A great deal has been written about Fibonacci series in recent years, and even more since the release of the infamous DaVinci Code by Dan Brown. Some of the books and articles have been rather simple, while others have been exceedingly complex.
Preferring simplicity in nearly all areas of my life, when it comes to using indicators in my trading I also try to avoid becoming overwhelmed with daunting algorithms and a plethora of lines and squiggles overpowering my trading screens. As such, in this three-part series on Fibonacci, I shall be speaking to you in layman’s terms, so that even those with the most basic of technical analysis skills shall come away with a core skill set to immediately apply to improve market timing, and in the process, the most sought-after goal of consistent profitability. In this week’s segment, I will begin by laying the foundation for understanding the development and theories leading to this popular tool used extensively by technical analysts.
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Leonardo Pisano, an Italian mathematician born in Pisa during the 12th century, was renowned as one of the most talented mathematicians of his day. He is most prominently recognized for his publication of the modern numbering sequence called Fibonacci series. The name Fibonacci itself was a nickname given to Leonardo. It was derived from his grandfather’s name and means son of Bonaccio.
Although Leonardo was not responsible for discovering the number sequence, it was his publication of Liber Abaci in 1202 which introduced it to the West. In his book, he used the sequence to suggest a solution to the hypothetical growth of a population of rabbits (assuming they never die, of course!). While many claims for the prevalence of Fibonacci series in nature are poorly substantiated, it does appear in many biological settings, such as in the progression of branches on a tree.
The Fibonacci numbering sequence, which can be traced as far back as the 2nd century BC in India, is created by first beginning with 0 and adding 1. At that point, each new number in the sequence is the sum of the previous two numbers. For instance, 0+1 = 1, 1+1=2, 1+2=3, and so on. The sequence of numbers hence looks like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, to infinity.
Although this numbering series is studied quite extensively in terms of its relevance to growth patterns in nature, it is when we take this series a step further that its applications become even more widespread. The relationship of each two adjacent numbers within this series yields a predictable ratio.
When you divide the former number by the latter after the first 3 pairs, beginning with 8 divided by 13, it yields approximately 0.618.
34/55 = .618181 ~ 0.618
55/89 = .617977 ~ 0.618
89/144 = .618055 ~ 0.618
Dividing the latter number by the former number after the first 3 pairs also results in another relationship from the sequence. This relationship yields approximately 1.618.
55/34 = 1.617647 ~ 1.618
89/55 = 1.618181 ~ 1.618
144/89 = 1.617977 ~ 1.618
The dimensional properties adhering to the 1.618 ratio occur throughout nature and the ratio is most referred to as The Golden Ratio. The uncurling of a fern and the patterns found on various mollusk shells are commonly cited examples of this ratio.
To take these relationships further, if you skip a number and then divide, the result is 0.382. This number, when added to 0.618, equals 1.
The ratios created using the Fibonacci series found their way into the financial mainstream during the late bull market of the 90s. Although futures traders had been using them for quite some time, it was not until the advent of real-time charting software was invented, which manually calculated the Fibonacci levels, that it became more readily available as a tool for the general public. The levels created by the Fibonacci series are now widely popular in all markets, although still most widely followed in the futures.
The main Fibonacci retracement levels which I use in the markets are the 138.2%, 100%, 61.8%, 50%, 38.2%, 0%, and -38.2% levels. Two other numbers often used by other traders of my acquaintance include 0.786 and 1.27. These are the square roots of 0.618 and 1.618. As I said earlier, however, I prefer to keep things simple and have never been compelled enough to add these to my chart analysis. The practical uses of Fibonacci ratios in technical analysis are as a means of projecting upcoming price corrections or retracement levels, and can be used both in terms of price projections, as well as time projections.
In next week’s installment of this educational series I will begin to explore the practical applications of utilizing Fibonacci levels while trading. In it, I will teach you not only how to draw Fibonacci grids correctly, but also how to read the projected price levels. This goes beyond simply identifying the actual price, to how to take a position based upon those price zones. To complete the series, the following week I shall divulge several more advanced applications of the Fibonacci series, taking Fibonacci trading to the next level.
I hope you have enjoyed this installment of Fibonacci Trading with Toni Hansen! To learn more about the unique style of technical analysis I use for locating high probability trades on all times frames and across numerous marketplaces, check out my Trading Made Simple CD series at http://www.swingtrader.net (Don’t let the name fool you! This is not for swingtraders only!) In my 10-hour audio/video CD course bundle, which also includes 400+ pages of text, I take technical analysis beyond all the indicators and patterns of traditional analysis and explore in great detail price and momentum development. This educational series is a culmination of 11 years of full-time trading and market analysis, detailing the core building blocks of all market moves. Please feel free to also email me any questions or comments directly through my website at http://www.tradingfrommainstreet.com.
Toni Hansen is one of the most respected technical analysts and traders in the industry with a high reputation for accuracy in both bull and bear markets. Her style of trading and market analysis transcends both time as well as market vehicles, making it attractive to investors and trader of stocks, futures, options, ETFs, and even the FOREX market. Toni is a frequent lecturer at trading clubs and industry expos. She is also a popular market columnist and is a repeat contributor to SFO Magazine. She recently co-authored High Profits in High Heels from Marketplace Books and SFO’s Personal Investor Series book Online Trading. Email Toni.