How to use the Fibonacci sequence when trading
The Fibonacci sequence is a key tool in a trader’s toolbox. It was first discovered centuries ago, and it has been credited – as a mathematic formula at least – to the Italian genius Leonardo Fibonacci. But what is the significance of the Fibonacci sequence when it comes to opening profitable traders? What do words like “retracement” and “ratio” mean in this context?
This article will delve into these details and look more closely at what it can offer you as an investor. It will explain the difference between retracements and ratios – and it will sound a note of caution on the way that traders can use it in a way that is critically analytical and not an object of over-reliance.
What is the Fibonacci sequence?
Put simply, the Fibonacci sequence is a formula which says something important about numbers and their order. In the Fibonacci sequence, any number (after the first and second) is the sum of the two numbers that proceed it. So, it begins with 0 and 1, and the sequence kicks in from there: 1 is the sum of 0 and 1, then it goes to 2, 3, 5, 8, 13 and so on.
It’s been described as a very significant discovery given its supposed ubiquity in the natural and scientific worlds. The pattern has been spotted in several environments such as plant life, and as a result, it’s been described as an example of nature’s magic.
Retracements and ratios
It’s important for a trader to have a basic understanding of what this sequence is from an academic and mathematical perspective. However, it’s also important to make sure that you know what it means in a trading context – as without that, you’re unlikely to be able to put it into practice and open profitable trades off the back of it.
One aspect of the Fibonacci sequence for traders is a Fibonacci ratio. This is a set of percentages which are derived from the numbers in the sequence – so 23.6%, 38.2%, 50%, 61.8%, and 100%. These come from dividing two Fibonacci numbers. In one case, it’s dividing one by its predecessor – so perhaps 34 divided by 21 to reach 0.61, or thereabouts. The 38.2% figure, meanwhile, comes from dividing 55 by 144: the gap, and number of leaps, between these two Fibonacci numbers are greater, but the principle is similar.
Another way to look at the Fibonacci sequence is through the lens of Fibonacci retracements. By applying the above ratios in the form of horizontal lines on a price chart, it’s sometimes possible to see how much movement – or retracement – has gone before in the price of that particular asset. It’s not fully known why this sometimes works, but it’s a documented phenomenon. From there, it’s possible to then plunge into trading with the knowledge of this tool on your side.
If this sounds complex, don’t worry – especially if you’re new to trading or are exploring the process for the first time. It’s normally possible to technically analyse for Fibonacci retracements and ratios using your broker’s provided platform, although it’s a good idea to familiarise yourself with your broker’s offer and check this out in advance just in case their platform doesn’t offer it. You can do this by reading FXTM reviews and similar on reputable knowledge repository websites like AskTraders.
A word of caution
While the Fibonacci sequence is important, it’s worth remembering that it’s just one of many options when it comes to technical analysis. There are lots of other chart analysis and technical tools available – and it makes sense to get a wide range of different analysis systems in place. At times, the Fibonacci sequence has been highly glamourised and turned into something seemingly magical. It’s no more or less magical than any of the other tools available – so remember to use it in the same critically analytical way as you’d use any other tool.
Overall, the Fibonacci sequence is a basic tool for traders to have on hand but it’s also by far one of the most important. When used properly, it can allow traders to build a potentially more accurate picture of the underlying market. Don’t be put off by its apparent mathematical complexity, either: with the right sort of technical analysis tools on side, you can quickly get your preferred trading platform into a position where it can do some or much of the analysis for you.