Wednesday, October 28, 2009

Fractals rule my world


A few months ago, I steered my trading boat into the wind and came into touch with a gentleman who has spent 15 years formulating a trading strategy that is at the same time beautifully simplistic yet insanely complex. This dichotomy captivated me, page by page, as I read through the science behind it. He's taken me under his wing and is mentoring me as a trader as I'm keenly interested in what he does.

Fractals are simple. You take a #, then keep multiplying it by the base #, and there's your fractal. For example,

How this relates to trading is fascinating. The charts I monitor are called CVB's, which are constant volume bar charts. This means that a bar is drawn on the chart for every X # of contracts that are traded; the top of the bar represents the highest price traded for those X contracts, the bottom represent the lowest price traded. Let's take a collection of 3 charts, which we shall call n, n+1 and n-1. Let's focus our attention on the n chart which using the fractal example above is 2401 (7x7x7x7). That means that n-1 = 343 and n+1 = 16,807. What you see when you look at these 3 charts is that they look identical...they're just zoomed in versions of one another.

Click the image...your eyes will thank you

What you see above are 3 CVB charts of 343, 2401 and 16,807 contracts for the e-Mini S&P December expiration futures contract (ESZ09). So, each bar represents that # of contracts traded. Now, if you look at the chart on the far right (16,807, the "slowest" of the charts) the portion in the circle is the chart in the middle and the circled portion on the 2401 chart is for the "fastest" chart the 343 on the far left. I squished the bars together on the fastest chart so you could see the resemblance better but you can confirm each of these areas by the time on the bottom of each chart. Notice how each of these charts look the same, at least in the highlighted areas? This is the fractal, in visual form. Each bar on the slower chart is comprised of 7x the data as the next fastest chart. So, each chart is in effect 7x "smoother" as the one before since it's had 7x the data to confirm the price discovery. The faster the chart the more "noise" there is since there's not nearly as much confirmation of areas of support or resistance, which is what traders identify as places to enter/exit a trade. Pretty cool, huh?

In case you're still reading...this business of fractals is pretty out there but effective in how it works. This method of trading does not rely on time--like 99% of the other traders out there swear is important in trading--but rather, takes a very organic view of trading by saying that volume dictates price movement, not time. It makes sense though...price does not move just because 5 minutes have elapsed or because it's 30 seconds later. Price moves on the transactions; the buying/selling of an instrument and this is what we call "price discovery" which is the essence of my job as a trader. Traders test the waters to see what prices will be accepted and rejected and then trade in the direction of least resistance, it's that simple. Investors and hedgers then hop on-board and follow the lead of the traders on the front-line, who have discovered what prices will be accepted or rejected by the Market.

The cool thing about this trading concept is that the strategy/indicator I've been given and spent so much time learning how to use tends to get me into moves earlier and keeps me out of the bad moves which ensures that although I'm on the front-lines, this soldier has the weapons and the intel necessary to stay one step ahead of the enemy.

More trading posts coming up in future posts...

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