If you have previously read any of my articles, you know that I am not a fan of moving averages, oscillators, or indicators as primary vehicles to determine market entries in e-mini trading. These indicators simply lag too much for my taste. I am an e-mini scalper and like real-time indicators. That being said, Im going to tell you about one of my favorite indicators, and it is a lagging indicator. I know that may seem like a contradiction in my thinking, but fractals are excellent chart formations to confirm a market reversal.

So, what is a fractal?

Most fractals consist of five bars. A bearish fractal’s first two bars have higher lows and higher highs, followed by a third bar that has a higher level and higher high. The last two bars have lower highs and lower lows. In short, it looks like a small pyramid. A bullish fractal looks identical to a bearish fractal except that it is inverted. I should also point out that most fractals are not perfectly proportioned but as long as the definition holds true they qualify as a fractal.

While many traders debate the level of randomness in price action, there can be no doubt that a considerable portion of all price action is, in fact, random. Depending on what book or source you care to reference, most estimates fall between 40% and 70%. In my estimation, the level of randomness is not really important. With a random level at a 40%, the margin of error is certainly impressive.

That being said, fractal formations form periodically in what sometimes appears to be a highly chaotic market. They are, in essence, formations within broader price movement and are used to identify potential reversals in price action. Most traders utilize multiple time frames to identify fractal formations; and traders seldom rely on fractals as a primary formation to initiate trades. However, when used in conjunction with a combination of real-time indicators, volume indicators, or your favorite oscillator they can help e-mini traders identify valid market reversals with a higher degree of reliability than most methods.

They are also very useful in identifying exit points in an ongoing trade. As an e-mini scalper, this use of fractals seldom factors into my thinking. However, swing traders can be tipped off about a potential reversal against the direction of their trade when a fractal forms. In other words, if youre in a trade and a fractal forms in the opposite direction of your trade, its time to get out.

I find fractals very useful in identifying reversals in longer time periods. A fractal formation that forms on an hourly chart is a more valid indicator of a market reversal than a fractal formation that forms on a three-minute chart. For a e-mini scalper, understanding longer-term trends can be useful and determining the direction you plan to trade on a given day. (As I generally work hard to trade with the trend and avoid counter trend trades)

To sum up:

• Fractals are lagging indicators. As lagging indicators, they are best used as a tool to confirm market reversals. This is one of the reasons I enjoy using fractals; market reversals are among the toughest variables to identify on a chart.

• The longer the time period used to identify a fractal formation, the more valid that formation is likely to be. Unfortunately, as scalpers we “need to know” market reversals in a shorter time periods than fractals offer. On the other hand, scalpers should also understand what the effects of longer-term trends are in the market. Of course, scalpers who regularly try to pick market reversals usually find themselves on the losing side of most trades; as the market reversal is a very difficult formation to definitively identify with a high degree of accuracy.

• As I mentioned earlier, its a good idea to chart fractals in multiple time frames and compare them with each other. This comparison will help the e-mini trader spot divergences that can keep them trading with the trend.

• Finally, once you have definitively identified a fractal formation, make sure you confirm that identification with other indicators or oscillators.

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