Introduction to the Fibonacci Sequence
Fibonacci is a number sequence discovered by the mathematician Leonardo Pisano Boglio, also known as Leonardo Fibonacci, in the middle ages. This sequence, which he is credited with having discovered, was in addition to a number of other mathematical accomplishments attributed to him, including spreading the Indo-Arabic numerals throughout Europe.
Generating the Fibonacci Number Series
The Fibonacci number sequence is generated by starting with 0, then increasing by one, and then adding the newly generated number to the prior numbers in the series. For example a short calculation of the Fibonacci sequence would begin : 0,1,1,2,3,5,8,13,21,34,55,89,144,233,377,610 etc.
Essential Fibonacci Ratios Used in Forex Trading
The true power of the sequence is expressed in the ratios created by the sequence, especially what is referred to as the “golden ratio” also known as the “golden mean,” which calculates to .618 (61.8 percent).
The golden ratio is found throughout nature. Some common expressions of the ratio are found in the arrangement of leaves and plants, floret patterns in flowers, bee hives and DNA. Most importantly though, the sequence is revealed in the patterns found in stock market prices.
The golden ratio is found by dividing a Fibonacci series number by the number immediately to the right of it in the series. Using an example created from the above number sequence, 34/55 produces .618.
Other key ratios used in fibonacci Indicator charting are calculated by dividing a series number by the number two places to the right of it. For example: 55/144 evaluates to approximately 0.3819 (38.19 percent). Dividing a series number by another series number three places to the right generates a ratio that is approximately .2352 (23.52 percent).
Reversing the order of the operands in the above ration generating exercise, in other words, dividing the leftmost sequence number (the larger one), by the rightmost (the smaller), produces a ratio that is approximately 1.618.
The Fibonacci Indicator
Fibonacci ratios are used in Forex technical trading to identify patterns predictive of currency price movement.
A common method of employing the ratio takes two price extremes on the currency’s chart and marks off horizontal lines at the key Fibonacci ratios at 0.0, 23.52 percent, 38.19 percent, 68.1 percent and 100 percent (oftentimes 50 percent is included because of its reliability in predicting the continuance of price reversals and other trend movements).
The chart’s price movement is then analyzed to reveal price support test levels and historical price level follow through at the Fibonacci percent levels.
Retracement, Uptrend and Extension Analysis
Retracements can be thought of as movement levels contained within the ratio chart markup levels.
On the other hand, extensions go beyond the 100 percent boundaries and run the new low to high to reveal possible support levels.
In terms of upward trends, the 1.618, 2.00 and 2.618 ratios are used by the trader to find possible resistance levels.
Forecasting Using the Fibonacci Ratios
By placing the fibonacci Indicator lines over the price chart and extending the lines past the current price, the investor can locate the price retracement and resistance levels.
However, when the price movement is in a downtrend, each Fibonacci retracement level should be thought of as a potential price support level where Forex traders again resume buying the security, thereby increasing higher price movement. As a result of the new movement, the downtrend is reversed.
Investors can use these support and resistance levels revealed by the Fibonacci ratios to set stop limit and buy orders, as well as set up other types of Forex currency hedging strategies.
The golden ratio calculated by Fibonacci series, along with the other useful ratios calculated from the series, is found throughout nature, and reveals itself in Forex currency price movement at key price movement levels. As such, it represents another charting tool for Forex currency traders to explore.
Forex technical traders can benefit from the series by creating portfolio management strategies which take support and resistance levels predicted by the key Fibonacci ratios into consideration.