Fractal Dimension Index (FDI) – Strategy, Rules, Settings, Returns

Fractal Dimension Index (FDI) – Strategy, Rules, Settings, Returns

The financial markets seem to move in a highly chaotic way, but beneath that apparent chaos lies some form of fractal patterns that can be exploited with the right tool — this is where the Fractal Dimension Index (FDI) comes in. What do you know about this tool?

The Fractal Dimension Index (FDI) is a technical analysis indicator that determines whether the market is trending in a sustainable fractal form, trending in an unsustainable almost straight movement, or trapped in a range. It uses the amount of volatility in an asset’s price to measure the strength of a trend in the market.

In this post, we will take a look at most of the questions you may have about the Fractal Dimension Index: what it is, how it works, and how you can improve your trading strategies with it. Let’s dive in!

Key takeaways

  • The Fractal Dimension Index (FDI) is a technical indicator that identifies whether the market is:
  • Trending in a sustainable fractal form,
  • Trending in an unsustainable, nearly straight movement, or
  • Moving within a range.
  • FDI measures the trend strength based on price volatility.
  • As an oscillator, FDI is displayed below the price chart and ranges between values of 1.0 and 2.0:
  • Above 1.5: Indicates a ranging market.
  • Below 1.5: Indicates a trending market.
  • Less than 1.3: Indicates an unsustainable trend, suggesting a possible reversal.
  • Traders use FDI to determine whether to apply trending or range-based strategies and to exit unsustainable trends in a timely manner.
  • More indicators are available if you click here: best trading indicators.

What is the Fractal Dimension Index (FDI)?

The Fractal Dimension Index (FDI) is a technical analysis indicator that determines whether the market is trending in a sustainable fractal form, trending in an unsustainable almost straight movement, or trapped in a range. It uses the amount of volatility in an asset’s price to measure the strength of a trend in the market.

The indicator is an oscillator and, thus, is usually placed in the indicator window below the price chart. It oscillates between values of 1.0 and 2.0, with values above 1.5 indicating a ranging market and values below 1.5 indicating a trending market. Values less than 1.3 are considered an unsustainable trend, which could reverse any time soon.

Traders can use the fractal dimension index to know when the market is trending or ranging, so as to know the type of strategy to use. The indicator can also tell when a trend is getting unsustainable so traders can get out of their positions in time.

Fractal Dimension Index trading strategy – rules, settings, and returns

Let’s backtest a trading strategy that has the following trading rules:

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

(Please look at the code below if you are unsure of the trading rules.)

The trading rules work best on trending assets, such as the gold price.

Hence, we backtest GLD, which tracks the gold price, and we get the following equity curve for GLD from its inception until today, including 0.03% commissions for each trade (0.06% for a round trip):

Fractal Dimension Index strategy
Fractal Dimension Index strategy

Trading performance metrics and statistics from inception until today (including 0.03% commissions per trade):

  • Number of trades: 192
  • Average gain per trade: 0.41%
  • Annual returns: 4%
  • Win rate: 75%
  • Time spent in the market: 10%
  • Risk-adjusted return: 40%
  • Max drawdown: 6%

This is the code we used for the backtest (Amibroker):

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

How does the Fractal Dimension Index work?

The Fractal Dimension Index works by assessing the fractal dimension of a price series using values that range from 1.0 to 2.0. It shows whether the market is trending in a sustainable fractal form, trending in an unsustainable almost straight movement, or trapped in a trading range.

While it does not show the direction of the trend, it can show how strongly the market is trending and whether the trend is getting close to an end. When the reading is less than 1.5, it indicates that the price series is persistent in one direction — in other words, the market is trending. The lower the value of the FDI, the stronger the trend, but the trend is only sustainable — moving in a healthy fractal fashion — up to a point. Below a reading of 1.3, the trend is considered unsustainable, which means it is moving in an almost straight-line fashion with no visible fractals. Such kind of movement will eventually end for the market to revert to a fractal movement or go into a trading range.

When the market is in a trading range, the indicator’s reading becomes greater than 1.5. The reading stays in that 1.5 to 2.0 range until the market breaks out of the range, and then, the reading drops below 1.5.

Who invented the Fractal Dimension Index?

The Fractal Dimension Index was invented by Benoit Mandelbrot, who is world-famous for inventing fractal geometry and applying it in the financial market. Mandelbrot introduced the FDI in his book titled: “The Misbehavior of Markets: A Fractal View of Financial Turbulence by Benoit Mandelbrot”.

Mandelbrot and his co-author, Richard L. Hudson, believe that stock prices move in fractal patterns. They described the Fractal Dimension Index as a way to measure “how convoluted and irregular” something is. And they believe it can be used as a trading indicator in the stock market.

Why is the Fractal Dimension Index important in trading?

