Leonardo Pisano (famously known as Fibonacci), an Italian mathematician was the only man behind this interesting subject. He was the first to write about the Fibonacci number sequence and its unique properties
When the financial market evolved, traders started to implement the Fibonacci methodology in their trading strategy and realized that Fibonacci worked in all the markets, individual stocks, future contracts, commodity and currency trading in any time frame.
What is Fibonacci number series and Golden Ratio?
Fibonacci number series starts with 0 and goes out to infinity. The next number in the series is derived by adding the previous two numbers. i.e. 2+3=5, 3+5=8, 5+8=13
Here is the Fibonacci number series
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144… infinity
Now, I am going to amaze you by giving you a simple task. Calculate the ratio by dividing a number in the series by the preceding number (e.g. 8/5 or 8/13).
Isn’t it interesting to see the ratio around 1.618? And that is called as Golden Ratio or Golden Mean.
You can take any two consecutive numbers in the number sequence and test if the ratio comes around 1.618 or not.
The other most important ratio to do Fibonacci trading is the 0.618(1/1.168) which is the reciprocal of 1.618. The ratios that are considered for trading are 0.382, 0.50, 0.618, 0.786, 1.00, 1.272, and 1.618.
How Fibonacci ratio is going to help us in trading?
Google can show you nearly 6,000,000 results for the keyword “Golden Ratio”. You can find this Golden Ratio in many areas like Architecture, Music, Nature and also in the Financial Market. If you ask me to relate Fibonacci ratios with the financial market, I feel the Fibonacci ratio represents the human behavior in the chart where the trend is likely to show support, resistance level or reversal when it touches the ratio. Fibonacci retracement and Fibonacci extension are some of the tools created based on Fibonacci.
Fibonacci analysis can be used in any market during any timeframe. But also, you should take consider the following factors to analyze the stock using Fibonacci
You should have sufficient data/historic prices of the stock
Ensure the chart shows significant swings i.e. Highs and Lows
Do not use Fibonacci in penny stocks as the volatility may be higher and meaningful swings cannot be identified
Benefits of Fibonacci analysis
When I started to learn Fibonacci analysis, I was scared about mathematics and calculations. But my trading platform has made my job easier. You can easily find software packages to show the Fibonacci ratios when you connect the highs and lows of a swing. Fibonacci study may appear like hard to learn but it is very useful to hone traders’ skills. I have listed some of the uses below
- Fibonacci shows support and resistance level
- Helps to time the market
- To identify the possible reversal
- To determine the price target/sell price
Trading strategies developed using Fibonacci have become common nowadays among professional traders. But still newbies to technical analysis will be curious to know about this methodology because of its wealthy information in this world. I am pretty sure new learners would be excited to explore Fibonacci trading and putting it into their trading rules.