Last week on my Sky Business show 'Money Makers', my special guest David Rogers from Dow Jones talked about Fibonacci levels.
There was a lot of interest by viewers so this week in Share School, I'm going to look at Fibonacci levels in more depth.
Some of you may remember the Fibonacci sequence from school:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.
You simply add the first number to the second number and get the next number, and so on.
Fibonacci sequences appear everywhere in nature. For example, the number of petals on a flower is usually a Fibonacci number:
Try it yourself. The next time you see a flower, count the petals and chances are they will be a Fibonacci number.
The sequence can be found in music or even on a keyboard:
All these numbers are Fibonacci.
If you divide one number in the sequence by the next number in the sequence, you get:
Gradually these numbers get closer to the Greek letter 'phi' which is described as the golden section, golden ratio, or divine ratio of 1.61803.
The golden ratio has applications in science, beauty and nature.
It comes up over and over again when measuring portions in the body or even as a measure of beauty. It's found:
It's even applied to design: if you look at the shape of our credit cards, the portions are 1:1.618, which is the golden ratio.
Fibonacci followers also believe that the sharemarket moves according to this cycle.
So how do you apply this sequence when you look at charts? You don't physically have to draw the lines. There are free charts on the web.
To use the Fibonacci tool, you need two points: the first point is the beginning of the trend and the second point is the end of the trend.
In the example below I've circled two points in red on a chart showing the S&P/ASX 200 index:
This charts the levels that are the potential levels of support or resistance.
You can see that most of the significant peaks and troughs have occurred near these Fibonacci levels which are 0%, 23.6%, 38.2%, 50% (although 50% isn't strictly speaking a Fibonacci ratio), 61.8% and 100%.
You often hear traders say that the S&P/ASX 200 will probably bottom at 2700. That's because 2700 is not only the level that the last bull market began but also because 100% is a Fibonacci ratio.
Just as in nature where the Fibonacci sequence occurs frequently but not always, in the markets Fibonacci also seems to occur frequently (but remember) not always.
So that's an introduction to the concept of Fibonacci. Some traders dismiss it — the Fibonacci sequence is not 100% correct with the sharemarket. But it's certainly something that most traders pay some attention to.
Happy investing!
Julia Lee Equities Analyst Bell Direct
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