The Fibonacci sequence is being used by traders to get some indication of how the market is likely to move.
Advanced trading education sometimes involves figuring out quite strange and seemingly illogical concepts. But these could make the difference in your performance in stock trading.
Can the Fibonacci numbers help predict market moves? According to experienced analyst Martin Tillier, they apparently can, though he was skeptical when initially introduced to the concept. When you think about it, it doesn’t quite seem logical to believe that calculating major stock market levels on the basis of some mathematical sequence actually works. Can the figures thrown up by a numerical relationship affect the real world stock prices?
The Fibonacci Sequence
LiveScience defines the Fibonacci sequence as number series where you get to a number by adding the two numbers just before it. So if you start with 0 and 1, and the sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, etc. The concept has its origin in the theories of many scholars of ancient Indian mathematics, particularly Pingala in 200 BC, Virahanka in 700 AD and Hemachandra in 1150. It was introduced to the Western world by Italian mathematician Fibonacci in his book Liber Abaci in 1202.
The Fibonacci sequence is considered to be one of the basic principles guiding nature and various natural occurrences, so much so that it is considered nature’s own numbering system. So what does this have to do with the stock market? Does nature’s numbering system affect the movement of stocks?
The Golden Ratio Derived from the Fibonacci Sequence
Tillier indicates that the significance lies in the “golden ratio” that’s derived from the Fibonacci sequence. This ratio measures the quotient of the adjacent values in the sequence which is around 1.618 or 0.618, the inverse. The 1.618 ratio appears in nature comprehensively. As a result, 61.8% and its inverse percentage, 38.2% are considered important percentages which traders use as the likely stopping points to retrace a move. If you extrapolate more, you come to 23.6% and 78.6% that are also considered important stopping points though not as much as the earlier percentages.
How Can the Golden Ratio Affect Market Pricing?
Now how can this interestingly repeating ratio actually influence market pricing? It may seem to be disconnected with what traders perceive as stopping points. But remember that market prices move about because one dimension of the seller and buyer battle is more aggressive than the opposite dimension, and the movements stopbecause the opposite dimension reasserts itself. Why that happens at particular points in time can probably be accounted for by the universality of this nature’s sequence. Since many traders use the Fibonacci sequence, the Fibonacci levels, also known as “fibs”, seem to work universally in stock trading.
Examples of Fibs in Action
You get to particularly realize the resourcefulness of fibs when you have a major resistance level broken and the succeeding move up has been a straight line. Then it’s hard to find pivot points for retracing since you don’t have any resistance levels or support on a straight-line move. Even when the move has shown hesitation in certain places, these levels are unreliable and weak. That’s where fibs helps you calculate a level for buying on a drop-back.
As you can see from the above chartof the S&P 500 posted on Nasdaq and pointed out by Martin Tillier, there are various fib levels, but the 38.2% retracement level was reached on the morning of November 16 after which the S&P 500 bounced off it significantly.
This chart depicting the WTI oil futures shows a bounce off the retracement level of 38.2% twice before a bounce off the level of 78.6% after having broken through.
So the Fibonacci sequence does make sense when you check out some examples, and Tillier recommends using Fibs particularly in situations where you want to buy on a stock pullback.
Also referred: https://www.livescience.com/37470-fibonacci-sequence.html
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