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Stocks & Commodities V. 28:6 (16-20): Fractal Dimension As A Market Mode Sensor by John F. Ehlers and Ric Way
TRADING SYSTEMS

Cycle Or Trend?

Fractal Dimension As
A Market Mode Sensor
You can use the fractal dimension as a natural way be defined by the fractal dimension that describes
to sense whether the market is in a cycle mode or sparseness at all magnification levels.
trend mode. To determine the fractal dimension of a generalized
pattern, we cover the pattern with a number N of small

Is
objects of several various sizes S. The relationship
the market trending or cycling? What in- of the number of objects in two sets of sizes is:
tuitively seems like an easy question to
answer is perhaps one of the most vexing in N2 S1 D
=
N1 S2
all technical analysis. If a trader knows the market
mode, then a straightforward approach could be log
N2
taken to adapt a trading strategy to that mode. We N1
D=
would apply a swing trading technique such as an S1
log
S2
overbought/oversold oscillator in cycle mode and a
trend-following technique such as a moving average As an example, we can start with a pattern that is a
crossing in trend mode. In this article, we address the line segment 10 meters long. We chose the two small
cycle/trend problem using the fractal dimension. dimensions as S1 = one meter and S2 = 0.1 meter.
A number of tools have been developed to differ- Placing boxes along the line, we can fit 10 one-meter
entiate between cycle and trend modes. For example, boxes on the segment, and therefore N1 = 10. Simi-
we can compare the trend slope over a full cycle larly, we can fit 100 0.1-meter boxes on the same 10
period to the amplitude swing of the cycle and use one-meter line segment, and therefore, N2 = 100. The
the ratio. More recently, we developed empirical fractal dimension of the line then computes to:
mode decomposition to separate the market into cycle
and trend mode components. In this article, we will 100
log
10
consider the fractal dimension as a natural way to D= = 1.0
1
determine whether the market is in a cycle mode or log
0.1
trend mode.
As a second example, we will use the pattern as a
Fractal dimension square that is 10 meters on a side instead of a line seg-
There is no argument that market prices are fractal. ment. Retaining the same sizes of our small boxes as
Price charts look similar regardless of time frame. If one meter and 0.1 meter on a side, respectively, we get
you remove the labels from a five-minute chart, a daily N1 = 100 and N2 = 10,000. When the square is our pat-
chart, and a weekly chart, you would have difficulty tern, the fractal dimension therefore computes to be:
telling them apart. Fractal shapes are self-similar be-
10000
cause they have the same roughness and sparseness log
100
regardless of time interval. This self-similarity can D= = 2.0
1
log
0.1

by John F. Ehlers and Ric Way
Copyright (c) Technical Analysis Inc.
WILLIAM L BROWN
Stocks & Commodities V. 28:6 (16-20): Fractal Dimension As A Market Mode Sensor by John F. Ehlers and Ric Way

