Fibonacci numbers have become a mainstay in stock market trading as a means of technical analysis. However, they’re still regarded as “magical numbers,” meaning that despite their popularity in trading, there’s still a lot of skepticism towards them.
If you’re looking to learn more about Fibonacci stocks, you’ve come to the right place—consider this your crash course.
The correct term for Fibonacci stocks is actually “Fibonacci retracements”. Fibonacci retracements are based on the 13th-century mathematician Leonardo Fibonacci’s key sequence of numbers.
In Fibonacci’s sequence, each number is found by adding the two previous numbers before it, beginning with 0 and 1. Therefore the sequence looks like this: 0,1,1,2,3,5,8,13,24,34…infinity.
You can divide any number in the series by the previous number and get a ratio of approximately 1.618—the Golden Ratio.
These numbers are also divided further by the following numbers two and three spots to the right, calculating the common relationship in a series of foundation ratios otherwise known as the Fibonacci retracement levels.
So, in stocks, the Fibonacci retracement levels are as follows: 23.6%, 38.2%, 50%, 61.8%, and 100%.
The Fibonacci sequence is very popular among technical traders. This is because each time a stock moves either up or down sharply, it usually retraces its path before its next move, allowing traders to gain insight into the direction of their stock prices.
Fibonacci retracement is calculated by taking the two extreme points on a stock chart, also referred to as a peak and a trough. The vertical distance of those points on the chart is divided by Fibonacci’s key ratios to identify the retracement levels. From there, horizontal lines are drawn to identify any potential support or resistance levels.
The Fibonacci numbers represent structures and sequences found in nature. These sequences piece together specific components of an organism’s physical nature to create a spiral that naturally conforms to a specific numeric sequence.
This natural spiral works the same way in the stock market, which is why Fibonacci retracements are one of the most widely used techniques among stock market strategies. It also helps that they’re relatively simple to use and apply to virtually any trading instrument.
Fibonacci ratios can help draw support lines, identify resistance levels, set target prices, place stop-loss orders, and can even be implemented in counter trend trading strategies. Above all, they give way to more predictability in rising and falling stock prices.
The bottom line is that despite how miraculous the Fibonacci sequence seems, Fibonacci trading tools still have their weaknesses. For example, like many other universal trading strategies and techniques, it’s subject to certain issues such as the Elliott Wave Theory.
Having said that, Fibonacci retracement can be a very powerful strategy when it’s used alongside other technical signals and indicators that guide traders in transforming patterns into actionable trading plans.Disclaimer: This content is intended for informational purposes. Before making any investment, you should do your own analysis.