The Fractal Dimension Index is important in trading because it helps traders to know the condition of the market — if the market is trending in a sustainable fractal form, trending in an unsustainable almost straight movement, or trapped in a trading range.

If the market is in a trading range, traders can use suitable strategies, such as mean-reversion strategies, to profit from the market or stay away if they don’t have a strategy for range markets. Likewise, in a healthily trending market, traders can use a trend-following strategy. When the trend seems unsustainable, they can close their trades or trail their profits more stringently.

How is the FDI different from other indicators?

The FDI is different from other indicators in that it may not be used as a timing tool to know when an entry setup is in the market, unlike other indicators like the RSI or stochastic which can be used to create entry strategies.

Traders use the FDI to ascertain the market condition so they know the right entry strategies to deploy. Most of those entry strategies are based on other indicators like moving averages and oscillators, which can be used to create entry setups.

What does the FDI measure in the markets?

In the markets, the FDI measures the fractal dimensions of the price to determine whether the market is trending in a sustainable fractal form, trending in an unsustainable almost straight movement, or trapped in a trading range. The indicator does not show the direction of the trend, but it can show the strength of the trend and whether it is getting close to an end.

A reading of less than 1.5 indicates that the market is trending. The lower the value of the FDI, the stronger the trend, but only up to a point — 1.3. If the reading is less than this value, it means the trend is unsustainable, which means it is moving in an almost straight-line fashion with no visible fractals, and will likely end soon.

How can the Fractal Dimension Index help traders?

The Fractal Dimension Index can help traders determine the state of the market. Traders can use it to know if the market is trending in a sustainable fractal form, trending in an unsustainable almost straight movement, or trapped in a trading range, so they know the right strategies to use to profit from the market.

For instance, if the market is in a trading range, traders can either trade with a range-trading strategy or wait for the market to break out of the range so they can trade the emerging trend.

What market conditions does the FDI identify?

The market conditions the FDI identifies are generally of three types:

  • Trading range: This is when the market is trading sideways, swinging back and forth within the same levels in a two-dimensional planar pattern, or what is called a rectangle chart pattern. When the market is in such a pattern, the FDI reading is usually within the 1.5 to 2.0 range.
  • Healthy and sustainable trend: This refers to a market trend with visible fractal formations, leading to higher swing highs and higher swing lows in an uptrend or lower swing lows and lower swing highs in a downtrend. The FDI reading in this market condition is usually less than 1.5 but more than 1.3.
  • Unsustainable trend: This is when the market moves in an almost straight fashion. This kind of movement is unsustainable as the market often reverses the gains to return to a fractal mode or moves into a trading range. The FDI reading in this condition is usually less than 1.3.

How is the FDI calculated?

The calculation of the FDI is very complex and uses the log function as in the formula below:

FDI = 1 + (LOG(length) + LOG(2)) / LOG(2 * (N))

But the good thing is that you don’t need to calculate the indicator yourself, as your trading platform would do that and plot the indicator once attached to the chart.

What timeframes work best with the Fractal Dimension Index?

The timeframes that work best with the Fractal Dimension Index will depend on the trading style, strategy, and the backtesting result. For example, a day trader may want to use an intraday time frame, such as the hourly 30-minute, or 15-minute time frame.

A swing trader, on the other hand, will definitely prefer higher timeframes like the 4-hourly and daily timeframes. However, regardless of the style of trading, the best way to know the best time frame is to backtest different timeframes and choose the one that works best.

How do I interpret the FDI values?

Here’s how to interpret the FDI values:

  • FDI values of less than 1.5 indicate that the market is trending and moving in a healthy fractal fashion — the lower the value of the FDI, the stronger the trend, but that is up to the point the trend is no longer sustainable. Note that the indicator does not show the direction of the trend.
  • A reading of less than 1.3 implies that the trend is unsustainable, which means it is moving in an almost straight-line fashion with no visible fractals — such kind of movement will eventually end for the market to revert to a fractal movement or go into a trading range.
  • When the indicator’s reading is greater than 1.5 (i.e., in the 1.5 to 2.0 range), the market is in a trading range.

When should traders use the Fractal Dimension Index?

Traders should use the Fractal Dimension Index when they want to know the prevailing market condition in order to decide the type of strategy to use in the market.

For instance, if the indicator shows that the market is in a trading range, traders can choose to deploy a range trading strategy or wait for the market to break out of the range and then trade the emerging trend with a trend-following strategy.

How does FDI indicate trending and ranging markets?

The FDI indicates trending and ranging markets by assessing the fractal dimension of the price movement. Whatever reading it shows will tell the user whether the market is trending or range-bound. When the indicator’s reading is greater than 1.5 — that is, in the 1.5 to 2.0 range — the market is in a trading range. On the other hand, when the FDI value is less than 1.5, the market is likely trending.

