Why the Fibonacci Series is Important for Technical Analysis

Technical analysis is a vast and diverse field of analysis. It has many tools that make it a successful method to analyze stock markets. The Fibonacci series is one such tool that has stood its test of time. It is a popular tool based on key numbers and their sequence. It was identified by mathematician Leonardo Fibonacci. Leonardo de Pisa, also known as Fibonacci to his friends, was a 12th–century monk. He discovered a fascinating numeric sequence that is found in mathematics as well as various other phenomena in nature. While studying the Great Pyramid of Giza, Leonardo discovered a unique ratio of numbers. The series of numbers 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, etc., is created by adding the first two numbers together, and that process continues in sequence.

In this case, we can take an example from the following sequence: 1+1=2, 1+2=3, 2+3=5, 3+5=8, 5+8=13 etc.

An interesting ratio is produced from this sequence. If each number is divided by the number following the sequence, it produces a remarkably constant ratio. The ratio value is 0.6180345. It has been referred to as the “Golden Ratio”. These ratios have been found in many studies, whether in mathematics or in nature’s natural series of events. A large majority of patterns in the leaves or petals of flowers, and also the formation of storms, happen in the sequence of the Fibonacci numbers.

So, how these numbers are derived might not be an important topic for discussion right now, but knowing what and how to use them can be a very important tool. The application of this sequence in the technical analysis has become an important determinant of support and resistance levels.

The common Fibonacci numbers are 38.2%, 50%, and 61.8%. The repetitious results that have become apparent through centuries of investment habits indicate that these numbers are significant when applied to human emotions. These numbers have become important pivotal points when analyzing retracement of a trend. The Fibonacci series numbers are the crucial numbers for the Elliott wave analysis. They play a major role in analyzing the way you think and how your emotions play a role in your investment decisions. Realizing that many technical investors use these critical levels to anticipate reversals, it makes sense to utilize these potential reversal levels when applying candlestick signals.

Fibonacci Retracements:

Fibonacci Retracements are based on a trendline drawn between a trough and a peak. If a trend is rising, the retracement lines will descend from 100% to 0%. If a trend is declining, the retracement lines will move up from 0% to 100%. Horizontal lines can be drawn at the common Fibonacci levels of 38%, 50%, and 62%. As the price retraces, support and resistance occur at or near the Fibonacci Retracements levels with a high degree of accuracy.

If the 38%, 50%, and 62% areas are known to be retracement levels that many technical investors are watching, then it makes sense to analyze what candlestick signals might be occurring at any one of those levels.

The advantage of being able to read the candlestick formations is very beneficial. It allows an investor to evaluate immediately which one of these levels is going to act as support or resistance. The knowledge allows you to position yourself ahead of other technical analysts who need confirmation that a certain level has been held. 

For the day-trader, utilizing this knowledge can be highly profitable when trading the index futures. Being able to enter a trade at the optimum level provides a very high-profit, low-risk trading platform. You can utilize the Fibonacci levels as a primary trade entry system or it can be added as an additional entry parameter.

If a trend pattern can be recognized, then watching for the candlestick signals at support levels that other investors are watching can prepare the investor for when a reversal should occur.

As seen in the chart given above, Arvind Ltd. had a strong uptrend which was followed by a pullback. To identify where the pullback should stop, applying the obvious technical indicators increases the probabilities of being in a correct trade. The chart illustrates the effective use of candlestick signals with the Fibonacci numbers. After an extended uptrend from 222 to 330, a pullback occurs.

Where can a pullback expect to stop?

Putting Fibonacci numbers on the chart becomes a logical target. After the chart doesn’t hold the important reversal levels of 61.8%, 50%, and 38.2%, a reversal is finally seen at the 23.6% level, i.e., at 259.  Is the 23.6% Fibonacci retracement level always placed to watch for a reversal? Not necessarily!

Also Read: All you need to know about the Japanese Candlestick

The candlestick reversal signals are the primary decision-making factors. Placing the Fibonacci retracement levels on the candlestick chart adds another element for indicating that a reversal has occurred.

To know more about Fibonacci Analysis you can watch the video below:

Hence the Fibonacci series and the Fibonacci Retracement is a tool of technical analysis which adds to the certainty of the downtrend having a reversal. Confirming the reversal and taking a trade against the trend is a decision which should be taken with a pinch of salt.