By James Sheffley
Anyone who suffered through Tom Hanks’s haircut and the many credulity-stretching contrivances of The Da Vinci Code movie- or the slightly less insufferable book (slightly)*- is probably familiar with the “Fibonacci sequence”. The sequence itself is pretty simply: (0),1, 1, 2, 3,5,8,13… Beginning with either zero or one, depending on whom you ask, the sequence is the sum of the two preceding numbers. So 1+1=2; 1+2=3; 2+3=5; 3+5=8; 5+8=13, etc. The importance of the Fibonacci sequence, certainly with regard to Forex trading, is its relationship to phi or the “golden ratio”: 1.618 (roughly). Or, as expressed by Wikipedia, “In mathematics, two quantities are in the golden ratio if their ratio is the same as the ratio of their sum to the larger of the two quantities.”
Clear as mud, right? Well, consider it this way: further up the Fibonacci sequence one gets, the closer to 1.618 two quantities get, if a quantity in the sequence is divided by its predecessor. So, 1/1=1; 2/1=2; 3/2= 1.5; 5/3=1.6666; 8/5=1.6, and so on (233/144= 1.16180555). The golden ratio has gained a historical air of universal importance by way of its (arguable) applicability to a great number of disciplines and apparent presence in nature.
Based in large part on the work of mathematician and philosopher and Adolf Zeising, the golden ratio has been found expressed in the positions of branches from plant stems; veins in leaves; swirls in nautilus shells, pinecones, the tops of poppy pods, flowers (some flowers supposedly only grow petals in Fibonacci-consistent groups- 13, 21, 34 etc.); the geometry of crystals; in the proportions of the human body; even, according to a 1991 scientific study, expressed in the structure of the human genome.
Image Courtesy of the University of Surrey, UK
And for hundreds of years the Fibonacci sequence and golden ratio have been employed for their (presumed) aesthetic and practical value by artists, musicians, scientists, architects, publishers, designers, mathematicians, mystics, writers, inventors, philosophers, etc. Everyone from Leonardo Da Vinci; Bartok; Salvador Dali; Plato; Euclid and Keppler to Maynard James Keenan, frontman of contemporary bands Tool and A Perfect Circle, have looked to the golden ratio for guidance and inspiration.
As such, the sequence and ratio have both been attributed an air of mystery (and mysticism), elegance and even spirituality. It’s that assumption of influence, gravity and the immutability of its significance to our world that has inspired a sizable chunk of Forex enthusiasts to apply Leonardo Fibonacci’s numeric secret and its captive ratio. So how is this done?
Well, there are some variations but far and away the most common system is “Fibonacci Retracement” (FR). If you were looking at a graph of a currency pair’s movements, FR involves plotting a diagonal “trendline” between an extreme high and an extreme low, and then using the phi- and Fibonacci-friendly percentages- 0%, 23.6%, 38.2%, 50%, 61.8% and 100% as horizontal line positions cutting through the trendline. It’s at or near these lines that price fluctuations are predicted to meet following a price’s big dip or climb.
Image Courtesy of Investopedia
The opportunity to chart these fluctuations as predictably consistent according to those earlier-mentioned Fib-friendly percentage lines would, of course, mean great profits if FR is a method that works. Whether or not it works is grist for another article, although the general-ish consensus among forex experts seems to be: FR works; FR doesn’t work; or FR works some when combined with more traditional forms of analysis, maybe. Hopefully that clears it up! Kidding aside, the effectiveness of FR is hotly debated and no final word on it looks to be coming any time soon, although even Fibonacci fanatics wouldn’t likely claim that FR is a replacement for all other classes of analysis and a good currency calculator. But if the mysteries of math and money appeal to you, consider reading up on the sexiest ratio and its use on the currency market.
*Apologies to fans of Dan Brown’s book from a Holy Blood, Holy Grail purist.
About the Author
James Sheffley fancies himself a Jack-of-Some-Trades in the finance game. After graduating from the University of Chicago with a degree in economics, Sheffley began his incredibly lucrative career writing for e-econ blogs. As a sideline, he enjoys a marginally successful career as a stock and forex day (and night) trader. When not firmly ensconced behind his keyboard, Sheffley can be found following in the footsteps of his hero, Sudhir Venkatesh, tracking underground economies.