However, when the value is less than 1.3, the trend is becoming unsustainable and could retrace, move into a trading range, or completely reverse.

What are the advantages of using the FDI in trading?

The advantages of using the FDI in trading include:

  • The indicator can help traders ascertain the condition of the market so they can decide whether to trade or stay on the sidelines.
  • It can help the traders choose the right strategies to deploy based on the prevailing market condition at the time so they have higher odds of making profits.
  • It can help traders know when the trend becomes unsustainable so they can either close out, lock in profits, or trail their profits at a tighter distance from the price action.

Can the Fractal Dimension Index predict market reversals?

The Fractal Dimension Index may not specifically predict market reversals, but it can predict the potential end of a trend by showing when the existing trend is unsustainable.

The trend is likely unsustainable if the FDI value is less than 1.3. What happens afterward is up to the market — it may reverse sharply and retrace all the previous movement, or it can go into a trading range before reversing or continuing to trend in the previous direction.

How does FDI respond to volatility in the markets?

How the FDI responds to volatility in the markets will depend on whether the market is trending or in a trading range. If the market is trending, increased volatility could mean bigger price strides in the trend direction, which would lead to an unsustainable trend — with FDI values dropping below the 1.3 mark.

On the other hand, increased volatility in a trading range would mean frequent back-and-forth swings within the range, and the FDI value would be in the range of 1.5 to 2.0.

What software supports the Fractal Dimension Index?

Most trading and charting software support the Fractal Dimension Index. From TradeStation and NinjaTrader platforms to Amibroker and Wealth-Lab, traders can find the code to implement the FDI in their trading analysis.

Even other less popular trading software supports the FDI. You simply need to pick the one that you find easy to use and that suits your needs.

How do I add the Fractal Dimension Index to my charts?

To add the Fractal Dimension Index to my charts, you simply go to the indicator settings of your trading platform and search for the indicator. You then double-click on it and it will be attached to your chart. A box may pop up for you to input your preferred setting if you don’t want the default setting (usually 30 for the length and 1.5 for the level). See the chart below:

Fractal Dimension Index settings
Fractal Dimension Index settings

What are common mistakes when using the Fractal Dimension Index?

The common mistakes when using the Fractal Dimension Index include the following:

  • Using the indicator alone for your entry and exit strategy in the market
  • Not using the indicator to track market condition but rather using it as a trading system
  • Not creating a robust trading strategy with clear entry and exit rules
  • Trading without first backtesting your strategy to be sure it has an edge in the market you’re trading
  • Trading without an adequate risk management plan
  • Risking too much per trade because you think the system is great and can make you money

How can beginners start using the FDI?

For beginners to start using the FDI, they have to learn what it is and how it works. That way, they will know how to use it and the indicators and other analysis tools to combine with it to create a robust strategy.

The key is to be able to create trading strategies with it and then practice the strategies on a demo account until they are comfortable with their skills.

Can FDI be combined with other indicators?

Yes, the FDI can be combined with other indicators to get the best value from it. The FDI is best used to assess the market conditions, and not for finding trade setups. So, it is important to combine it with other indicators that can be used to find entry and exit setups.

For instance, if the FDI shows that the market is in a healthy trend, you can use moving averages to find the trend direction and dynamic support/resistance levels and then use momentum oscillators, such as the RSI or stochastic, to find entry setup in the direction of the trend.

How do professional traders use the Fractal Dimension Index?

Professional traders use the Fractal Dimension Index to track the market conditions so they can determine whether to trade or not and which strategy to use. If the market is trending, they use a trend strategy and if it is in a trading range, they can either use a mean-reversion strategy or stay out.

Some also use the FDI for portfolio management, rotating their funds into stocks in a sustainable trending condition while rotating out of those in unsustainable trends and trading ranges.

What are the limitations of the Fractal Dimension Index?

The limitations of the Fractal Dimension Index include the following:

  • The FDI is mostly good for assessing the market condition and may not be suitable for finding entry setups
  • It cannot directly tell you how to manage risks
  • It can lag the price by a lot

What is a good strategy for using the Fractal Dimension Index?

A good strategy for using the Fractal Dimension Index is to use it to track the market conditions to know when the conditions are right for your trading strategy.

So, you trade when the conditions are right and stay away from the market when the conditions are not suitable. If you have different strategies, you can use the FDI to know when to use each strategy.

How can I improve my trading with the Fractal Dimension Index?

You can improve your trading with the Fractal Dimension Index by using the indicator to assess the market condition to ascertain the type of trading strategy that would work in the prevailing market condition.

If the market is in a trading range, you trade with a range trading strategy, like a mean-reversion strategy, and when the market is in a healthy trend, you trade with a trend-following strategy — when the trend becomes unsustainable, you close out or trail your profits closely.

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