Some facts on Fibonnacci Ratios that you need to be aware of in order to trade profitably.

Why? Simply because these numbers or rather the relationship between these numbers and their ratios often indicate important points in analysing charts for profit.

In fact I would say that there isn’t a trader out there that hasn’t heard or used them and more importantly many of the ‘auto-trading’ platforms use them exclusively as signals.

So what is a Fibonacci ratio?

These ratios appear in nature and in the financial markets they often indicate levels at which strong resistance and support will be found. They are easily seen in nature seashell spirals and flower petals, in art, geometry, architecture and even in music.

The ratios are made up from a sequence of numbers 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.

One of the major characteristics of this 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 ratios are 23.6%, 38.2%, 50%, 61.8% and 100%. Fibonacci retracement is created by taking two extreme points which is usually a major peak and trough on a chart and dividing the vertical distance by the key Fibonacci ratios listed above.

How are these numbers related and how are the ratios calculated?

The 23.6% ratio is found by dividing one number in the series by the number which is three places to the right. For example: 13/55 = 0.2364.

The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example: 13/34 = 0.3824.

The key Fibonacci ratio of 61.8% - also referred to as “the golden ratio” or “the golden mean” - is found by dividing one number in the series by the number that follows it. For example: 13/21 = 0.6190.

We don’t know why these ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset’s price to reverse. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above.

How are Fibonacci Ratios of any use?

Because the markets tend to reverse right at levels that coincide with the Fibonacci ratios.

For example, if the GBP/USD rallies 100 pips and then corrects, it will often correct 61.8%. Right at, or close to the 61.8% retracement the pair is likely to reverse and start advancing again.

Of course it is not always this simple. Fibonacci support and resistance levels can and do fail. But the fact is that it does happen and is often called a trader’s “edge.”

A trader has an edge when he knows the probabilities of a particular action are greater than normal and Fibonacci ratios help provide this edge!