Fractals are a fantastic all round tool, not only do they help you spot market flow but they also identify the main places that are suitable to draw your Fibonacci tool from. On top of this they can be used as a really solid trailing stop loss.
The reason they work well as a trailing stop loss is that they allow for the way the market moves.
For example, when going up the price will move in waves so it will make an initial move up and then retrace part of that move before continuing in its original upside move.
If you were long in this scenario without a solid exit plan you could get scared into exiting early as price retraces back towards your entry level only to see it carry on up as soon as you’ve exited.
This kind of thing can be extremely frustrating and cause you to wonder whether you will ever become successful at trading the Forex.
If you use Fractals as your trailing stop loss you actually need these retracements for the new fractal to form so if you’re expecting the retracements you are much less likely to be scared out of your trades too soon.
On the flip side if the trade does go bad you will still have reduced your risk or ideally locked a small amount of profit in.
Let’s see how they look on a chart:
First of all let’s say you went short from resistance represented on the chart by the black line.
Next you will notice that price fell away from the black line, BUT then proceeded to come back up towards your entry level…
At this point you could be inclined to just take a small profit for fear of getting stopped out.
But if you are waiting for fractals to form you will be happy to see this move up because you will notice what happened next: a new Fractal formed thus giving you a place to adjust your stop loss to.
Quite soon after, the price plummeted down and eventually after several more retracements more fractals formed on the way down, giving you new places to adjust your stop loss to and locking in some nice profits.
Once you see a new fractal form, you need to wait until the second candle to the right of the swing point has closed confirming it as a true swing point.
As soon as you get the close of the candle it is best to place your stop at the tip of the actual Fractal indicator rather than the actual price candle.
This allows for the price to come and retest the area of support or resistance.
Just so that’s clear, let’s use a chart example:
The benefit of this method is that you catch the nice big runs that price makes without getting frightened out of the trade early, resulting in small losses and large winners.
The negative aspect of this method is that when you have a few losses in a row often you will have been in profit before you took your loss.
This can make you feel like you are losing too much and have a negative impact on your psychology making it harder to be consistent.
In reality it only takes one or two winners to cover many losses.
Next: Scaling Out