A fractals trading strategy: applying shadow trading and Fibonacci for successful setups

I touched on fractals a few weeks back, and promised that I’d bring you more details to build up a fractal trading strategy …

Here I want to show you how we can combine three tools: fractals, shadow trading, and Fibonacci levels. Each of these may sound complex, but don’t be put off … the joy of fractal trading is that we’re only ever looking at a window of 5 candles, so these setups are beautiful in their simplicity.

What are fractals again?

A quick recap … a fractal is any block of five candlesticks in which the central candle forms a high or a low.

A bearish fractal will have a high in the middle, while a bullish fractal will have a low in the middle …

These simple formations crop up all over our charts.

And shadow trading?

Shadow trading is all about looking at the wicks of our candlesticks and how they compare with the bodies of the candles. In general, long bodies with shorter wicks show decisive trading behaviour, while longer wicks with short bodies show indecision.

Where we have long upper wicks, it suggests that a higher price has been rejected, and it can be a bearish signal.

Conversely, a long lower wick suggests a lower price has been rejected, and may be a bullish sign.

You can find more details on shadow trading here.

Putting it together

Take a look at the fractal marked up in the pink box on this hourly USDCAD chart …

We have a long upper wick on our central high candlestick, followed by a decisive move away from that high, shown in the long red bodies of the two candles that follow it.

Add to this that we’re in a downtrend (that red line is a 100-period simple moving average), and I’ve drawn in a Fibonacci retracement from the recent high-low.

As you can see, that leggy high on our fractal is bang on the 100 SMA, and the 61.8% Fib level.

And here’s what happened …

Of course, not every setup will give us that kind of perfect-storm of signals. For a start, trending prices don’t tend to touch the 100 SMA very often.

Here are some more examples …

On the chart above, we have a long wick of a bearish fractal on the Fibonacci level, giving us another option to get into this downtrend move.

Positioning of the profit targets should be cautious – bear in mind that the fractal is formed in just 5 candles, so we shouldn’t expect long-term predictive powers from such a modest pattern. In the example above, it reached the 61.8% Fibonacci extension, but you should treat each setup individually – look at your entry, look at recent price action, and consider what would be a reasonable ask.

Note on the example below, that by using the fractal pattern, we’re getting a nice early entry, and can collect a respectable profit by the time the price has retraced to the low at ‘A’, which would be a sensible place to take first profits.

Getting successful signals

The beauty of these shadow-trade setups, combined with fractals is that they are very easy to spot. Leggy candlesticks literally jump out of the charts at us, and we’re only ever looking at the most recent 5 bars on the right of our screens.

A few points to bear in mind …

• Fractals work best on longer timeframes, so start with hourly charts or longer.
• Get stops in nice and tight behind the extreme of the fractal.
• Open promptly, as the fractal pattern is breached.
• Look at price action when positioning your targets – is there support/resistance blocking your path? And don’t get too ambitious – remember, your entry is based on a 5-bar pattern, so we aren’t looking too long-term.

And let me know how you get on …

 

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