Forex and Fibonacci Trading Systems

Leonardo Fibonacci was an Italian mathematician, considered by some to be "the most talented mathematician of the Middle Ages,” who bought a sequence of numbers to the attention of the western world from the Hindu-Arabic numeral system during the 13th century.

Fibonacci numbers form a sequence defined by this recurring relation:

After two starting values, every number in the sequence is the sum of the two preceding numbers. The sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10946, 17711, 28657…….and so on.

These numbers possess a number of interrelationships, one such being the fact that any given number is approximately 1.618 times the preceding number. Interpretation of the Fibonacci numbers in technical analysis attempts to anticipate changes in trends as prices tend to be near lines created by the Fibonacci studies. The four popular Fibonacci studies are arcs, fans, retracements, and time zones. The use of Fibonacci numbers in Forex trading is an attempt to predict patterns in market swings with a view to using those predictions to buy and sell currencies at the points at which maximum profit can be gained from the transaction with a minimum of risk. A trader can use Fibonacci numbers to set stop loss orders - if at least three Fibonacci price levels come together in a relatively tight zone, a stop loss placement below or above the zone may be set. A Fibonacci number can be used to define stops - if a trader trades against a support zone and the support zone is violated i.e. the price trades below that zone, there is a potential for loss and the position should be closed. Some would say that using Fibonacci retracements helps to take the emotion out of trading by giving a pre defined exit point. Depending on the risks you are prepared to take per trade, Fibonacci numbers can also be used to define position size and once a pattern has completed against a Fibonacci price zone they can be used to set profit objectives - bank partial profits or tighten stop loss levels.

The golden ratio can be used to describe the proportions of everything from nature's smallest building blocks, such as atoms, to the most advanced patterns in the universe, such as unimaginably large celestial bodies. Nature relies on this innate proportion to maintain balance, but the forex market also seem to conform to this golden ratio. The golden ratio is defined as the ratio that results when a line is divided so that the whole line has the same ratio to the larger segment as the larger segment has to the smaller segment. Expressed algebraically, normalizing the larger part to unit length, it is the positive solution of this equation:

Retracement is a term used in technical analysis that refers to the likelihood that a currency's price will retrace a large portion of an original move and find support or resistance at the key Fibonacci levels before it continues in the original direction. These levels are created by drawing a trendline between two extreme points and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Fibonacci retracement is a very popular tool used by many technical FX traders to help identify strategic places for transactions to be placed, target prices or stop losses. The notion of retracement is used in many other indicators such as the Elliott Wave theory, Tirone levels and Gartley patterns, .