The mathematician Fibonacci or Leonardo of Pisa in 1202 first published his Fibonacci sequence. In order to calculate the number of pairs of rabbits he would have at the end of a year based on their behavior of breeding, Fibonacci developed this famous sequence of numbers. Forex traders find this type of no-nonsense approach very profitable.
So you see, what many people mistakenly take as a mere mathematical abstraction, just “fooling around” with numbers, is rooted in very real-world applied mathematics. To state things very basically, the Fibonacci sequence can be used to detect and describe otherwise hidden patterns in the world around us.
How can this be applied to investing? Very astute investors understand that there are hidden patterns in the stock market–based on the mass of investors’ behavior. “Buy low and sell high” and “The best time to buy is when there’s blood in the streets” are but two investment aphorisms that not only work, but also come from understanding hidden patterns of the investment markets.
These patterns cannot be seen by a day to day observation of market conditions, but reveal themselves when you step back and take a look at the big picture. Short term fluctuations in the market are nearly impossible to accurately forecast. However, the trends which occur over time most certainly are predictable. Investors of all stripes, including Forex traders have used the Fibonacci sequence to plan their investments and make large profits in the currency exchange markets.
The Fibonacci sequence is a string of numbers with each number being the sum of the two numbers which preceded it. For example, one such string would be 1,1,2,3,5,8,13,21 and so on. These numbers are related in several ways. Any given number in a Fibonacci sequence is about 1.618 of its predecessor – the “golden ratio” of the Greek mathematicians.
Of all the Fibonacci series the two applications in wide spread use by Forex traders and investors are arcs and retracements.
A Fibonacci chart is made of three curved lines which represent support levels, key resistance and ranging. A trendline is first drawn between two points (generally the high and low points over a given period of time). Three curved lines are then drawn which intersect the trendline at the 38.2%, 50% and 61.8% points. Decisions about buying and selling are made at these points (i.e. – when the price of the commodity in question reaches these points).
In the world of investment, retracement relates to the reversal in movements of the price of a stock. An impressive reversal can counter the prevailing trend in the stock. Successful progressive investors focus strongly on the retracement patterns and possibilities. The Fibonacci method of retracement evaluates the prospects of the price of a financial asset being more superior than is average as well as supporting or resisting at key Fibonacci levels before continuing on its original course. Between the two extreme points a trendline is drawn and then its vertical distance by the ratios of 23.6, 38.2, 50, 61.8, and 100 percent, according to Fibonacci.
The Fibonacci retracement is widely used by sophisticated traders to find: strategic places for transactions to be placed; target prices; and stop-losses. Other technical tools including Tirone levels, Gartley patterns, and Elliott Wave theory all make use of retracement.
The Fibonacci formula simply works and is useful while investing. Forex traders worldwide are finding it successful while using it.
