Feral pigs, Fibonacci, and a lesson in technical analysis

Cane toads, feral cats, rabbits, carp and feral pigs … what do they have in common?

They are the top five public enemies in Australia.

This week I read an article about the rabbit population down under – how it’s once again getting out of control, and the tragic effects that the long-eared pests have on Australian farming communities.

But as a trader, I can’t think “rabbits” without thinking “Fibonacci” …

The man and his rabbits

Leonardo Fibonacci was a 13th century mathematician who, among other achievements, brought the numbers 0–9 to Europe, long before Sesame Street got the idea. And very useful they’ve turned out to be.

What he’s most famous for, however, is his ability to count rabbits.

The question that Fibonacci posed was how fast rabbits could breed. Let’s say we’ve got two rabbits. After a time, they produce two new rabbits. Then, after a time, these four rabbits produce four more rabbits, and so on ….

The number of rabbit pairs each month goes something like this: 1, 1, 2, 3, 5, 8, 13, 21, 34, …

Have you spotted the pattern?

Each number is the sum of the previous two numbers.

Apologies for the maths lesson …

… you’re probably wondering what the heck this has to do with your trading …

To be honest, it’s something I ask myself, too.

The magic number

The ratio between consecutive Fibonacci numbers (i.e. dividing one number by the next) moves towards the magic “golden ratio” number of 1.618 (or its inverse, 0.618) – this ratio appears all over the place in the natural world: from daisy petals to seashells, from whirlpools to DNA molecules …

And some traders believe that these magic numbers have a power over the way we trade – with retracements naturally falling at these levels.

The magic levels are at:

61.8% (found by dividing one number in the series by the number that follows it)

38.2% (found by dividing one number in the series by the number two places to the right)

23.6% (found by dividing one number in the series by the number three places to its right)

So, the purist Fibonacci fan will draw lines on his chart at 23.6%, 38.2%, 50%, 61.8% and 100% (the 50% comes from another maths-bod called Gann – more on him another day) – and our Fib Fan will expect his retracements to fall at these levels.

I’m afraid my personal feeling about Fibonacci levels is that they’re a load of old mumbo-jumbo – rather like looking for retracement levels in your tealeaves.

So why do I religiously draw Fibonacci levels on my charts?

If you can’t beat them …

Just has the markets are drawn to round numbers – because they are a natural target for traders’ orders – so, too, the market often pivots around these Fibonacci levels.

As so many traders use these levels to place buy and sell orders, the support and resistance levels become a self-fulfilling prophecy.

So, whatever you think of Fibonacci – if you want to get your support and resistance lines in the right place, you need to get your head around his numbers.

Luckily for us, we don’t need to be mathematical whizzes to apply Fibonacci to our trading. With most charting packages, you simply click on the “Fibonacci retracements” tool, and you’ll be shown exactly where these levels are.

So get drawing those lines!

Related posts:

Do Fibonacci retracements work? Pt2: How to use Fibonacci Retracement