Leonardo
Fibonacci da Pisa was a thirteenth-century mathematician who posed a
question: How many pairs of rabbits placed in an enclosed area can be
produced in a single year from one pair of rabbits, if each gives birth
to a new pair each month starting with the second month? The answer:
144.
The genius of this simple little question is not found
in the answer, but in the pattern of numbers that leads to the answer:
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, and 144. This sequence of numbers
represents the propagation of rabbits during the 12-month period and is
referred to as the Fibonacci sequence.
The ratio between consecutive numbers in this set approaches
the popular
.618 and 1.618, the Fibonacci ratios and its inverse. (Relating
non-consecutive numbers in the set yields other popular ratios - .146,
.236, .382, .618, 1.000, 1.618, 2.618, 4.236, 6.854....)
...In
addition to recognizing that the stock market undulates in repetitive
patterns, R. N. Elliott also realized the importance of the Fibonacci
ratio. In Elliott's final book,
Natures''Law,
he specifically referred to the Fibonacci sequence as the mathematical
basis for the Wave Principle. Thanks to his discoveries, we use the
Fibonacci ratio in calculating wave retracements and projections today.
How to Identify Fibonacci
Retracements
The
primary
Fibonacci
Ratios
that I use in identifying wave retracements
are .236, .382, .500, .618 and .786. Some of you might say that .500
and .786 are not Fibonacci ratios; well, it's all in the math. If you
divide the second month of Leonardo's rabbit example by the third
month, the answer is .500, 1 divided by 2; .786 is simply the square
root of .618.
There are many different Fibonacci ratios used
to determine retracement levels. The most common are .382 and .618.
However, .472, .764 and .707 are also popular choices. The decision to
use a certain level is a personal choice. What you continue to use will
be determined by the markets.
...It's worth noting that
Fibonacci retracements can be used on any time frame to identify
potential reversal points. An important aspect to remember is that a
Fibonacci retracement of a previous wave on a weekly chart is more
significant than what you would find on a 60-minute chart.
