Fibonacci numbers are number which are naturally occurring in nature. To appreciate these naturally occurring numbers, one should study the pattern below.
0 , 1 , 1 , 2 , 3 , 5 , 8 , 13 , 21 , 34 , 55 , 89 …
From the above, you should be able to identify that the sum of the preceding two numbers is equal to the next. This pattern repeats itself over and over again.
0 + 1 = 1
1 + 1 = 2
2 + 3 = 5
3 + 5 = 8
8 + 13 = 21
13 + 21 = 34
21 + 34 = 55
34 + 55 = 99
Eventually, as the numbers in the pattern gets larger, a golden ratio is reached. This golden ratio is approximately 1.618. For example, 89 ÷ 55 = 1.618 ( rounded off to 3 decimal places). The golden ratio is found repeatedly in nature, history, science, the arts and in the financial markets. Also, if one were to divide the preceding number by numbers after it, one will very often find ratios of 38.2%, 61.8%.
21 ÷ 55 x 100% = 31.8%(1 decimal place)
21 ÷ 34 x 100% = 61.8%(1 decimal place)
For the purposes of trading, one should look at 38.2%, 61.8% and 50% as important ratios for the prediction of a reversal in price. Certain charting software can have these fibonacci levels drawn on the charts for a trader. Retracements are measured from the last significant top or bottom.
How should option traders use fibonacci ?
When looking at fibonacci, option traders can study these ratios that are made repeatedly by a stock. Sometimes a security makes a 50% retracement consistently. The options trader can enter into a bearish position at 50% retracement levels in a dominant downtrend. If the dominant trend is upwards, he can enter into a bullish position. Fibonacci retracement ratios represent turning points in a security’s price.
Fibonacci is a complicated topic and is a highly recommended tool for option traders. Serious option traders should do a more detailed study on Fibonacci retracements.
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