Stocks & Commodities V.

27:4 (26-29): Fibonacci Tools by Alexander Sabondin

CHARTING

Discovering The World Of Fibonacci

Fibonacci Tools
Here’s a look at the numbers
behind the Fibonacci
sequence and how it can be
applied to your charts.

by Alexander Sabodin

he sequence of the

T Fibonacci num-
bers is considered
to have been dis-
covered by Leo-
nardo of Pisa, better known
as “Fibonacci,” a 13th-cen-
tury Italian mathematician.
(“Fibonacci” is an abbrevia-
tion of filius Bonacci; filius
is Latin for “son of.”) In the
early 1200s, after traveling
through parts of the Middle
East and studying with Arab
mathematicians, Fibonacci
published his book Liber
Abaci, or “Book of Calcula-
tion,” which introduced to
the West something that is
one of the greatest discover-
ies of all time: the decimal
numeration system, includ-
ing the position of zero as
the first number in the num-
ber sequence. This system,
known as the Hindu-Arabic
numeral system, includes
zero, 1, 2, 3, 4, 5, 6, 7, 8, and
RUSS SPITKOVSKY

9 and is commonly used to-

day instead of Roman nu-
merals.
Fibonacci became one of
the best-known mathematicians of his time. He wrote three produces one more couple every month since the second
essential, ground-breaking books on mathematics: Liber month?” This resulted in the Fibonacci sequence of numbers:
Abaci, published in 1202 and updated in 1228; Practica
Geometriae (“Practical Geometry,” a compendium on geom- 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
etry and trigonometry), published in 1220; and Liber
Quadratorum (“The Book of Squares”). The mathematic sequence begins with 1 and the next number
forms the sum of the two previous ones:
THE FIBONACCI SEQUENCE
1 + 1 = 2; 1 + 2 = 3; 2 + 3 = 5; 3 + 5 = 8…
In Liber Abaci, Leonardo presented the following task: “How
many couples of rabbits, placed into a rabbit corral, can be Why is the sequence so important? The sequence strives
produced for a year by a rabbit couple, if each couple for a constant ratio slowly, but this ratio is irrational — that
Copyright © Technical Analysis Inc. www.Traders.com
Stocks & Commodities V. 27:4 (26-29): Fibonacci Tools by Alexander Sabondin

is, a number with an endless and unpredictable sequence of bonacci ratio.

decimal numbers in the fractional part. It is impossible to In nature, the golden proportion can be seen in diversity
express it precisely. If any number of the Fibonacci sequence such as spiders spinning their cobwebs as logarithmic spirals,
is divided by the previous one (for example, 13:8), the result pine cones, snail shells, ocean waves, ferns, sunflower and
is a value fluctuating around an irrational value daisy seed arrangements, all of which form logarithmic
(1.61803398875…). But it would be impossible to determine spirals. In addition, the Fibonacci sequence is the mathemati-
the exact ratio to the last decimal number, and hence, it is cal base of the Elliott wave theory. Fibonacci numbers are
represented as 1.618. even mentioned as the answer to a puzzle in Dan Brown’s
This ratio has been referred to by other names, ranging best-selling novel, The DaVinci Code.
from “divine proportion” in ancient times to the “golden
section,” the “golden average,” or the “ratio of rotating FIBONACCI SEQUENCE IN THE MARKET
squares” (or logarithmic spiral). The mathematician Johannes The existence of Fibonacci ratios in geometry is well known.
Kepler called the ratio “one of the treasures of geometry.” In The application of these ratios in trading is gaining popularity
mathematics, the Greek letter ϕ (phi) is adopted as the symbol as well. A glance at a price graph suggests that price move-
of the ratio: ment is an alternation of rises and falls. With an ascending
trend, each rise and fall is higher than the previous. But how
ϕ equals 1.618 can you measure the length of the emerging correction? One
of the most popular methods is to apply Fibonacci levels.
It has also been referred to as the “golden coefficient.” There are three major correction levels — 38.2%, 50%,
The Fibonacci sequence as well as its numbers can have and 61.8% (Figure 2). During a strong trend, a correction
numerous combinations. This is not just a game with num-
bers, but the most important mathematical expression of
100%
natural phenomena. The best-known and interesting applica-
tions of the mathematical sequence are the pyramids of Egypt Movement Correction
and Mexico, and the plants found in nature!
38.2%
FIBONACCI RATIO IN GEOMETRY
Mathematical properties of these ratios are not of great practi- 50%
cal interest to us. Although this is not intended to be a lecture
61.8%
in geometry, it could be worth your while to pay some attention
to the main examples that have some importance to trading.

Golden section: Any segment may be divided in such a way 0%

that the ratio between its smaller and bigger parts will be
FIGURE 2: THREE MAJOR CORRECTION LEVELS. The three major correction
equal to the ratio between the bigger part and the whole levels are 38.2%, 50%, and 61.8%. The 61.8% correction level is considered
segment (Figure 1). This ratio is always equal to 0.618. to be the most important of the three.

