Chaos Theory

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The Chaos Theory is not a theory about disorder as some people think, but on the contrary – a theory about a different order or rather about a higher order that we are unaware of.

The “CHAOS” notion was first applied to the financial markets by a well-known American analyst and trader Ph.D. Bill Williams in his first book “Trading Chaos” published in 1995.

The author calls “CHAOS” a new coming information, being in a way an energy, which by means of the feedback and further actions of the market players starts moving prices for financial and raw material assets upwards or downwards. CHAOS is freedom. It is a freedom of world perception, thinking and motion. CHAOS is a patch of least effort, which the energy takes. TRADING CHAOS is a well-known trading strategy applied to the stock market trading which is based on a non-linear movement.

Analysis of the graphical line of the price movement enables to reveal certain patterns that later become trading signals for the traders and analysts.

This web site does not intend to repeat or describe the Chaos Theory in financial markets. The Internet has more than enough information about the Trading Chaos. Besides, it is much better to read the original source several times and complete a training directly from the author of the strategy. My objective is to give a short summary of the main postulates of the theory and of the trading signals of the strategy and then to present you my software related to this theory that generates every single trading signal, to teach to trade “CHAOS” using a specialized software.

In his Trading Chaos apart from the psychological aspects Bill Williams describes the following notions and trading signals:

1. “Safety Cushion” is a loss limit that a trader is able to afford not to destroy his trading account when the market is volatile. Safety cushion is placed one minimum deviation of the price above of below the highest high or the lowest low of the second bar (candle) to the back from the considered higher level taken from the period. For the day trading range the higher level is considered to be a week, while for the 4-hour charts – a day, i.e. there must be a multiplicity equal approximately to five.

2. Bars. Candles. A rough estimate of the direction of the trend movement depending on in which third the last bar was closed. The description of the bullish and bearish extreme bars, the generation of which shows the possible change in the direction of the market movement. “Dive” and “climb” bars claiming the trend directed movement. Neutral bars that confirm the formed directed market movement rather than its change.

3. Fractal is a diagrammatic price model consisting out of a series of five consecutive bars, where the bar midpoint has either the highest or the lowest price compared to the two neighbouring bars. The fractal with the highest high of the bar midpoint is called a buy fractal and the fractal with the lowest low of the midpoint of the price bar is called a sell fractal. Crossing the fractal level by regular price movement in one way or the other indicates the generation of a directional impulse price movement that has a profit generation potential.

4. Fractal signal, fractal start, fractal stop (fractal stop-turn). Fractal signals may be of two types – buy signal and sell signal. If you view the chart from the right to the left, the fractal buy signal will be a fully formed fractal with the central bar position higher than the position of two neighbouring bars to the left and to the right and if there is a fully formed fractal start further left from the fractal signal. And the fractal sell signal, respectively, is a fractal with the central bar position lower than the positions of two neighbouring bars to the left and to the right and if there is a fully formed fractal start further to the left from the fractal signal. Signal fractal break brings us to the market in the direction of the break. Fractal start is the first signal placed on the chart further left from the fractal signal. If the price formed the fractal signal and than moved back to the fractal start, this cancels all trading signals and we should wait for the generation of the next fractal signal and place our pending order one minimum price deviation higher (lower) than the signal fractal level.
Fractal stop is the second fractal targeted in the opposite direction from the fractal start. Fractal stop-turn (stop) has the lowest (highest) position out of two fractals targeted in the opposite direction from the fractal signal.

5.  Market wave movement. The distance between the opposite fractals is called a market wave. The wave theory provides for the price movement which graphically forms eight waves in the following order: the first wave is the impulse wave, the second is the correcting one, the third – the impulse one, and the fourth, which is generally the longest wave, is the correcting one and is considered to be the most complicated out of all the waves, the fifth wave – the impulse one. Five waves are followed by three correcting waves À, B and C. The wave À is targeted against the wave trend, the wave  corrects the wave À and is targeted at the general trend that formed the “five waves”. The third wave C moves in the direction opposite the main trend. Wave movement forms the trend cycles. The wave is the main market structure. The fractal is the main wave structure.

6. Market rhythm. The first mentioning of the indicators and their settings. Bill Williams suggested using three simple sliding middle lines on closure with the parameters 5, 13, 34 and MACD indicator with the parameters (5,34,5). The buy trading signal is formed if the flattened lines stand in the sequence 5>13>34 and the histogram of the MACD indicator grows. The sell signal ÌÀ 5<13<34 and MACD decreases its positions. 

