Leonardo de Pisa de Fibonacci was born in Pisa, Italy in or around 1175 AD and died around 1250. He was known as the greatest European mathematician of the Middle Ages and was one of the first people to introduce the Hindu-Arabic number system into Europe. The positional system we use today replaced the use of Roman numerals and is based upon 10 digits, a decimal point and a symbol for zero.
The Numbers
One of his works introduced the idea that a pair of rabbits in a field take one month to mature and then produce a new pair every month. Assuming that they do not escape or die their breeding pattern will be;
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233……….
Other natural occurrences also adhere to these rules: the rows of scales on a pineapple, the pattern of the seeds on a sunflower, and the branches on a sneezewort plant all show evidence of this sequential pattern.
Now, it is not so much these numbers but rather the relationship between them that has fascinated traders over the years to such an extent that they are now regarded as an entirely natural happening within the Forex trading environment.
Take, for example, the following numbers from above…………………55, 89, 144, 233….
We can see that
89 / 144 = .618..................................................144 / 233 = .618
144 / 89 = 1.618................................................. 233 / 144 = 1.618
And that
89 / 233 = .382............................................. 59 / 144 = .382
Also, the square root of .618 is .786
And, the square root of 1.618 is 1.27
The key ratios are
.382 = 38 %
.50 = 50%
.618 = 62%
.786 = 79%
1.27 = 127%
1.618 = 162%
2.618 = 262%
There are many other interesting facts about Fibonaccis, (refer to... “Fascinating Fibonaccis: Mystery and Magic in Numbers” by Trudi Hammel Garland) but the real interest for traders today is to understand how these numbers come to play such an important role in the market.
Current estimates are that the Forex market turnover is approaching 1.5 trillion dollars per day. To put some perspective on this number it is 10x the value of shares transacted globally on a daily basis and dwarfs nearly all other global markets. The effect of this is that liquidity (the amount of buyers and sellers in the market at any given time) is extremely high. Let us compare the Forex market with what happened in the dotcom boom period in equities of the late 1990s. Equity prices were firstly driven higher by holders not prepared to sell their stock too cheaply (and remember the amount of stock available for any one company is finite). Secondly, and more crucially for trader-investors, share prices were driven lower by those forced to sell at any price. Gaps appeared in the market as traders and investors looked to liquidate their positions. From this example we can see the positive impact that the liquidity factor will have for the Forex trader.
The major currency pairs (EUR v USD, GBP v USD, USD v CHF, USD v JPY) will almost certainly have prices in the market which are very close to where the market perceives it should be. If a gap appears it will be filled very quickly by any one of the thousands of traders who are prepared to accept some risk and enter a bid or an offer.
A More Structured Approach
It is fair to say on one hand that the way the market operates is very simple; people create a “market” by being prepared to buy or sell at a given price. However, it is equally correct that the market has become increasingly sophisticated; it is less the case now that people are prepared to buy because they “feel like it” or that “I think it goes up”.
Traders analyse more than ever where certain chart points are and consequently where they would like to enter and exit the market. If we accept the sophistication argument it follows that more traders are looking to take a slightly more scientific approach. Acceptance of the importance of chartpoints by enough traders will eventually mean that they become a self-fulfilling prophecy as the market orientates itself towards these points.
Let us look at an example:
There may any number of reasons for this (herd mentality is often cited; traders, as human beings, feel more secure in the knowledge that they are in line with others and not out on a limb where they feel exposed and more open to more risk) but what becomes interesting is gaining the knowledge to use this information to our best advantage.
It is a fact that the market moves in waves rather than linear fashion from point A to B: the graphic below shows this to be the case.
Why do we suppose that these points will be reached?
Well, as we have seen these numbers evolve from a natural habitat and if we accept that the vast majority of traders are human then similar rules apply. This concept becomes increasingly powerful if we include the idea of these points becoming self fulfilling as more and more traders awake to the idea that they are important points in any market.
A Dead Cert?
At this juncture we need to examine the possibility that this is not a foolproof system…..if it were the market as we know it would cease to exist. External factors will always play a part in destroying any theory. To expect the unexpected would be a wise thing for any trader to remember when entering a trade, because it will happen. Unexpected deaths of politicians, Central Bank intervention, unexpected macro economic figures can all help to change the market’s perception and direction. Nor is it an exact science despite Fibonacci’s accepted genius as a mathematician.
Where one person (using a particular chart) will draw a line may be totally different to where another will, ostensibly using the same information. Exact projection points being hit will be the exception rather than the rule but broadly speaking the framework will be useful for a trader and the knowledge invaluable. As traders become more knowledgeable and experienced in the market they will be better able to distinguish which points to draw the lines from and to and so have greater clarity and accuracy thus improving their profitability.
