Fibonacci ratios, discovered by Leonardo Fibonacci, are used in technical analysis to identify price resistance and support levels and turning points in price trends. Elliot Wave Theory uses Fibonacci ratios to identify inflection points in five-wave patterns. Fibonacci ratios are also used to identify retracement levels. While some traders are zealous supporters of these methods, others acknowledge their value but do not place too much trust in them. Research shows that they give accurate forecasts only half the time.
Fibonacci ratios are the result of dividing members of the Fibonacci series of numbers with members that follow or precede them. Fibonacci ratios are used in technical analysis of stocks and other financial and commodity markets as a means of recognizing and forecasting patterns in price movements. More specifically, they are used to identify price resistance and support levels and possible turning points in price trends, as well as to forecast the long-term course of market movements. Dividing one member of the Fibonacci series by the next in the sequence, starting with 55 and 89, yields approximately 0.618, the inverse of which is known to mathematicians as phi, or the Golden Ratio. Successive ratios in the series, obtained by dividing a number by the second and third trailing members of the series, yield 0.382 and 0.286, all of which are used to determine potential turning points in price trends.
The Fibonacci series and proportions were discovered by the 13th century Italian accountant and mathematician Leonardo Fibonacci. The first application of it in financial markets is attributed to RN Elliot, a late 19th century telegraph operator, railroad executive, and accountant. Later in life, Elliot used them to analyze trends in stock market prices and came up with what is known as Elliot Wave Theory. Professional stock market trader Robert Prechter popularized Elliott Wave Theory again in the 1980s when he republished all of Elliott’s work and used it as the basis for his own investment service.
Elliot wave theory stipulates that stock market prices tend to rise and fall in five-wave patterns whose inflection points correspond to Fibonacci ratios. The first major wave is followed by a second wave in the opposite direction, typically retracing 61.8% of the initial wave. A third wave in the original direction is typically the largest. The fourth wave again moves against the original trend and is followed by a final fifth wave in the original direction. Fibonacci ratios tend to mark turning points in the series of waves.
Fibonacci ratios are also used to identify so-called retracement levels. These plot possible support prices and resistance levels. They correspond to Fibonacci ratios 0.618, 0.382 and 0.236 multiplied by values at market peaks and valleys. In addition to the Fibonacci ratios, many traders also use 50% and 78.6% to indicate potential support and resistance levels.
Supporters of Fibonacci ratios and Elliot wave theory tend to be zealous in their belief. They usually attribute faults to the theory on its misapplication rather than evidence that it is not always or universally valid. Others acknowledge that the Fibonacci and Elliot methodologies are valuable and can provide traders with an “advantage”, but do not place too much trust in them. After conducting some research, an investment research group found that the Fibonacci support and resistance levels and the Elliot wave theory will give accurate forecasts only half the time.
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