Predicting Forex and Stock Market with Fractal Pattern

1.1  Geometric Recognition and Prediction, the Bible for Successful Trading

Order is present not only in the universe but in human world too. We can find order everywhere including fashion, music, architecture, financial market, arts, and disease. Order can be present in our world as the different form of regularity. For example, they could be present as symmetry, balance, structure, repeating, cycle, or trend. Recognition of these regularities in our world makes our life meaningful and provides us enhancing experience. Sometimes, recognizing regularity brings us new scientific discovery and technological development leading to better life. For example, once we can model the blueprint of virus gene, we can create vaccine for virus by changing the blueprint. Hence, recognizing genetic structures of deadly virus can save millions of our life each year from Measles, Mumps, Corona Virus, and Influenza. Another important but interesting example is recognizing geometric shapes in objects. This ability is used almost everywhere in our life from designing house, creating CAD model of a car, drawing portrait, and creating 3D animation. Regularity is attractive. We love symmetry and balance. Hence, from child hood we are often attracted to play with the geometric shapes like triangle, rectangle, and circle. When we grow up, some of us are capable to apply these skills to more complex tasks as in architecture, arts, and even in the financial trading.

Although the recognition skills can vary from individual to individual, we can tell that almost everyone has the skills. Let us take some example of this in ourselves. Now imagine that you are a single adult male at the age of late twenties. Say that you are looking for marriage. In selecting your marriage partner, you can consider multiple of factors. Physical attractiveness is one of them. She might be a colleague from the same company or a friend from the same school or a friend from the same town. You might know her for a short time or for a long time. During the date with her, you will spend a lot of time to talk to her. Voluntarily and involuntarily, you will use your recognition in many different ways to find out some attractiveness from her. For example, you might use your recognition in finding attractiveness in her face.

What is the classic wisdom behind the face attractiveness? In his writings on human anatomy, Leonardo da Vinci described that face can be divided into three equal thirds. What is this equal thirds means? It tells the proportion in your face in horizontal dimension as shown in Figure 1.1-1.

Figure 1.1-1: A face divided into equal horizontal thirds

In vertical dimension, face can be divided into equal fifth. The width of eyes will represent two fifth and width of nose will represent one fifth. Figure 1.1-2 represents the proportion in vertical dimension.

Figure 1.1-2: A face divided into equal vertical fifths

Most of time, this sort of recognition is taking part involuntarily in our brain. However,  face attractiveness is one of the most frequently used recognition when we fall in love with others. Hence, we can tell that one of the important factor for face attractiveness is proportion within face or ratio between facial features. We use proportion and ratio to find regularity in our face, for example, symmetry or balance.

Next thing we can consider in the face attractiveness is the size of certain facial features. For example, size of eyes or lips can play an important role. Some man love a girl with big eyes. Plastic surgery to make eyes bigger is one of the most frequently performed procedure in the developed countries like USA, Japan and UK.

Figure 1.1-3: Before (left) and after (right) the eye surgery

Hence, we can land on the two main variables in defining face attractiveness. They are ratio and size of facial features. When we talk about face, these two main variable might be less catchy. However, we might be able to get you immediate reaction when we talk about the body attractiveness. Using the ratio variable, we can tell that certain ratio like hip/waist or chest/waist can appeal more to you than the other ratios.  Although it really depends on your preference, some man might prefer a girl with greater hip to waist ratio.  Some other man might prefer a girl with smaller hip to waist ratio. Likewise, some woman might prefer a man with bigger chest to waist ratio and vice versa. Of course, they are personal preference. You might have one preference among these figures of glamorous, slim, average, or athletic body. We can tell that these body figures are highly related to the ratio of each feature.

Figure 1.1-4: Sketch of male and female body

What about size variable? Say that your friend is going to introduce his friend to you. Your friend set a dating for you and her. Your friend gave you her photo. From the photo, you might find attractiveness with this girl in her face and in her body.

How about if she is a tall girl with 2 meter height and your height is only 1.72 meter? Before you meet her in dating, her height could put you on a lot of thinking. Some might go ahead with dating but some might want to cancel dating. There could be many reasons if you think that this dating is not going to happen. Simply, you might just prefer a small girl. Alternatively, you might be scared to see other people’s reaction when you walk with her on the street. Some people might believe that she would not like you because you are smaller than she is. Whatever the reason could be, we can tell that the size variable cannot be ignored.

Figure 1.1-5:  A girl dating with a man

So far, we brought the example of physical attractiveness. In the example, we can tell that geometric recognition is based on size and ratio variable like below:

Geometric Recognition = Size + Ratio.

