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Fibonacci Numbers
Have you ever heard of Leonardo Fibonacci?
No, he didn't paint the Mona Lisa. And he's not the guy behind the counter at Vinnie's Pizza.
Fibonacci was a well-known Italian mathematician who lived from around 1175-1250. He made great contributions to the world of mathematics, including introducing the decimal system to Europe.
He also studied a sequence of numbers that has since become known as the Fibonacci Numbers, or the Fibonacci Sequence.
The Fibonacci Sequence start with a 0 and a 1, and each new number is the sum of the two previous numbers (0 + 1 = 2, 1 + 2 = 3, 3 + 2 = 5). The first numbers in the sequence are as follows:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144...and so forth into infinity.
Fibonacci found that these series of numbers and their ratios to one another were prevalent throughout nature and can in fact be seen all around you.
Ok, ok, so what does this have to do with forex trading?
Well, quite a bit in fact. You see the ratios that are found in the Fibonacci numbers can be seen in the price movement of currencies (as well as stocks and other investments).
Without boring you any further, I'll give you the big 3 numbers that you should remember: 0.382, 0.500, and 0.618. There are others, but these are the most significant.
These numbers are used to calculate "retracement levels", which are used by many traders to determine when to place buy and sell orders. Here's how it works:
Assume the price of a currency pair (or a company's stock for that matter) is trending upward. History shows us that prices tend to hit a peak, go into a temporary reversal, and then resume the trend. The reversal is where Fibonacci numbers come in.
The price of a currency that is trending can be expected to reverse back to one of the Fibonacci numbers and then bounce back to continue the trend. If you forecast this correctly you can buy in just before the upward trend continues and score big profits.
The online trading platform you use should be able to chart the Fibonacci numbers for you. You just draw a line from a low point to a high point, and the retracement levels are automatically mapped on the chart for you.
Of course, its not quite as simple as trading when the price hits a Fibonacci number. There are other things to consider:
You don't know which retracement level the price will stop at. If you choose .382 and it drops to .618 you could lose a ton of pips.
Similarly, if you choose the wrong low/high points, the retracement levels will be all out of whack.
And quite frankly, as accurate as they can be at times, sometimes Fibonacci numbers just don't work at all. There are many variables at play in the forex market. You can't rely solely on one method to predict price movement.
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