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 28:6 (16-20): Fractal Dimension As A Market Mode Sensor by John F. Ehlers and Ric Way
FRACTAL DIMENSION INDICATOR IN EASYLANGUAGE
Inputs: Price((H + L)/2),
N(30); {N must be an even number}
Vars: Smooth(0),
count(0),
N1(0),
N2(0),
N3(0),
HH(0),
LL(0),
Ratio(0),
Dimen(0);
Smooth = (Price + 2*Price[1] + 2*Price[2] + Price[3]) / 6;
N3 = (Highest(Smooth, N) - Lowest(Smooth, N)) / N;
HH = Smooth;
LL = Smooth;
For count = 0 to N / 2 - 1 begin
If Smooth[count] > HH then HH = Smooth[count];
If Smooth[count] < LL then LL = Smooth[count];
End;
N1 = (HH - LL) / (N / 2);
HH = Smooth[N / 2];
LL = Smooth[N / 2];
For count = N / 2 to N - 1 begin
If Smooth[count] > HH then HH = Smooth[count];
If Smooth[count] < LL then LL = Smooth[count];
End;
N2 = (HH - LL)/(N / 2);
If N1 > 0 and N2 > 0 and N3 > 0 then Ratio = .5*((Log(N1
+ N2) - Log(N3)) / Log(2) + Dimen[1]);
Dimen = Average(Ratio, 20);
Plot1(Dimen);
Plot2(1.6, “1.6”, Blue);
Plot3(1.4, “1.4”, Blue);
A perfect square represents an idealized geometry not found
in nature. Natural fractals like that of a seashore lack the true
regularity of an algorithmic structure but are self-similar in a
statistical sense. Thus, in order to determine the fractal dimen-
sion of natural shapes, we must average the measured fractal
dimension made over different scales.
We could measure the fractal dimension of prices by cover-
ing the curve with a series of small boxes. This is burdensome,
but if we take into account that the price samples are uniformly
spaced, the box count is approximately the average slope of
the curve. Therefore, we can estimate the box count as the
highest price during an interval minus the lowest price during
that interval, divided by the length of the interval itself. The
equation for the number of boxes is then:
HighestPrice – LowestPrice
N1 =
Length
We compute the fractal dimension by computing N over
two equal intervals to get the averaging over each interval.
Interval 1 covers the period from zero to T bars ago. Interval
2 covers the period from T to 2T bars ago. Therefore, N1 =
(HighestPrice – LowestPrice) over the interval from zero to
Copyright (c) Technical Analysis Inc.
TRADING SYSTEMS
T, divided by T. Similarly, N2 = (HighestPrice – LowestPrice)
is over the interval from T to 2T, divided by T. We also define
a N3 = (HighestPrice – LowestPrice) over the entire interval
from zero to 2T, divided by 2T. Since we are looking backward
in time, the slope computation of the fractal dimension is:
log N1 + N2 – log N3
D=
log 2
The fractal dimension varies over the range from D = 1 to
D = 2. When D = 1 prices are in a straight line — that is, the
market is in a trend mode — the trend can be up, down, or
sideways because the fractal dimension has no sense of slope.
When D = 2, the prices are swinging up and down within the
box over the observation period; in other words, the market is
in a cycle mode. When D = 1.5, we have the boundary between
being in a trend mode or cycle mode. Since the measurement of
the fractal dimension is only an estimate, there is no clear-cut,
black & white distinction between trend mode or cycle mode
at the boundary. Thus, we choose to plot a “fuzzy” boundary
extending from D = 1.4 to D = 1.6 within that range.
The fractal dimension indicator
The EasyLanguage code to compute the fractal dimension indi-
cator is given in the sidebar “Fractal Dimension Indicator.” We
choose to use the average of the high and low prices to compute
a line indicator (price) because this average is smoother than the
closing price alone with respect to high-frequency components.
We then smooth price using a four-tap finite impulse response
(Fir) filter to entirely notch out the two- and three-bar cycle
components. A Fir filter is similar to a moving average except
that the selected coefficients enable the elimination of the un-
desired two- and three-bar period cycle components.
The computation of N1, N2, and N3 are as previously
described. We then smooth the ratio using a 20-bar moving
average to create the resulting fractal dimension indicator. The
length of the moving average is somewhat arbitrary, with 20
being a good match for the default input setting of N = 30. The
indicator is plotted as Plot1, with the fuzzy boundaries plotted
as Plot2 and Plot3.
The fractal dimension in action
The fractal dimension indicator is applied to approximately one
year of data of Microsoft Corp. (Msft) in Figure 1. The indicator
shows that Msft is in a trend from mid-July 2008 until January
2009. From the slope of the data, this is clearly a downtrend.
Between January and mid-April 2009, the indicator is in the
fuzzy region and from mid-April it begins another trend. This
time the trend is up, as determined by the slope of the data.
It may be instructive to describe the action of the fractal
dimension indicator from a theoretical perspective. In Figure
2, this indicator is applied to a sine wave the period of which is
continuously increasing from left to right. The period has been
 Stocks & Commodities V. 28:6 (16-20): Fractal Dimension As A Market Mode Sensor by John F. Ehlers and Ric Way
TRADING SYSTEMS

measured in the bottom subgraph, and

the period is indicated on its vertical
axis. In this case, we have set the input
N = 20. When the cycle period is less
than N, the cycle swings fill the box and
a cycle mode indication results. When
the cycle period is greater than N, the
indicator reads segments of the longer
cycles as trends. This is a reasonable
interpretation of a trend. However,
the prices tend to fill the box near the
peaks and valleys of the longer cycles.
The moving average in the indicator
reduces the excursions of these swings
to improve interpretation of the trend
mode.
MESA SOFTWARE

Trend or cycle?
By its very design, the fractal dimen-
Figure 1: fractal dimension indicator in action. Here you see the fractal dimension indicator applied on the sion is a natural descriptor of trend
chart of Microsoft (MSFT). The indicator shows that MSFT is in a trend from mid-July 2008 until January 2009. From the modes and cycle modes in the market.
slope of the data, this is clearly a downtrend. Between January and mid-April 2009, the indicator is in the fuzzy region,
Its use provides you with another tool
and from mid-April begins another trend. This time the trend is up, as determined by the slope of the data.
to better apply your strategies for ei-
ther swing trading or trend-following
trading.

John Ehlers is a pioneer in the use of

cycles and Dsp techniques in techni-
cal analysis. He is the author of the
Mesa8 program and is the chief sci-
entist for www.isignals.com. Ric Way
is an independent software developer
specializing in programming algorith-
mic trading systems in C#. He may be
reached at ricway@taosgroup.org.

Suggested reading
Ehlers, John F., and Ric Way [2010].
“Empirical Mode Decomposition,”
Technical Analysis of S tocks
& C ommodities , Volume 28:
March.
‡EasyLanguage (TradeStation)
‡Mesa Software

See our Traders’ Tips section beginning on

page 70 for program code implementing
John Ehlers’ technique.
Figure 2: fractal dimension indicator applied to a theoretical sine wave. The period of the sine
wave continuously increases from left to right. The period has been measured in the bottom subgraph, and the period
is indicated on its vertical axis. In this case, we have set the input N = 20. When the cycle period is less than N, the
cycle swings “fill the box” and a cycle mode indication results. When the cycle period is greater than N, the indicator
reads segments of the longer cycles as trends.

Copyright (c) Technical Analysis Inc.

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