Fun with Fibonacci
12th century monk Leonardo de Pisa, better known to his
friends as Fibonacci, discovered a fascinating mathematics sequence that appears
throughout nature. Beginning with a simple 1 + 1, the sum of the last two number sets that
precede it creates another Fibonacci value:
1+1=2 1+2=3 2+3=5 3+5=8 5+8=13 8+13=21 13+21=34 21+34=55
etc, etc.
For reasons that remain unknown, major ratios drawn from
these numbers describe a predictable interaction between trend and countertrend movement
in markets. The most important ones to remember are 38%, 50% and 62%. Applying these
percentages to trending price predicts the extent of retracement contrary to the
underlying trend, as well as how far a new high or low will travel. For traders, these
hidden points represent invisible support/resistance zones where prices will hesitate
and/or reverse.
Fibonacci numbers closely relate to Elliott Wave theory.
However, using them requires only a short primer in that arcane study. At the minimum,
develop the basic understanding that primary trends travel in 5 waves (3 forward and 2
backward) while countertrends move in 3 waves (2 forward and 1 backward). That’s all
you need to easily manipulate Fibonacci price grids.
Grab some charts and a good charting program. All good
technical analysis software has this Fibonacci function. For example, both SuperCharts and
Real Tick allow custom entry of all major points. Lay Fib lines over the extremes of
dynamic trends using the Fibonacci Grid. Or just take a calculator and measure swing
action from intraday, daily or weekly quote listings.
Placed correctly, you’ll notice that most markets
swing off Fibonacci ratios as they move from support to resistance and back. Once you get
the knack of it, you'll see that trends in all time frames have common elements and
similar proportionality.
Trade decisions using Fibonacci retracement must include
entry/exit analysis (risk:reward) with respect to key pivot points. Focus on getting into
a market at major ratios while standing aside as price hovers between key zones. Most
times, the smartest execution will be counter the most immediate short-term trend.