Firstly, let us dig deeper on the characteristics of size variable. Size like length, height, or width is a measurement. Fortunately, we have various measurement units available for geometric shape. For example, meter (m), centimetres (cm), kilometres (km) are internationally accepted measurement unit for length. Another important characteristic of size variable is that it helps to compare an object to an object. This provides us the linkage to statistics. For example, averageness and outlier is the statistical information we can gain when we can measure length of the same object in many samples. For example, with size, we can answer to the question like what is average height of male in the world. In addition, someone can ask if 2 meter tall male is outlier in USA. With size, we could relate one object to another object inside the population or samples. Last, but not least, attribute of size variable could have the direct relationship with functionality. For example, to lift a heavy dumbbell, we need to have a certain size of the muscles and certain thickness of bone. While many adults can lift 15 to 20 Kg dumbbell with one arm, this is hard task for children because size of the muscles and bones in arm are smaller in children. Another example is the case of buying clothes. You can find the perfect looking clothe in the shop.  However, if your size is out of stock, then, there is no way to buy the unfitted cloth for yourself. Size can often limit or provide the certain functionality for an object. Hence, many of us can roughly recognize the certain length like 1 meter or 20 cm for example.

Figure 1.1-6:  Different height and body size

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Secondly, let us dig deeper on the characteristic of ratio variable. To get ratio, we have to divide one length by another length. Hence, Ratio is unit-less. As soon as we divide a length by another length, we are left with just ratio. Ratio is a numeric value without unit. For example, width of nose to face ratio can be calculated like below:

Width of nose / Width of Face = 4 cm / 20 cm =  0.2

Ratio is highly related to the recognition of symmetry. In turn, symmetry is often related to balance of an object. For example, we recognize balance and unbalance every day in our life. When we recognize unbalance around us, we are often unhappy or we can feel fear from it. For example, say you are driving in a car in the high way. A truck is passing your car. As soon as you notice the unbalanced loading in the truck, you will start to feel fear. Obviously, your intuition thinks that the stuff on the truck can fall on the high way. Most of case, it might not happen but it could happen with some low level of chance. Especially, when the road condition is bad due to rain or snow, the chance of accident can increase dramatically. Your prediction is not bad in fact. It is better to take precaution when you find the notable unbalance around you.

Figure 1.1-7: Potentially dangerous loading on truck

In history, ratio was often used to describe a balance and unbalance in physical appearance. For example, the golden ratio was often used to measure the beauty in our face and body. Likewise, in financial trading, this golden ratio was further extended under the Fibonacci ratios.

Size and ratio is in fact very much related together because ratio is size divided by size. If size helps us to compare an object to another object for statistical regularity, then ratio helps us to find geometric regularity inside an object. Size is an absolute value. Length or height of an object is universally the same even if measurement unit changes. It is absolute. On the other hands, ratio helps us to define the relative relation of one size to the other size. For example, one can measure the ratio of chest to hip. At the same time, one can measure the ratio of chest to waist. Even though the chest is common numerator, these two ratios tell us entirely different story about the attractiveness of our body. Ratio is relative.

The geometric recognition can be used to make prediction of certain behaviours in human world. We can make the prediction like if your dating would be successful with a girl based on the physical attractiveness point of view. We can also make the prediction on if a designed cloth would sell more on the certain country by analysing the physical characteristics of buyers. In addition, we can make the prediction if a new 3D animation characters can appeal to children. Likewise, we can apply this geometric recognition to predict the direction of the financial market.

Although the geometric prediction comes after the geometric recognition, we can tell that geometric prediction is also departing from recognizing size and ratio variable of an object. Unlike the recognition stage, in the prediction stage, we will be using our internal and external knowledge around the object to amplify or to tune our prediction. For example, everyone can recognize the unbalance in the leaning tower of Pisa (Figure 1.1-8). Based on the unbalance, many would feel uncomfortable or scared to walk around the tower Pisa. We know that the 57 meters tall tower made from the white marble should not be causing some light casualty only if they collapse. However, we know it is safe for last 300 years. Even though it was struck by the several strong earthquakes in history, it survived. Based on this knowledge, we can make the prediction that it is safe to walk inside the tower Pisa. Hence, people are not scared to go on the top of the tower Pisa. In the future, situation can change though.

Figure 1.1-8: Tower of Pisa in Italy

As we discuss so far, the first step of our prediction is geometric recognition. We can formulate geometric recognition like below.

