The Basics of Fibonacci TheoryBefore diving into Fibonacci theory, let's first answer the question, "Who is Fibonacci?" After all, knowing the history will give you the background you need to understand how this trading theory is rooted in mathematics and history. Leonardo Pisano, better known as Leonardo Fibonacci, was a European mathematician in the Middle Ages. He wrote Liber Abaci (Book of Calculation) in 1202.
It’s there that the Fibonacci Sequence was born: A series of numbers where each figure is the sum of the two preceding it. The Fibonacci sequence begins with zero and one, which are known as seed numbers. Each subsequent number is the sum of the two preceding ones, so here's how the sequence starts: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
While the sequence itself isn't crucial for traders, it provides the basis for Fibonacci ratios that you often see traders adding to their charts to anticipate price action.
What are Fibonacci Ratios?
Fibonacci ratios are percentages derived from dividing numbers in the Fibonacci sequence. Key ratios include 23.6%, 38.2%, 61.8%, 78.6%, and 161.8%. For example, the 61.8% ratio is found by dividing a number in the sequence by the one that follows it, resulting in approximately 0.618. These ratios, known as the golden ratios, frequently appear in mathematics, geometry, architecture, and art.
Fibonacci Retracements for Traders
Fibonacci retracements are often used to help predict support and resistance levels when a market retraces after a significant move. For instance, if a market drops 150 points in a bear trend, a countertrend might find support or resistance at a Fibonacci ratio of the initial move, such as 23.6%, 38.2%, 61.8%, or 78.6% of the move.
With this simple bit of knowledge, you now have the basic understanding of Fibonacci ratios, and you can utilize this to better understand charts that have ratios drawn on them, as well as experimenting with the various Fibonacci tools available on TradingView. Whether you're analyzing short-term trends or long-term movements, incorporating Fibonacci principles can provide unique insight into possible moves based on universal mathematical principles.
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