As the computer software and special trading and analytical software improve, the Chaos Theory becomes even more developed in the financial markets. Bill Williams uses new computer possibilities in the relatively stable markets. Based on the results of the researches the author published his second book called “New Trading Dimensions”, which materially expanded the list of particular trading signals. The sliding middle lines described in the first book get new parameters and form an absolutely new indicator – ‘Alligator’. The market signals for entering the market at the fractal break are generated depending on their location against the Alligator’s mouth. The author introduces two new indicators ÀÎ (Awesome Oscillator) and ÀÑ (Accelerator Oscillator) into the traders’ use. He clearly describes the signals from these indicators. I will try to list those signals, but the description to them and the visualization may be viewed on the ‘indicators’ page of this web site.

Signals coming directly from the price chart and Alligator indicator according to the description in the book “New Trading Dimensions”.

We trade in the direction of the developing trend. We do not trade if there is no trend.
We define the availability or lack of the trend according to the lines of the Alligator indicator. If the lines are intertwined, there is no trend in the market. If the Alligator lines are separated and oriented in the same direction, this means the market is in the condition of the trend in the trend wave of one or another level. It is necessary to trade according to the indicator’s open lines. The point of entering the bullish trend market is the fractal break above the teeth line of the Alligator indicator (red line), and the bearish trend – in the fractal break below the abovementioned line. In such a way the trader never stays aside of the trend which is being generated.

If following the rise or fall period with the open Alligator’s lines the price of the period has closed in the indicator’s mouth, this means that after the period of trend movement the market enters the stage of correction, consolidation or maybe even turning. The signals from the “Balance Line” may be seen from the chart. They include:
- buy signal above the balance line
- sell signal below the balance line
- buy signal below the balance line
- sell signal above the balance line

Let me remind you that the balance line for the day range is a blue line of the Alligator indicator – jaw line.
Signals from the ÀÎ (Awesome Oscillator) indicator:
- the signal of the generation of the price divergence and the “Twin Peaks” oscillator indicators. Even if there is no divergence in the market, this signal tells the trader that the trend movement in the market is weakening.
- The signal showing that the histogram of the ÀÎ indicator crosses the zero line.
- The signal showing the change of the colour of the histogram into the opposite colour that indicates respective trend set by the Alligator indicator. The signal is called “Saucer”.

Signals from the ÀÑ (Awesome Oscillator) indicator:
There are three types of signals from this indicator. The first two types of the signals come from the histogram when the histogram of the AC indicator is below or above the zero line. If two consecutive bars of the histogram are formed above the zero line, the break of the highest high of the corresponding bar position with the second such column of the AC histogram will be considered a buy signal. A sell signal – similarly, but with the AC histogram in this case below the zero line. The third type of the signal is the colour of the histogram of the AC indicator. If it is green, it means that the prices in the market tend to increase, if it is red – to decrease. The change of the colour of the histogram by the AC indicator is an initial signal to the trader that the histogram of the AO indicator will also change its colour soon.

Further accelerated development of computer technology at the beginning of the 21st century did not only allow applying the up-to-date methods of market analysis, but gave new possibilities of computer trading which substantially changed the market prices behaviour. The market became more volatile and variable. In their recent book “Trading Chaos second edition” Bill Williams and his daughter Justine Williams made material changes to the trading tactics and adjusted their interpretation of the indicators indices. The new contemporary trading techniques based on the “Trading Chaos” strategy exclude the AC indicator and the signals coming from it from the analytical pattern. Only three indicators remain in the chart, namely: Alligator indicator with the original settings, Fractals indicator and AO indicator. Now it is called “Super AO”. The analysis starts from analyzing the last generated bars and their location against the Alligator indicator’s lines. The book repeatedly includes the information about the understanding of the extreme, neutral and targeted bars. The fractal signals are described, as well as the understanding of the direction of the market with the help of the Alligator indicator, the notions of ‘divergence’ and ‘Squat-bar’ are explained on examples. The last book out of the trilogy substantially reduces the number of the trading signals:
- “First Wiseman Signal”- formation of the bullish or bearish divergent bar (B/D/B).
- “Second Wiseman Signal” is a signal for adding on the breakpoint the maximum (minimum) price of the corresponding bar with the third bar of the histogram of the Super AO indicator.
- “Third Wiseman Signal” is the entrance to the market at the breakpoint of the fractal level.

The book clearly regulates the signals for placing the points of protecting the trading profit and points of entering and exiting the market. The trading strategy becomes more aggressive, flexible and complying with the contemporary markets. Trading according to this system is very profitable on the one hand, but extremely dangerous on the other. The danger lies in non-readiness, wrong interpretation of the signals described in the Russian version of the book, lack of special software. The mission of this web site is to give the trader the opportunity to get trained in trading according to the “Trading Chaos” strategy with the help of using the author’s training video course Home Study Course of Bill and Justine Williams, to provide the special software for the efficient trading based on the abovementioned strategy.

Good luck in trading!
TREND is with us!