Forex Trading with Fibonacci

By: Martin Bottomley
Trading on the foreign exchange markets is a complex business to say the least, and so it will come as no surprise that almost every trader will spend a high percentage of their time searching for anything that will provide an extra edge.

Fibonacci - or to give him his full and correct name Leonardo Pisano, was an Italian mathematician who lived in Pisa in the middle ages.

Amongst his many claims to fame he is credited with calculating "The Golden Ratio" and "The Fibonacci Series" by which the next number of the series is obtained by adding the last two numbers together...... 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, ...

The thing that is quite surprising about the Fibonacci series is that this mathematical sequence naturally occurs so very often in nature, and in so many facets of life. This may have something to do with why it is felt that Fibonacci has a part to play in helping us to trade on the foreign exchange.

Now stay with me here, because we need to take a look at the all important inverse ratio, because it is the use of the inverse ratio that we traders are most interested in.

If you divide one of the "Series" of numbers by the previous number in the series you will always get the answer 1.618 and if you divide a "Series" number by a "Series" number two along you will always get the answer 2.618 or put another way the inverse ratios of 0.618 and 0.38916 respectively.

Do you really need to know any of this? Well yes and no.

Sometimes it puts things into perspective of you understand how they came to be used and it is of course extremely important to understand as much as possible of what is going on in the minds of the other market participants.

You will, if you have been trading for more than a short while, have come across the retracement levels of 38% and 62%.

Guess where they were calculated from.

Yes, they are the rounded numbers derived from the Fibonacci series and portrayed as a percentage.

Many traders freely state that when a retracement is underway, price will generally "turn" at one of these levels and if it does not, then it is no longer a retracement, it is a reversal.

Over time an extra level has been included which is 50% but as far as I can ascertain this is not a number that is attributed to our friend Leonardo.

So what is the truth of all of this?

It is true that Leonardo Pisano, was an Italian mathematician who lived in Pisa in the middle ages, and it is likely true that he was the first to document "The Golden Ratio" and "The Fibonacci Series".

As to whether the Fibonacci levels will work when used as a trading aid is, I believe, largely dependent upon how popular the Fibonacci trading levels theory is at any given time.

If the price of a currency pair has reached 1.5670 from a low of 1.5282 and then price starts to retrace, and if the vast majority of traders who are active on this currency pair believe that the Fibonacci levels are a valuable trading aid, then price will most likely bounce at the 38% level of 1.5525 or at the 50% level or at the 62% level.

If on the other hand the majority of traders who are active on this currency pair believe that the Fibonacci levels have no trading aid value at all, then price will most likely settle at whatever is the current perceived market value of that pair.

Do I use Fibonacci levels?

Well to tell the truth, I do watch the levels, but only because so many traders believe that they work, and maybe this belief alone is enough to endorse their use.

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