Initially, Williams' ideas aroused much controversy because of their revolutionary nature. Indeed, in his theory, the analyst disputes the truth of some unshakable laws of fundamental analysis. However, his personal experience and the experience of his numerous followers proved the high efficiency of the system; so, it became an integral part of analytical forecasting, and his indicators were included in the standard toolkits of most trading platforms. While studying the method of Three Wise Men, we will delve into fractal geometry, get familiar with new indicators and will be able to have a simpler view on the market processes, arranging its chaotic structure into a measurable order.

Let us first study some theory and then move on to practical examples. Williams writes that most traders and investors think that the market is too complex, and so, they miss obvious things. The markets are not mysterious and unfathomable. The primary purpose of any market is to ration, existing and future supply to those who want it the most. Differently put, any market is a tool that helps us set a reasonable price, that will balance the power of those who buy and those who sell.

When you understand how any market works and its purposes you can refute some basic principles of fundamental analysis. According to him, the primary job of the market is to instantly find that exact place where there is an equal disagreement on value and an agreement on price. So, the market cannot endue even the least bullish sentiment before the price will start rising.

Based on this principle, there is logically follows another truth that is also a sensation.

There cannot be any such thing as an oversold or overbought condition, a there is no such thing as bullish or bearish consensus. The market is ruled by two types of ideas, they are opinions and facts. Opinions are the most popular ideas. On the one hand, they are quite powerful, as they, like any other beliefs, have a huge impact on trade and investment decisions. On the other hand, opinions have an influence only on some traders, basically weak holders, who I wrote about in the series of lessons about the VSA model.

Facts, on the contrary, are not numerous and are often less important for traders than opinions. And this is very strange, as facts have an impact on all market participants. Bill Williams suggests that neither economical, nor technical, nor fundamental analysis provides an accurate picture of a market is.

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As an alternative to common approaches, the author suggests the chaos theory and fractal geometry. The science of chaos outlines three fundamental principles for the study of the market energy:.

Bill Williams Indicators and Trading Strategies | AvaTrade

All structures contain movement and an inclination toward movement; this means they tend to change from one state to another state. Any structure has four elements:. The structures that have the most influence on your trading results are composed of desires, beliefs, assumptions, aspirations, and, most of all, your understanding of the underlying structure of the market and yourself. In practice, the behavior of most market participants is determined by two types of underlying structures.

They are action-reaction and the infinite cycle model. This type of structure produces an action-reaction behavior. A simple example is a pendulum. A rise is always followed by a fall. In this structure, change is experienced from time to time, but it does not last. Any progress turns out to be temporary. This type of the underlying structure makes us move back and forth just like a pendulum.

Unlike the previous, Type One structure, a structure that aims at solving problems, a Type Two structure is geared for action that brings something new into the current situation. This is a cycle model, like an infinity sign or number eight. First, such a trader tries to reduce the importance of the problem.

bill williams chaos theory pdf

As a result, instead of making real profits for a somehow long time, the trader moves back and forth between solving problems, stopping progress and as a result, new problems. One of the key factors of successful trading the Three Wise Men strategy is understanding your type of thinking. As a trader, you, first of all, need to accept your way of thinking, using its benefits and flaws. From a psychological point of view, Williams sees the market as a three-dimension structure that includes three components:. Williams believes that the development of traders is stepwise. In total, he distinguishes five steps:.

Level One, the novice. At this level, a beginner trader sees the enormous amount of information contained in the tools at this level.

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The main objective at this level is to learn to trade in the market and not lose money while you gain experience. Most novice traders search for a mechanical system that will make them rich and successful if they can just put the pieces of the market puzzle together. This is a bad idea. Level two, the advanced novice. At this level, a trader expands the horizons timewise to include more tools than he used at level one.

Level three, the competent trader. At this level, the trader can quickly and exactly use the tools of the market to increase trading efficiency. Level four, the proficient trader. Our objective at this level is to align our own persona underlying structure with the underlying structure of the market. Williams states that when that happens, winning becomes the path of least resistance. Level five, the expert trader.

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At level five, we flow deeply into the realm of chaos. Things that seem occasional at the first level, are now logical and natural at level five.

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At level five, trading a low-stress way of living. The basic tool in the Three Wise Men strategy is the Alligator indicator, which is a combination of three Moving Averages:. The chart displays the Alligator that consists of three MAs of different lengths and with different shifts. The Blue Line is the Balance Line. Differently put, it shows where the market would be if there were no new incoming information.

So, the distance between this line and the current price is an indication of how the traders interpret this new incoming information. The Red Line is the moving average for one significant time frame lower. So, roughly, if the time frame on the current chart is a daily one and refers to the Blue Line, the Red Line would approximate an hourly chart.

And the Green Line will show where the market would be in the minute chart. The markets usually stop, reverse or become balanced before most participants realize what is really going on.

Trading Chaos by Bill Williams: Three Wise Men trading strategy

That is why traders miss potentially profitable situations and even experience losses, entering trades at wrong points. The Alligator helps you select an optimal time to open a position. The Green Line will be the first indicator that significant amounts of contracts are coming into the markets and are biased in one direction. The next, a more exact signal is the Red Line. The Blue Line is a confirming signal proving that we have made the right decisions. Let study a few basic patterns on the examples. A pattern showing the lines going apart is referred to as the Hungry Alligator by Williams.

Note that when the lines start separating, the first line to react to the positive new incoming information is the green line, next the red line reacts, and the blue one is the last to turn. The prices cross the line for the first time when the bull trend is exhausting. There is not yet a clear trend, even though the price seems to be rising, and so, the price can go any direction.

Now, let us see a bear market. If with a steady up-move, the green line lips is on the top, next, there is the red line teeth and the blue line jaws is at the bottom.

In a bear market, the lines are in the opposite order. The red zone of the chart displays the Sleeping Alligator when a downtrend starts, it opens the mouth downside. Note that, during the entire downtrend, bars close below the Alligator lips green line. When the bear trend is exhausting, the price chart breaks through the lips upside. The red zone in the chart marks the Alligator sleeping for a long time while there is a sideways trend. So, the big idea is to stay out of the market when the Alligator is sleeping and to be in the market when the Alligator is awake and hungry.

Otherwise, entering any trades will yield only losses. In the past, bull markets ended when all the bulls had bought and there were no new buyers. This will then guide you towards better decisions.