They are a very popular tool among technical traders and are based on a particular series of numbers identified by fib forex Leonardo Fibonacci in the thirteenth century. The Fibonacci series of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.
Each term in this sequence is simply the sum of the two preceding terms and sequence continues infinitely. However, the sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1. 618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies. The key Fibonacci ratio of 61.
Golden ratio” or “Golden Mean” – is found by dividing one number in the series by the number that follows it. For some reason, these ratios seem to play an important role in the financial markets, just as they do in nature, and can be used to determine critical points that cause price to reverse. Price action is never random, and every wave leaves behind the clues for the next move. We can thus, use the previous price action to determine the anticipated price movement. Most of the technical analysis that we follow is based on Fibonacci ratios. Price has an uncanny way of respecting Fibonacci ratio’s, often quite precisely.
Frankly there is nothing magical about these numbers, and price reacts at these levels simply because a majority of traders are following the ratios. But instead of following the masses, we use the various Fibonacci ratios in a different way which gives us an edge over the crowd. Another common mis-interpretation of the Fibonacci numbers is that traders tend to use the same Fibonacci ratio for all kinds of situations. Just like the different tools in a carpenter’s tool box, each ratio should be used in a particular situation. While you obviously cannot use a hammer for a job that requires a screw driver, similarly you cannot use Fibonacci retracements in a situation where the Fibonacci fans are required. We have clearly defined the use of each Fibonacci ratio for a particular setup, which gives us a tremendous advantage over the crowd. The basic use of Fibonacci retracements is to find potential levels of support or resistance “behind” the market.