At the end of the day, there is no "Holy Grail," but the fact that an 800-year-old indicator works just as well today as it did centuries ago means there could be. In this article, we want to understand if this 13th-century mathematics tool can make you serious money today. In a word, yes. But, you've got to understand what Fibonacci analysis is and how it works to make it profitable...
"Fibo" is short for Fibonacci - as in, Leonardo Fibonacci. Born in Pisa, Italy, around 1170, he's considered by many to be the single most influential western mathematician of the Middle Ages. His 1202 book, Liber Abaci ("Book of Calculation"), remains instrumental to our understanding of mathematics to this day and is filled with examples that applied to money-changing, interest calculation, and commercial bookkeeping, for example.
Today we know Leonardo simply as "Fibonacci," which is the same name given to a numerical series in his book that he did not discover but that he used as an example. Despite their reputation as being difficult or complex, in reality, Fibonacci numbers are easy to learn and easy to understand.
The Fibonacci sequence, if you're counting, looks like this... 1 1 2 3 5 8 13 21 34 55 and so on.
Right away you can see a pattern. One plus one equals two. One plus two equals three. Two plus three equals five. And so on.
But if you look closer, something else emerges. Every number in the Fibonacci series is approximately 0.618-to-1 in terms of its relationship to the number after it. This ratio never changes because the proportion remains the same.
This is important so don't lose that thought; we're going to come back to it in a minute in order to better understand what is Fibonacci, the mathematical sequence that shows everywhere.
What's simply amazing is that Fibonacci (and lots of scientists after him) have found Fibonacci numbers in nature. For example, the number of petals on flowers is often a Fibonacci number, as is the number of "cells" in a pineapple's skin. Pinecones, sunflowers, beehives... they all display Fibonacci's numbers or Fibonacci sequence in some way.
More amazingly, plant leaves are often arranged in spirals or shapes that, when counted, are found to be adjacent Fibonacci numbers. In fact, if you divide the arc they form along a vine, for example, the arc length angle ratio is equal to 137.5 degrees. The numbers are so consistent that the relationship is actually called the "Golden Ratio" or the "Golden Mean."
Mathematically, it looks like this, where the Greek letter phi represents the golden ratio:
Geometrically, if you draw it out, the Fibonacci ratio or "Golden Mean," if you prefer, looks like this...
These relationships can be found all over the place in the natural world in everything from dolphins' fin sections to the ratio between human forearms and hands. Even the cochlea in our inner ear is a "golden" spiral adhering to this set of proportions. Fibonacci numbers and ratios can also be found - you guessed it - in the forex and stock market.
Continue reading for more information or start playing around in a risk-free demo account and notice the predictive power of Fibonacci in Forex.
Admittedly, a lot of people have problems coming to terms with this. The data is a dubious fit, they say. Or, the computerization makes a natural order impossible, they challenge.
We disagree. Forex and stock market represents the combined inputs and decision making of millions of participants at once. That means it is more like a living, breathing system than a static one. So while computers may temporarily change things, the natural order of human decision making is still very much a part of how markets work (see also what is forex and how to make money with it). This means you can use the Golden Mean and the Fibonacci series to analyze them if you know what you are doing.
Notice how price tends to move from one key "Fibonacci" level to another, especially when it comes to spotting likely reversals or breakdowns.
By the way, most online trading apps and stock simulators now include drawing tools based on the Fibonacci series. So even if you are mathematically challenged, you can still harness the power inherent in the numbers.
Start by "anchoring" on a recent major swing high or low if you're a day trader. If you're an investor with a multi-year perspective, I think a major market turning point is more appropriate. Then, extend the Fibonacci ratio or tool to subsequent turning points. What you are looking for is the "fit" between properly scaled charts and the Fibonacci tool you are using - be it arcs, lines, or ratios, for example.
You'll know you have it when prices line up along key lines and intervals. Then you can look to what traders call the "hard right edge" or the last data point you have available and predict likely future turning points and market trends, as well as potential breakouts and key reversal levels, even though they haven't happened yet - often with remarkable accuracy. This, in turn, gives you an edge because you can be "on guard" for market movements that will take others by surprise.
Let us show you…
The 57 % decline from October 2007 highs to March 2009 lows established an analytical anchor for the rally that built all the way to April 2010 when the markets had their first hiccup. Not coincidentally, the S&P500 Index tacked on 83% over 13 months covering - drum roll, please - approximately 61.8% of the distances from the 2007 peak to the March 2009 low.
What's more, the Fibonacci analysis suggested that the pullback would peter out around 1010 despite the fact that millions of investors thought we were one leg away from another financial apocalypse. In fact, it held at 1,008, which is almost smack on the 38.2% Fibonacci retracement level suggested by the Fibonacci series and, in turn, the converse of the Golden Ratio.
Subsequently, the stock index reversed and marched higher through May 2011, peaking just shy of the 78.6% before falling again to its next logical retracement level of 50% before taking off in earnest to where we are today.
Obviously, there is an element of subjective interpretation here, but you cannot deny the fact that Fibonacci analysis helped investors identify each of these important market turning points months in advance.
This stuff is so good that we like to joke that if you put 5 Fibonacci Forex Traders in a room you will get 10 opinions about where the markets are headed. All joking aside, though, no two investors have the same time frame or risk tolerances. So the fact that there is a difference in opinion is vindication that Fibonacci numbers can help you spot opportunities others don't see. Knowing what we've just explained, you now have the power to do the same thing.
Understanding what is Fibonacci is important, but if you want some help, MetaTrader 5 AM Broker offers a full set of Fibonacci tools. Play around in a demo account and notice the predictive power of Fibonacci.