?

Fractal chaos bands can improve trading decisions by showing you when the market is consolidating and when it is breaking out of tight consolidation. Traders love price breakouts from a tight consolidation because it often can make explosive moves following the breakout. And, the fractal chaos bands can easily give such indications.

What are common mistakes when using Fractal Chaos Bands?

The common mistakes when using fractal chaos bands include:

  • Using the indicator as a standalone strategy, which often ends with many false signals
  • Thinking the indicator can work in all market conditions, including choppy markets
  • Not having a backtested strategy with clear entry and exit criteria and risk management parameters

How does volatility affect Fractal Chaos Bands?

Volatility affects fractal chaos bands by influencing its breakout signals. When the market is very volatile — that is, non-directionally swinging about — the chances are high that the indicator will give plenty of false breakout signals in either direction.

One way to reduce that is to increase the period of the indicator so that wider swing points will be used in plotting the bands.

What historical data is needed to analyze Fractal Chaos Bands?

The historical data needed to analyze fractal chaos bands is the price swing points — the swing highs and swing lows over the chosen period. However, to analyze the signals from the indicator, you can add volume or volume indicators to analyze volume changes during breakouts, which can help confirm real breakouts.

How do Fractal Chaos Bands compare to moving averages?

Fractal chaos bands compare quite favorably with moving averages in that its slope can also show trend direction like the moving averages do. But what is important is that you can combine both to get the best out of a trending market.

While the moving average helps identify the trend direction, fractal chaos bands offer breakout signals for near-perfect entries.

Can Fractal Chaos Bands be combined with volume indicators?

Yes, fractal chaos bands can be combined with volume indicators to get better breakout signals. You can use volume indicators to analyze volume changes during breakouts, which can help confirm real breakouts. When a breakout happens on a huge volume, it’s likely to be a real breakout.

What literature can help deepen understanding of Fractal Chaos Bands?

The literature that can help deepen your understanding of fractal chaos bands effectively include this page you are reading and other finance and trading websites like therobusttrader.com and tradingstrategies.com. Finally, we recommend this book: “Fractal Trading II: Advanced Instruction for Trading Financial Markets.”

What are the best practices for using Fractal Chaos Bands effectively?

The best practices for using fractal chaos bands effectively include:

  • Combining the indicator with other indicators and analysis tools, such as trendlines and price action analysis.
  • Creating robust strategies with clear entry and exit criteria
  • Backtesting your strategies to be sure they have a positive expectancy
  • Keeping to your risk management rules

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