What's the Purpose of Fibonacci Sequence in Finance?

The Fibonacci sequence is a series of numbers where each number is the sum of the two preceding numbers. This sequence has been found to have applications in various fields, includingfinance. In this article, we will explore the purpose of the Fibonacci sequence in finance and how it is used by investors and traders.

Understanding Fibonacci Retracement

One of the most popular ways that the Fibonacci sequence is used in finance is through Fibonacci retracement. This is a technical analysis tool used by traders to identify potential levels of support and resistance in financial markets. The tool is based on the idea that financial markets tend to retrace a predictable portion of a move, after which they continue in the original direction.

Fibonacci retracement levels are calculated by dividing the vertical distance between a high and low point in a market move by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. These levels are then used to identify potential levels of support and resistance.

For example, if a stock price moves from $10 to $20 and then retraces to $15, traders may use Fibonacci retracement levels to identify potential levels of support. The 38.2% retracement level would be $13.84, the 50% retracement level would be $12.50, and the 61.8% retracement level would be $11.16. Traders may then use these levels to enter or exit trades.

Using Fibonacci Extensions

Another way that the Fibonacci sequence is used in finance is through Fibonacci extensions. This is a technical analysis tool used by traders to identify potential levels of price targets in financial markets. The tool is based on the idea that financial markets tend to move in waves, and that these waves can be predicted based on the Fibonacci sequence.

Fibonacci extensions are calculated by adding the key Fibonacci ratios of 127.2%, 161.8%, 261.8%, and 423.6% to the distance between a high and low point in a market move. These levels are then used to identify potential price targets.

For example, if a stock price moves from $10 to $20 and then retraces to $15, traders may use Fibonacci extensions to identify potential price targets. The 127.2% extension level would be $27.28, the 161.8% extension level would be $32.50, the 261.8% extension level would be $52.50, and the 423.6% extension level would be $85.00. Traders may then use these levels to set price targets for their trades.

Applying Fibonacci Time Zones

In addition to retracements and extensions, the Fibonacci sequence can also be used to identify potential time zones for market moves. This is a technique known as Fibonacci time zones. The idea behind Fibonacci time zones is that financial markets tend to move in cycles, and that these cycles can be predicted based on the Fibonacci sequence.

Fibonacci time zones are calculated by dividing the length of a market move by key Fibonacci ratios of 38.2%, 50%, and 61.8%. These levels are then used to identify potential time zones for market moves.

For example, if a stock price moves from $10 to $20 over the course of 100 days, traders may use Fibonacci time zones to identify potential time zones for future moves. The 38.2% time zone would be 38 days, the 50% time zone would be 50 days, and the 61.8% time zone would be 62 days. Traders may then use these levels to anticipate potential market moves.

Conclusion

In conclusion, the Fibonacci sequence is a powerful tool used by traders and investors in finance. Through techniques such as retracements, extensions, and time zones, traders are able to identify potential levels of support and resistance, price targets, and time zones for market moves. While the Fibonacci sequence is not a guarantee of success in finance, it is a valuable tool that can help traders make more informed trading decisions.