The Math Behind The Fib

How to use Fib Numbers when trading

More math, if your squeamish I strongly advise you look away. The math is here only for those of you who want to know it. You charting software will do all the math for you so if you really hate math you can skip this part!

BUT

If you skip this part how many more corners are you going to cut? Just do not make it a habit!!

There are two terms you need to know when talking Fibs:

1) Fibonacci Retracement
2) Fibonacci Extension.

Fibonacci Retracement:
Remember that jumble of numbers that was the previous fib sequence on the last page? Take the numbers 55 and 89, when you divide the lower number (55), by the higher number (89) you get a ratio called the "golden mean". In this case, 55 divided by 89 equals 0.618. You can do this with any two numbers as long as they are sequential. Divide 89 by 144 and you get 0.618. Divide 233 by 377 and you get 0.618.

The process of determining retracement levels in the Forex is based on the same ratio concept above, but by using different numbers in the sequence. Fib retracement levels are determined by taking any number in the sequence, dividing it by itself, then the next number in the sequence, then the next number, and so on. Because the sequence is based on ratios you can use any number in the sequence to determine retracement.

The standard retracement levels you want to use are:

23.6%, 38.2%, (50%), 61.8%, (78.6%), and 100%

Though the 50% and 78.6% lines are not a standard Fib ratio it is recognized as a support/resistance level by many traders. As a general rule you do not want to go any lower than the 23.6% line. You could create a 14.6% line, but that is not standard and considered worthless because of it's proximity to the base price.

Fibonacci Extension:
Fibonacci Extensions simply put are just a continuation of a Fibonacci Retracement. The Fib Extension "extends" beyond 1 (a Fib number divided by itself). It is determined the same way, by using ratios within the Fib Sequence.