By MTI Europe
The Numbers
One of his works introduced the idea that a pair of rabbits in a field take one month to mature and then produce a new pair every month. Assuming that they do not escape or die their breeding pattern will be;
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233……….
Other natural occurrences also adhere to these rules: the rows of scales on a pineapple, the pattern of the seeds on a sunflower, and the branches on a sneezewort plant all show evidence of this sequential pattern.
Now, it is not so much these numbers but rather the relationship between them that has fascinated traders over the years to such an extent that they are now regarded as an entirely natural happening within the Forex trading environment.
Take, for example, the following numbers from above…………………55, 89, 144, 233….
We can see that
89 / 144 = .618..................................................144 / 233 = .618
144 / 89 = 1.618................................................. 233 / 144 = 1.618
And that
89 / 233 = .382............................................. 59 / 144 = .382
Also, the square root of .618 is .786
And, the square root of 1.618 is 1.27
The key ratios are
.382 = 38 %
.50 = 50%
.618 = 62%
.786 = 79%
1.27 = 127%
1.618 = 162%
2.618 = 262%
There are many other interesting facts about Fibonaccis, (refer to... “Fascinating Fibonaccis: Mystery and Magic in Numbers” by Trudi Hammel Garland) but the real interest for traders today is to understand how these numbers come to play such an important role in the market.
Current estimates are that the Forex market turnover is approaching 1.5 trillion dollars per day. To put some perspective on this number it is 10x the value of shares transacted globally on a daily basis and dwarfs nearly all other global markets. The effect of this is that liquidity (the amount of buyers and sellers in the market at any given time) is extremely high. Let us compare the Forex market with what happened in the dotcom boom period in equities of the late 1990s. Equity prices were firstly driven higher by holders not prepared to sell their stock too cheaply (and remember the amount of stock available for any one company is finite). Secondly, and more crucially for trader-investors, share prices were driven lower by those forced to sell at any price. Gaps appeared in the market as traders and investors looked to liquidate their positions. From this example we can see the positive impact that the liquidity factor will have for the Forex trader.
The major currency pairs (EUR v USD, GBP v USD, USD v CHF, USD v JPY) will almost certainly have prices in the market which are very close to where the market perceives it should be. If a gap appears it will be filled very quickly by any one of the thousands of traders who are prepared to accept some risk and enter a bid or an offer.
A More Structured Approach
It is fair to say on one hand that the way the market operates is very simple; people create a “market” by being prepared to buy or sell at a given price. However, it is equally correct that the market has become increasingly sophisticated; it is less the case now that people are prepared to buy because they “feel like it” or that “I think it goes up”.
Traders analyse more than ever where certain chart points are and consequently where they would like to enter and exit the market. If we accept the sophistication argument it follows that more traders are looking to take a slightly more scientific approach. Acceptance of the importance of chartpoints by enough traders will eventually mean that they become a self-fulfilling prophecy as the market orientates itself towards these points.
Let us look at an example:
http://www.forexfactory.com/pics/articles/mti.gif
There may any number of reasons for this (herd mentality is often cited; traders, as human beings, feel more secure in the knowledge that they are in line with others and not out on a limb where they feel exposed and more open to more risk) but what becomes interesting is gaining the knowledge to use this information to our best advantage.
It is a fact that the market moves in waves rather than linear fashion from point A to B: the graphic below shows this to be the case.
http://www.forexfactory.com/pics/articles/mti2.gif
Why do we suppose that these points will be reached?
Well, as we have seen these numbers evolve from a natural habitat and if we accept that the vast majority of traders are human then similar rules apply. This concept becomes increasingly powerful if we include the idea of these points becoming self fulfilling as more and more traders awake to the idea that they are important points in any market.
A Dead Cert?
At this juncture we need to examine the possibility that this is not a foolproof system…..if it were the market as we know it would cease to exist. External factors will always play a part in destroying any theory. To expect the unexpected would be a wise thing for any trader to remember when entering a trade, because it will happen. Unexpected deaths of politicians, Central Bank intervention, unexpected macro economic figures can all help to change the market’s perception and direction. Nor is it an exact science despite Fibonacci’s accepted genius as a mathematician.
Where one person (using a particular chart) will draw a line may be totally different to where another will, ostensibly using the same information. Exact projection points being hit will be the exception rather than the rule but broadly speaking the framework will be useful for a trader and the knowledge invaluable. As traders become more knowledgeable and experienced in the market they will be better able to distinguish which points to draw the lines from and to and so have greater clarity and accuracy thus improving their profitability.
By MTI Europe