Geometric Recognition = size + ratio (or proportion)

Since this book is about financial trading, we will not use the colour in our equation. In our financial trading, we will be OK without it. However, if your application is outside financial trading, then you might add colour variable in your equation. After the geometric recognition, we make our prediction based on the size and ratio of the geometric shape as well as the surrounding knowledge around the object. Hence, we can write the geometric prediction equation like below.

Geometric Prediction = size + ratio + surrounding knowledge around object where size and ratio is measured from geometric shape of the object.

We also describe some general properties of size and ratio variable of geometric shape in the Table 1.1-1.

Table 1.1-1: Characteristics of size and ratio variable of geometric shape

By substituting size and ratio with statistical regularity and geometric regularity (Table 1.1-1), we can formulate more general version of the geometric prediction equation like below:

Geometric Prediction (General version) = statistical regularity + geometric regularity + surrounding knowledge around object

If one is looking at purely technical version of Geometric Prediction equation, then it can be written like below:

Geometric Prediction (Technical version) = statistical regularity + geometric regularity

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In this book, we will show you how to apply this geometric prediction equation for financial trading. Although application of geometric prediction in financial trading might look complicated, you have just understood the two main variables for the geometric prediction. They are size and ratio. If one ask which one between size and ratio is more important, they are equally important. By using one of them only, your prediction is not complete. For example, as we have seen in our dating example, ratio in face and body alone cannot predict your dating success completely. It is better if we know height of each other. It is even better if we know the size of some other features like size of eyes, nose, lips, limbs, and hands. Likewise, to predict the sales of a designed cloth, we need to know how potential buyers will recognize the various ratios in the designed cloth. At the same time, we also need to know the size of cloth will fit to the majority of potential buyers in the market.

This book is about financial trading. The book is written to help you to predict financial market for profiting. When we use the geometric prediction in the financial market, we also need to look into ratio and size of the price pattern. However, there is some specific aspect, which you have to understand before applying this geometric prediction to make profits. In financial market, we are not talking about single geometric object like a face, body, or cloth but it is about fractal pattern. Fractal pattern consist of geometric shapes too. Hence, everything we have learnt so far about the geometric prediction is applicable. However, fractal pattern is the never-ending patterns that keep repeating the same or similar geometric shape in different scales. Hence, in financial market, we will come across the case in which small and large geometric shapes are present together. In another words, you will be busier at analysing multiple geometric shapes when you make prediction.  Without understanding the nature of fractal patterns, you can not make the complete prediction in the financial market. Hence, to help you understand the fractal patterns, we will be covering some of the basic topics in next couple of chapters.

Figure 1.1-9: Fractal patterns in the financial price series

1.2  Turning Point, Peak, Trough, Swing High, Swing Low, and ZigZag

To recognize the geometric shape in our chart, we need a measurable object. In financial market, the geometric recognition is done in the two dimension of price and time. Price is usually placed in Y axis and time is usually placed in X axis. In financial market, we recognize the geometric shapes in the candlestick chart. Some might use range bar chart. In this book, we will be using candlestick chart most of time because they are easy to read.

When we look at the plain chart, we can recognize almost nothing. It is because we do not know which object we will be studying in the continuous price series. For an object to be measurable, the object requires boundary or outline. Hence, to recognize any geometric shapes in our chart, we need a good logic of dividing the continuous price series into some measurable objects. Typically, it is best to start with Peak Trough Analysis.

Figure 1.2-1: Empty EURUSD H1 chart

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In Peak Trough Analysis, we define peak and trough in an alternating manner. The analysis will start from oldest price data to latest price data. If we start with peak, then we will detect trough, peak, trough, peak, and so on to the right. If we start with trough, then we will detect peak, trough, peak, trough, and so on to the right. Each peak and trough requires having the certain distance in price and time as shown in Figure 1.2-2. Doing this manually could be quite tedious. Fortunately, there is a Zigzag indicator available everywhere to do this task automatically. At the same time, we provide Peak Trough Analysis free for audience of this book. Please refer to the downloading guide for Peak Trough Analysis tool in this book.

Figure 1.2-2: Definition of peak and trough in candlestick chart

Once the Peak Trough Analysis is done, your chart will look like this. What peak trough analysis is doing here is that turning the continuous price series into many triangles. Three points are equivalent to one triangle. For example, a set of peak, trough, and peak can form one triangle. Likewise, a set of trough, peak, and trough can form one triangle too. When we just label peak and trough, it is hard to notice the presence of these triangles (Figure 1.2-3). However, if we provide the outline to each triangle, then you could see them more clearly (Figure 1.2-4).