The Mysterious legacy: Fibonacci sequence.
Let’s begin by understanding that psychology plays an important role while trading.
The sequence 1,1,2,3,5,8,13,21… moves towards certain irrational ratio forming an endless unpredictable sequence of the decimal number which cannot be expressed precisely.
In short piece of writing, we quote as 1.618 and often referred as Golden ratio, Golden mean, divine proportion, In algebra, it is known as Phi.
The ratio around the Phi number can be easily understandable by knowing the relationship between numbers.
- A number divided by the previous number is approximately 1.618(21/13=1.618…)
- A number divided by next highest number is approximately (13/21=0.618) and this referred to 61.8% in Fibonacci retracement level.
- A number divided by another two place is approximately 0.3823(13/34). And this referred to 38.2% in Fibonacci retracement level.
Or it is easy to understand by the following method.
- 1:1=10000 less than phi by 0.618.
- 2:1=20000 more than the phi by 0.3820.
- 3:2=1.5000 less than phi by 0.1180
- 5:3=1.6667 more than phi by 0.0486
- 8:5=1.6000 less than phi by 0.0180.
And the sequence continuous when each number is divided by the previous number,
Reaching closer and closer to 1.618.
There is a lot common between nature and chart reading.
Anything based on phi is indeed beautiful and which have no phi looks ugly and unnatural.
Ralph Nelson Elliot in his theory to identify the price movements (wave patterns) uses Fibonacci sequence to measure waves.
In Elliot Wave Principle, Robert Prechter quotes,
….the proportion of .618034 to 1 is the mathematical basis for the shape of playing cards and the Parthenon, sunflowers and snail shells, Greek vases and the spiral galaxies of outer space.
The Greeks, mathematicians, scientist, naturalist, artist, architecture base much of this proportion.
There is a lot to prove that the phi has the fundamental in nature, from the honey bee, spiral in sunflower, snail, pineapple, banana, plant, petals in a rose, starfish, shark… and the list goes on…
If you want something to measure easily.
Then try this.
- Measure from shoulder to finger tip.
- Measure from Elbow to finger tip.
Divide the larger number to smaller.
- Measure from head to foot.
- Then Belly bottom to foot.
The result will be same and close to 1.618, the golden ratio is unavoidable.
As most traders agree that psychology plays a vital role while trading.
And consciously or subconsciously we seek the golden ratio.
In technical analysis, we apply this sequence in five different methods
- Fibonacci retracement
- Fibonacci arc.
- Fibonacci Time Zone.
- Fibonacci Expansion.
- Fibonacci Extension.
And typically into three section 38.2%, 50%, 61.8% and we use more multiplication if need like 23.6%, 161.8%, 423% and so on.
The very basic yet very important aspect in
Technical analysis is Support and resistance.
Where do we draw support and Resistance level?
Support and resistance refer to supply and demand, the identical meaning of supply is bearish or selling, and for demand is Bullish or buying.
The support line is drawn by applying the logic and when the price approaches near to support it is expected that demand will overcome and vice versa.
Instead of picking up support & resistance level randomly, one can refer Fibonacci retracement levels.
Fibonacci retracement horizontal line indicates areas of support or resistance.
They are calculated by first locating the high and low or low and high on the chart.
In downtrend five lines are drawn, the first at 100% (the high on the chart), the second at 61.8%, the third at 50%, the fourth at 38.2% and the last one at 0%