Introduction to Fibonacci Numbers & Trading

In the field of mathematics, Fibonacci numbers (alternatively called the Fibonacci Series or Fibonacci Sequence) are the numbers featured in the following integer series:  

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10946, 17711, 28657, 46368, 75025, 121393 ……. and so on.  

This particular integer series was first discovered by Leonardo of Pisa, who was also known as Fibonacci. The Fibonacci numbers display a recurrence relation, a series of Fibonacci numbers is started with a 1 which is then followed by a 1, with the third number being calculated from the first two (1+1) and so on. So for example in the sequence above the fourth number (3) is calculated by adding the second and third number together (1+2).  Which is easy enough to understand.    

This Fibonacci numbers are then interpreted in a rather interesting way. If you begin measuring the ratios of each number next to one another you will get what are often called Fibonacci ratios. These ratios are the same numbers that often used in various forms of technical analysis. The ratios are as follows:  0.236, 0.382, 0.500, 0.618 and 0.764. These ratios are used in a number of different Fibonacci tools which are meant to help the trader predict changes in market direction.

Those who endorse Fibonacci ratios simply assert that you just need to understand how to use this magic ratios alongside technical analysis. With it being claimed Fibonacci ratios can be used to identify both support and resistance levels. Why are these ratios supposed to operate as both resistance and support levels? Well, there is no clear reason why this should be the case. However it has been asserted by some that we subconsciously seek out these so called golden ratios. A more plausible but hardly believable explanation may be that we are not psychologically comfortable with particularly long trends meaning that particular ratios or numbers often signal the end of trends.  

There are five different types of trading tools which are derived Fibonacci’s discovery namely Fibonacci arcs, fans, retracements, extensions and time zones. All of which I will outline at a later date. The lines created by these different methods of using Fibonacci ratios are often believed to signal changes in trends when prices draw close to them. 
Some have contended that Fibonacci tools can predict market movements with accuracy rates of above 70%. Many believe the use of Fibonacci numbers is both risky and time consuming though recently a number of tools have been developed to help traders easily calculate things such as Fibonacci retracements. However many traders struggle reading and implementing the results which means many would better of not using Fibonacci as compulsory support and resistance levels.  
I am personally of the opinion that the majority of the alleged effectiveness of the Fibonacci, is down to the influence that Fibonacci studies have had on many traders and are not down to any real market driving forces. During times when the market is relatively quiet the Fibonacci tools work effectively due to the fact that there are thousand of traders who are putting their faith in these tools. With a cascade of traders artificially creating these resistance and support levels. This characterization seems particularly accurate as it appears that Fibonacci tools work better when trading Forex than other instruments. This I contend is partly due to the fact that Forex traders generally have a greater faith Fibonacci tools, therefore creating a self fulfilling prophecy. 
In conclusion it appears that Fibonacci tools could be useful tool. However there are not a tool which should be overly relied on. The best approach being to use Fibonacci tools in combination with other methods. In future I will outline how one can use the different Fibonacci tools to help identify changes in market direction. 


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