The Fibonacci series are popular trading tools. Understanding the ways in which they are used and the extent up to which they can be trusted is important for traders to obtain success from the Fibonacci series. It is known that some traders depend on Fibonacci tools to make important trading decisions. Fibonacci studies are also seen as tools that influence the market.
The famous Italian Leonardo Pisano Fibonacci selected the ancient Indian system of nine symbols and some other mathematical skills leading to the development of the Fibonacci numbers and lines.
The Fibonacci Series
The Fibonacci sequence is as follows:
This sequence represents a chain of numbers that is seemingly endless and is difficult to express. The series tends towards a constant ratio. On dividing each number by its next number, a constant ratio is achieved. On dividing each number with its preceding, a fixed ratio is obtained that approaches 1.618. This is so called the golden ratio because it occurs very frequently in nature. Petals on flowers, tree branches, spirals in fruits and vegetables, the eyes, fins and tail of dolphin, arrangement of bones in the human body all follow a Fibonacci series. The structure of human DNA falls into this ratio. The wave patterns of the ocean, the growing of a sunflower or a tree, growth of population of different species, and so on all fall into this ratio.
The use of Fibonacci numbers in Technical Analysis
Many Fibonacci patterns are widely used in the technical analysis and it is found in all the markets. The ratios help in finding the support and resistance levels. They also find use in the prediction of time frames for the price levels. Fibonacci ratios help in the prediction of support resistance and target levels.
Technical analysis uses these ratios in the form of percentage terms.
Fibonacci retracements and extensions
The golden ratio serves as support and resistance level. The level at which buying can be done is the support level. The level at which selling can be done is the resistance level. The recent high and low helps in the calculation of Fibonacci retracements and extension levels. It could be calculated on a manual basis or in the sheets of excel. Fibonacci tools are also provided by the charting software.
Fibonacci Fan Lines
The lines based on the Fibonacci ratios are the Fibonacci Fan Lines. Estimation of the support and resistance levels or potential reversal zones is done by the fan lines.
They are also known as Fibonacci extensions. They are used for the projection of future price levels. Recent swing low swing high and price retracement against the swing high are used to draw the Fibonacci projection.
Popular opinion says that when applied accurately, the Fibonacci tools give a successful prediction of the market behavior in 70% of the cases, especially when a specific price is predicted. Many think that multiple retracements’ computations are quite time consuming and not very easy to use. The complexity of the results for reading and the unsuccessful attempts of the traders to actually understand them is probably the biggest disadvantage of Fibonacci series. Yet, it cannot be denied that it influences the trading decisions of thousands of traders.
The Fibonacci series does not provide any magic solution for traders. They were creations of the human mind, an attempt to erase uncertainty.
Elliot wave theory and Fibonacci levels correspond with each other and this acts as additional tool while making investment decisions.
Rohit Gadiam, CEO, CapitalVia Global Research told ETMarkets.com, “Ideally, it should be used as a supporting tool once the decision has already been made using another indicator. Among other indicators, one should use a trend following indicator such as moving average.”
He also said, “Fibonacci level is very useful and investors should keep it in mind where the level is before they make an investment. It serves as a great tool to manage risk. However, in a sideways market or a market that is lacking momentum, it may not be that accurate.”