Fibonacci ratios are mathematical relationships, expressed as ratios, derived from the Fibonacci sequence. The key Fibonacci ratios are 0 percent, 23.6 percent, 38.2 percent and 100 percent. The key Fibonacci ratio of 0.618 is derived by dividing any number in the sequence by the number that immediately follows it. For example: 8/13 is about 0.6154, and 55/89 is about 0.6180. Got that? We’ll have a quiz in the morning.
In the early 1980s I used the Fibonacci ratios to come up with trading patterns and I used it to day-trade commodity futures contracts for myself and clients. When I saw a certain pattern, I would use the ratios to find the ideal potential trade entry point, the ideal target to sell and the ideal point to bail out if things went wrong. I thought I had discovered the magic formula for all times.
The great news was that it worked almost exactly 61 percent of the time, just like Fibonacci would have predicted. The bad news was the percentage was the average over a one year period or longer. The short term results were all over the place. When it was hot, it was incredible. When it got on a losing streak, the draw down was so bad it took an incredible leap of faith to hang in there.
Today, Fibonacci ratios are used by many technical traders as they try to find support and resistance levels for stock and option prices. High-frequency traders have developed computer models to take advantage of it.
Knowing where the Fibonacci traders would likely place their buy and sell orders, they place stop-loss orders just under that price to go short and then enter large, rapid-fire sell orders above it to try and drive the price down and trigger the stops. This is not a game for the faint of heart.
So what does all this mean for most of us today? Probably not much. But it’s a great story and perhaps you learned a little about some of the methods Wall Street traders use. Now you know the rest of the story. As for me, I’ll just have a glass of that Fibonacci wine please.
Nick Massey is a columnist for The Edmond (Okla.) Sun.