The Fibonacci analysis gives ratios which play an important role in the forecasting of market movements. This theory is named after Leonardo Fibonacci of Pisa, an Italian mathematician of the thirteenth century. He introduced the Fibonacci sequence (the sum of the two preceding terms), which consists of the following series of numbers:
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, and so on.
This sequence exhibits several remarkable relationships, in particular the ratio of any term in the series to the next higher term. This ratio tends asymptotically to 0.618 (the Fibonacci ratio). In addition, the ratio of any term to the next lower term in the sequence tends asymptotically to 1.618, which is the inverse of 0.618. This proportion is known by several names, like the golden ratio, the golden mean, divine proportion, and PHI, among others.
Financially speaking, the Fibonacci proportion constitutes a tool for calculating price targets and placing stops. For example, if a correction is expected to retrace 61.8 percent of the preceding impulse wave, an investor might place a stop slightly below that level. This will ensure that if the
correction is of a larger degree of trend than expected, the investor will not be exposed to excessive losses. On the other hand, if the correction ends near the target level, this outcome will increase the probability that the investor's preferred price move interpretation is accurate.
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