The Fibonacci number sequence and golden ratio can be found throughout nature and traders such as Gann applied them to financial markets and made millions using this unique tool as part of his trading method.
The Fibonacci number sequence and golden ratio is used by many savvy traders today so let's look at how they can make huge profits in ANY financial markets.
Support and resistance levels are critical for all traders as they can help identify entry and exit points when trading.
Fibonacci percentage "retracement" levels derived from the Fibonacci number sequence and golden ratio are an innovative and useful tool for any trader, so why are they so useful? Let's find out.
Fibonacci Numbers and Golden Ratio
The Fibonacci sequence was printed in the Liber Abaci, written by Leonardo Fibonacci in 1202. It introduced Hindu-Arabic numbers to Europe for the very first time and they replaced Roman numerals.
The Fibonacci number sequence was based around the following equation:
How many pairs of rabbits can be generated from one single pair, if each month each pair produces a new pair, which, from the second month, starts producing more rabbits?
While the Fibonacci number sequence and golden ratio was used to solve the above equation, the result was that it produced a number sequence that has importance throughout the natural world.
After the first few numbers in the sequence, the ratio of any number in relation to the next higher number is approximately 0.618, and to the previous lower number is 1.618. These two figures are known as the golden mean or the golden ratio.
The Golden Mean and Golden Ratio
These numbers are pleasing to us and appear throughout biology, art, music, weather, creatures and even architecture.
Examples of natural objects based on the golden ratio are: snail shells, galaxies, hurricanes, DNA molecules, sunflowers and many more objects that occur in the natural world.
Retracement Levels
The two Fibonacci percentage retracement levels considered the most critical by traders are: 38.2% and 62.8%. Other important retracement percentages are: 75%, 50%, and 33%. So how can traders use them? Well, there are three main advantages.
1. Fibonacci numbers define exit numbers
If three or more Fibonacci price levels come together, a stop-loss can be placed above the area which indicates an important area of support or resistance.
Setting stop-loss orders using Fibonacci retracements allows traders to set a predefined exit point, so they can exit the market if they are wrong. This means they can trade in a disciplined fashion and protect their equity, which is critical to all traders.
2. Fibonacci levels can define position size
Depending on the risk a trader wants to take on a trade, Fibonacci numbers can give the size of position to be taken, in terms of risk the trader wishes to assume. This is simply because the monetary loss from the stop for a trade is different on most positions taken in the market. A stop close to resistance and support may mean that a bigger position than one where support or resistance is farther away.
Traders can therefore decide position size within their money management parameters easily and have a predefined exit point.
3. Fibonacci numbers & profit per trade
With Fibonacci numbers, once a pattern completes against a Fibonacci price area, traders can use them to lock in profits. This indication of how far a profit may run enables traders to lock in profits at predefined levels.
The advantage of the Fibonacci number sequence is they are a predictive tool. So they allow traders to have specific stop loss and profit objectives in advance. Traders can then use them to lock in more profits and cut losses to a minimum, which is essential for longer term profitability.
Gann used them for this purpose and that is why they are such a useful tool for traders. One of the keys to trading any market is discipline. To cut losses and run profits and win over the longer term by trading without emotion. Gann knew this, and all traders who have traded know how emotions can wreck a trading plan and the Fibonacci number sequence makes a trader stay disciplined.
Do They Work?
Gann understood that using Fibonacci numbers could make large profits and cut losses on his trades and he used them to amass a fortune of over $50 million. Fibonacci numbers are useful but should be used as part of a trading plan. Gann, for example, did not just rely on them — he had an array of innovative tools that he combined to make stunning profits.
He was one of the most successful traders of all time and his legend lives on and many savvy traders around the world still use his methods. Check them out and you may be glad you did. Not only are they innovative, they can give you big profit potential and that's what we all want as traders.
by Sacha Tarkovsky
