What do flowers and Mozart's sonatas have in common with this stock charting tool?
They all feature Fibonacci numbers, which were first discovered by Indian mathematicians.
Later, Leonardo of Pisa, son of an Italian merchant, introduced them to Europe.
He traveled around the Mediterranean, where he was exposed to Arabic numerals, which were
more conducive to arithmetic than Roman numerals.
His book Liber Abaci helped popularize Arabic numerals and explained Fibonacci numbers.
The Fibonacci sequence is formed by adding two numbers together to get the next number
in the sequence.
The sequence starts with 0 and 1 and is followed by 1, 2, 3, 5, 8, 13, 21, 34, and
so on.
Fibonacci numbers are found throughout the natural world.
For example, the number of petals in a flower will typically be a Fibonacci number.
Like delphiniums, and daisies.
Music also contains Fibonacci numbers.
Think of a musical scale.
It contains eight tones and five semi-tones,
for a total of 13 notes on a scale.
The Fibonacci sequence is more than just a string of numbers, though.
When these numbers are represented geometrically, the Fibonacci numbers create a fractal, or
shape, that infinitely repeats as it grows in scale.
This shape is created because each number in the sequence is perfectly proportional
to the next.
A Fibonacci number divided by the previous number is 1.618.
This is called the golden ratio.
Similarly, each number divided by the next number is also the same: .618 the golden ratio
minus one.
Though the lower numbers in the sequence are a little less precise,
as the numbers get higher and higher, the ratio is always the same.
If you divide a Fibonacci number by the number two ahead in the sequence, you also always
get the same number: .382.
These magic ratios are found throughout the natural world and art.
In a hive, 61.8% of the bees will be female and 38.2% will be male.
Mozart's sonatas also followed this ratio.
A sonata has three parts: the exposition, development, and recapitulation.
In Mozart's sonatas, the exposition was almost always 38% of the composition, while
the development and recapitulation was 62%.
So what do these ratios have to do with trading?
Some traders use Fibonacci ratios in an attempt to identify patterns in stock prices.
Stocks' prices rarely move in linear paths instead, they tend to move in zigzags.
These zigzags sometimes seem to bounce off of floors, called support, and ceilings, called
resistance.
Support and resistance set expectations.
Traders expect the price to stay between support and resistance.
When a stock's price finally moves past one of these levels, it's called a breakout.
Many trading platforms include drawing tools that use Fibonacci ratios to help identify
these areas of support and resistance.
For example, using the Fibonacci retracement tool, you can overlay Fibonacci ratios between
a low and a high.
Notice how the price seems to reverse direction as it approaches a Fibonacci level.
Bullish traders might place buy orders at one of these Fibonacci levels, in hopes that
after the stock bounces off support, the price will continue moving upward again.
Some traders swear by Fibonacci ratios, whereas others are more skeptical.
Even if you can find price charts that follow Fibonacci patterns, some may say it's a
self-fulfilling prophecy: if a critical mass of traders are buying and selling stocks based
on support and resistance levels found using Fibonacci ratios, then the price may follow
those patterns.
Fibonacci-based tools are just one of many ways to analyze stock prices.
Other financial data and chart studies can provide additional insights.
Because if you're only focusing on Fibonacci patterns,
you might start seeing them everywhere.
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