Why Fibonacci is Important in Forex Trading

Fibonacci numbers are one of two important numerical series that have valid usefulness to Forex traders. The series is derived by adding the previous number to the present number to create the next. If we start at 1 and add zero we get 1. When we add 1 to 1 we get 2. 1 to 2 gives us 3 and so on. The series looks like this: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 etc.

It's more than common to see markets make turning points on Fibonacci time counts. Useful on yearly, monthly, weekly, daily, hourly and even one minute charts this phenomena is demonstrable time and time again.

One of the many interesting features of the Fibonacci number series is its relationship to the Golden Mean. If you were take a line and intersect that line so that it made two parts in such a way that the larger cut divided by the smaller cut was exactly equal to the original line divided by the larger cut, you would have the ratio that is known as the Golden Mean.

If you take the fifth Fibonacci number which happens to be 5, enter it into your calculator and hit the square root button, add 1 and divide the result by 2 you will also derive the Golden Mean or 1.618 to three decimal points which is all you need for Forex analysis.

If you take any two adjacent numbers in the Fibonacci series and divide the larger by the smaller you will also find a close approximation to the Golden Mean. For example 5 divided by 3 is 1.6 and 144 divided by 89 is 1.618.

If you take any two numbers and add them in the same way as we did above to create the Fibonacci series you will eventually find that you will come to the same result of 1.618, when dividing the larger number by the previous smaller number. Go on, try it for yourself.

From the Golden Mean a series of related ratios may be derived that are useful in determining both aspects of critical importance to traders, namely time and price. The two best known of these ratios are 0.618 and 0.382. Note that when added together they add up to one and when you divide the larger by the smaller you get the Golden Mean.

But there are many more ratios that can be derived from the Golden Mean. It is amazing but not surprising to see these ratios in play in the Forex markets as they mark the line in the sand where price exhausts and trends reverse.

The ratios may be used to compare the distance of one price move with another or the distance in time of one move with another. Yes, it is possible to time the market on occasion with Fibonacci based ratios. There are other geometric ratios that are significant for Forex market time and price comparisons in addition to Fibonacci so to use these time and price comparison techniques you need to understand the other important geometric ratios that occur repeatedly.

I'd urge all Forex Traders to study the Fibonacci number series. There are numerous resources on the Internet and an inexpensive title in the Wooden Book catalog by Scott Olsen that is very worthwhile, even though it barely mentions the financial markets.

The more you study the Forex markets the better equipped you will be able to trade successfully. A good understanding of Fibonacci and the ratios derived from it will end up serving you very well. Happy Trading!