A B C
amounts to approximately 38.2%. A pullback during the
FIGURE 1: THE GOLDEN SECTION. The ratio of the total length (AC) to middle of a trend could last up to 50% and in the case of a deep
the large segment (AB) is equal to the ratio of the large segment (AB) to correction, the trend should be expected to finish close to the
the small segment (BC).
61.8% level. Out of these levels, 61.8 could be the most
important because after the 61.8% level is broken, the trend
But this is not just algebraic division of a segment into two that existed prior to the break no longer exists.
equal parts. The golden section can be found in nature. The When trading conservatively within a trend, it is the
human body is an embodiment of the golden section in 61.8% level that traders consider to be the most important
everything, from general dimensions to the arrangement of and reliable.
the human face. Art is significantly improved through the In addition, the entry point from the 61.8% level provides
application of the golden section, and its value and applica- the best potential profit/loss ratio (Figure 3). Take the follow-
tion were especially notable in ancient Egypt and Greece and ing situation. When you wait for a correction after an ascend-
during the Renaissance. ing trend movement, you always have a guiding point for
Leonardo da Vinci himself believed that the golden pro- setting the first profit-taking target (T/P). Usually it is the last
portion was of great value and applied it to many of his high set by price, since it is the nearest resistance level. It is
paintings. Further, such expressions as the gold rectangle and reasonable to place a stop-loss (S/L) below the support level
the golden spiral (logarithmic spiral) exists in geometry. In from where the ascending price movement started. Look how
order to draw them accurately, you must employ the Fi- much your profit exceeds your risk, and how much worse the
Copyright © Technical Analysis Inc. www.Traders.com
 Stocks & Commodities V. 27:4 (26-29): Fibonacci Tools by Alexander Sabondin

Resistance
T/P

38.2%
50%
ratio between S/L and T/P would have been if you entered
61.8% your trade at the 38.2% or 50% and placed your S/L below the
Buy
same support.
Of course, it is more profitable to buy from the support
Support level, but do not forget that we act based on the fact that we
are within the trend. Figure 4 shows an example of how the
S/L
61.8% correction level can work favorably.
FIGURE 3: SETTING PROFIT TARGETS AND STOP-LOSSES. Entering at the 61.8%
level gives you the best profit/loss potential. FIBONACCI
EXPANSION
GBPUSD, H4 1.5105 1.5281 1.5071 1.5221
Fibonacci expansions are cre-
100% ated by identifying three points
that describe two waves. You
then draw three lines inter-
secting the “assumed” waves
100% at the Fibonacci levels 61.8%,
61.8%
100%, and 161.8% (Figure 5).
50% Significant price changes
38.2% should be expected near these
61.8% 61.8% lines.
50% This case is subject to the
following logic: According to
METATRADER (METAQUOTES SOFTWARE)

38.2%
Dow theory, the main trend
0.0 has three development phases.
The first phase is regarded as a
mere bounce from the support
0.0
level. The phase with the larg-
est potential for profit gaining
is the second phase. During
FIGURE 4: IMPORTANCE OF THE 61.8% LEVEL. Here you see how the 61.8% correction level can work in your favor. the second development phase,
traders who use technical
EURUSD, Weekly 1.3887 1.3963 1.3313 1.3430 methods of following the
trends enter their positions.
Prices rise vigorously, and eco-
nomic information becomes
more optimistic.
161.8% 3 As a rule, the second phase
(in wave analysis it is referred
to as the third wave) cannot be
smaller than the first. Accord-
100% FE 100 ing to Elliott wave theory, the
second phase either equals the
1 first or frequently exceeds it
61.8% FE 61.8 by 1.618 times. In Figure 5 the
third wave appeared to be
0.0 longer than the first by 161.8%.
These values can be used to
forecast the target.
2

FIGURE 5: FIBONACCI EXPANSION. These expansion lines can be drawn at 61.8%, 100%, and 161.8%. You can expect significant
prices changes at these points.
Copyright © Technical Analysis Inc. www.Traders.com
Stocks & Commodities V. 27:4 (26-29): Fibonacci Tools by Alexander Sabondin
CHARTING

DO FIBONACCI LEVELS WORK IN TRADING? SUGGESTED READING

You can always check the performance of the Fibonacci Hartle, Thom [1997]. “Using Fibonacci Ratios And Momen-
values by applying them to historical charts. You can apply tum,” Technical Analysis of STOCKS & COMMODITIES,
the Fibonacci correction levels and expand on any time scales Volume 15: November.
with similar success. When you use them with other technical Teseo, Rudy [2002]. “Those Ubiquitous Fibonacci Ratios,”
analysis tools, they can become useful assistants in your Technical Analysis of STOCKS & COMMODITIES, Volume
work. 20: March.

Alexander Sabodin is a private trader, analyst, and advisor

for the forex market in Belarus. S&C

Copyright © Technical Analysis Inc. www.Traders.com

Article copyright 2012 by Technical Analysis Inc. Reprinted from the April 2009 issue with permission
from Stocks & Commodities Magazine.

The statements and opinions expressed in this article are those of the author. Fidelity Investments
cannot guarantee the accuracy or completeness of any statements or data.

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