The Fibonacci Series is a naturally occurring numerical pattern beginning with 0,1, and computed by adding each number to the one prior to it in the series. So, we add 0 + 1, and receive 1, which is the 3rd item in the series. By adding to third item to the second in the sequence, we get 1 + 1, or 2, which is the fourth, and so on. The Fibonacci series has uses in many scientific fields, and it is a continuing area of research for mathematicians, while traders do not concern themselves with the numbers, but the ratios between them.
A number in the Fibonacci sequence, when divided by the number preceding it, will yield a proportion that tends to the Golden Ratio in math. This proportion is the most important value in forex Fibonacci analysis. This ratio, and numbers derived from it by various operations form the basis of the Fibonacci Retracements Traders have discovered over the years that any leg of a trend is sooner or later followed by a correction phase. That is, a movement that takes place in one direction is succeeded by another in the opposite direction, but with a different magnitude. The Fibonacci ratios are used to determine the size of these retracements for trading opportunities. For example, if the price moves from 0 to 1 in a currency pair in period A, we expect that it will make another movement in the opposite direction in the corrective phase. The size of this movement will be (size of the initial movements x Fibonacci Ratio). If we can guess the size of the correction, we can enter a trade position, and make a profit in return.
Retracements are most useful in range patterns and the consolidation phase of trends. However, their flexible nature makes it possible to use them in just about any kind of market pattern, since the tendency of prices to follow the Fibonacci ratios is a well-established fact. All the common caveats about technical tools apply here as well. The market can decide to negate any pattern with no hint or warning, and a formation that seems strong and reliable can be eliminated in an instant by sudden inflow of capital or information. With those in mind, Fibonacci analysis is a great tool for all kinds of traders.
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