Fibonacci’s sequence: The golden ratio of trading?

Using Fibonacci’s sequence to find retracement levels is a method I like.

5 minute read

The Fibonacci sequence of numbers starts with 0 and 1 and increases based on the sum of the previous two numbers.

 

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55 and so on.

Fibonacci’s Sequence
Fibonacci numbers are not only interesting to learn about, but they are seen by many as a crucial aspect with regard to their technical analysis. Extensive back-testing shows just how often stocks will react when they hit Fibonacci retracement levels.

The Fibonacci sequence is fascinating for many reasons, the most prominent being that these numbers have a prevalent tendency of showing up in nature. The number of rows in a pine cone, hurricane spirals, the structure of DNA and even honeybee family trees all demonstrate Fibonacci string sequence. By dividing each number in the string by the last produces a number which is known as the Golden Ratio (1.618030), which is terminology you will usually hear whenever Fibonacci numbers are mentioned. The fact that the Fibonacci sequence presents itself so frequently in the natural world is the reason for its strong links to stock market behavior, and the hypotheses that run alongside this.

 

If tree fern’s prongs unravel in Fibonacci sequence, and the shell of a snail grows in a way equal to this same Golden Ratio, then it could be reasonably assumed that this number represents natures most efficient way at achieving infinite growth from a starting point of 0. Incorporating Fibonacci into your trading practices, whichever way you choose to do that, will provide an organic influence in your trading methods. It most definitely presents traders with a concept worth considering when attempting to formulate a trading plan that will be effective in accumulating profits from a relatively modest starting point.

 

By identifying the low and high in a selected trend, and marking the Fibonacci retracement levels between these points, it can provide you with an insight into where the current price might move to when it reverses. The Fibonacci retracement levels are at 23.6%, 38.2%, 61.8% and 76.4%. Some traders also use the level of 50%, but this is not derived from the Fibonacci sequence so it seems highly illogical to pay any attention to this it. It is worth noting that these percentages can also be used to predict where price might move to when it breaks out into an extension, which can be useful for closing out positions for maximum gains.

 

Whether or not you believe Fibonacci retracements will be useful in your trading plan, it is nonetheless a topic which any professional trader should have an in-depth knowledge of. A large amount of market participants use these areas of the chart in order to form the basis of their positions, and subsequently, place their stops in locations close to these areas.

 

Your aim should always be to use as many methods as possible in order to determine where your competitors are entering the market and exiting the market. If you focus your energy on attempting to correctly identify these areas and marking them on your chart, as opposed to assuming that the method itself will provide you with a fool proof entry system, then you will find that you are now trading in a way which is sensible and logical in order to profit in the markets.

"Fibonacci numbers are naturally occurring, and for that reason alone it would be foolish to dismiss retracement levels when practicing any form of chart analysis."

Using Fibonacci retracements in conjunction with strong support and resistance levels can provide solid basis for entry, and should be considered a reasonable starting point for any technical analyst. Real time price action in these locations will either confirm or deny whether a retracement level has been respected, and if the latter is true, then seeking entry to the market at a localized margin, with a view to take profits down at the next level can prove an extremely efficient tactic.

 

Once you have gained confidence in both understanding and implementing Fibonacci retracements into your trading practices, your results should improve, and furthermore, being able to incorporate this method into higher time frame charts (4 hour and above) can be extremely advantageous in accumulating substantial profits with which to add to your trading portfolio. Not every price move will adhere to Fibonacci, but you will be surprised just how often it does present itself in the markets, which surely adds strength to the widely believed notion that the markets are a natural phenomenon and that the human behavior behind the charts is less calculated than people would like to believe.

 

Stock market theories make up an important part of a trader’s perspective of the markets as a whole, and whether you place more belief in the fact that the charts demonstrate stronger tendencies towards Elliot Wave Theory, Gann Theory, Fibonacci retracement levels or any other hypothesis; the bias you lean to will strongly influence the decisions you make when opening positions; this is confirmation bias in its true sense. Forming a balanced opinion requires empathizing with the market participants you are competing against, and understanding their reasoning for trading at any given location. Fibonacci presents itself as one of the most alluring ideas due to its organic nature, but it’s important to remember that opposing traders can be trading with equal (sometimes more) conviction based on their own ideologies of how the market works. The positive side to this is that it inevitably presents us with a multitude of opportunities with which to profit from.

 

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