Will the Past Repeat Itself: The Concept of the Fibonacci Analysis

Fibonacci Analysis was created by Leonardo Fibonacci and can be applied to almost any dimensional property and is a highly valuable tool when it comes to finance.

Ever wonder what will happen in the future?  Ever wish that you could predict what will happen in the stock market?  Well, there may be a way.  Instead of using a crystal ball, analysts and traders alike are using Fibonacci Analysis in order to signify what the future may hold.

In finance, Fibonacci Analysis is used in order to predict the different levels of support and resistance and is also used to forecast price.  Needless to say, Fibonacci Analysis is considered to be one of the most important tools to traders and technical analysts.

Fibonacci Analysis is based on the Fibonacci Ratios.  These ratios were derived from the Fibonacci sequence and were founded by Leonardo Fibonacci.  The ratio derived from the sequence is often referred to as the “Golden Ratio” due to the reason that almost everything in the universe has dimensional properties and observes the Fibonacci Ratio.

The Fibonacci Sequence is the sum of the two preceding terms (1, 1, 2, 3, 5, 8, 13, 21, 34, 55 etc.).  Based off of this sequence, the “Golden Ratio” of 61.8% and other key leveled ratios (23.6%, 38.2%, 50%, 61.8%, 100%, etc.) are based on the distance between the sequenced numbers.  For example, by taking three numbers from the above sequence, it can be seen how the above ratios are derived:

(34-21)/34 = 38.2%

(34-21)/55 = 23.6%

(34-21)/21 = 61.8%

(34-21)/13 = 100%

There are four main methods of the Fibonacci Ratio used in finance:  arcs, fans, retracements, and time zones.  These four methods are all charted methods.

Using the key Fibonacci levels mentioned above, an arc is created by establishing a trend line amid two swing points.  The key ratios are then added to the chart and an arc is formed at each level of the price chart.  The chart is used to monitor how a stock performs at each key level.  If a stock exceeds the 38.2%, 50%, or 61.8%, it should be purchased.

Fans measure speed of a trend’s movement and whether or not it will move upward or downward.  Once again, the key ratio levels are used to create support and resistance trend lines.  It can be determined, through the use of fans, if a price falls below a trend line, than the price is expected to fall to the next trend line.  If a price rises above a trend line, then the price is expected to rise to the next trend line.

By charting two extreme points (0% and 100%) and then dividing the vertical distance with the key ratios, retracements are formed.  Horizontal lines are used to produce support and resistance levels like that of fans in order to predict trends.

Time zones are vertical lines distanced by the Fibonacci Sequence.  It is interpreted by recognizing significant changes in price near or at the vertical lines and are most applicable to long-term analysis.

Using Fibonacci Analysis is an amazingly powerful tool that is used by traders and analysts all over the world in order to help predict price and trends in any market.  This is an incredibly valuable tool that should be used whenever technical analysis is needed and whenever you may want to predict the future.

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