Using Fibonacci Ratios

All right. Don’t grimace!

Fibonacci ratios are used a lot in Forex trading, so you need to know about them. Fortunately, you don’t have to delve into them as deeply as the great man himself.

Leonardo Bonacci, more generally known as Leonardo Fibonacci, was an Italian, born the son of a wealthy merchant in Italy in 1170.

Most young guys like to get to know girls, go to the bar, and go watch the game.

But not our Leo. Oh no. He was happiest when sitting at home poring over his abacus. As a result, he discovered some amazing things about numbers. He managed to find a simple series of numbers that actually described the proportions of things in the universe.

Starting with 0, he then added 1 to it which gave 1. Then he added the two 1’s together and got 2. Then he added the 2 to the second 1, and got 3. Then the 3 to the 2 and got 5, and so on.

It goes like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, zzzzzzz…..

So, 0 + 1 = 1, 1+ 1 = 2, 2 + 1 =3, 3 + 2 = 5, and so on.

Exciting, isn’t it?

You simply add each number to the preceding number to give you the next number. If Leo hadn’t died in 1250, heaven knows what number he would be up to by now.

It gets better. After the first few numbers in the series, if you divide the lower number of any two by the one immediately following it, you always get 0.618. So, for instance, 55/89 = 0.618. If you divide a number by the one not immediately following it, but by the one after that, you get 0.382. So for instance, 55/144 = 0.382.

Impressed?

Yeah, we thought so.

These ratios are known as the “golden mean”. We are not going any further (although we could). Put your hand up if you are still awake.

We are going to deal with only two Fibonacci findings: retracements and extensions.

Fibonacci retracement levels are as follows:

0.236, 0.382, 0.500, 0.618, 0.764

Extension levels:

0, 0.382, 0.618, 1.000, 1.382, 1.518

Here is the good news. You don’t have to know how to work all this out. Your software will do it all for you, because some kind software developer in darkest Mesopotamia spent fourteen years in a cave creating it for you. However, we’ve mentioned it because it’s a good idea to know the basics.

The fact is that traders use the Fibonacci retracement levels as possible support and resistance zones. Very many traders use the same levels, and will use them to place buy and sell orders, or stops. As a result, the levels have a tendency to become self-fulfilling prophecies.

For the same reason, traders use the extension levels to take profits. Once more, they tend to work because so many traders are making use of them.

Swing Low, Sweet Chariot…..

Most software designed for charting purposes uses both retracement and extension levels. However, in order to apply these to your charts, you will have to identify points known as Swing High and Swing Low points.

Actually, this is not too difficult, although it might sound it.

A Swing High is simply a candlestick with a minimum of two lower highs on both the left hand side and the right hand side of itself.

Of course, you know what’s coming next.

A Swing Low is a candlestick with a minimum of two higher lows on each side.

OK, if you’ve got a headache, you can toddle off and lie down in a darkened room. Not to worry, we’ll explain it all in the lessons that follow.