Mathematics is a principal science, the fundamentals of everything. Every object, action or phenomenon can be explained from a mathematical point of view, although we do not always understand the rules, which govern the Nature...
One of such mysteries is the Golden section ratio and the sequence of Fibonacci numbers.
0, 1, 1, 2, 3, 5, 8, 13, 21 to infinity. The essence of the sequence is that each subsequent number is the sum of the previous two. When we divide each of the sequent number to the previous one, in the result we will have a value close to 1.6, which is the ratio of the Golden section.
Well, but where does it concern Forex market? We can give two explanations.
Explanation 1: magic of numbers
If you stretch Fibonacci grid on the chart from lows to highs for any time period, you will see that the price stops over near the indicator’s lines. Each line is a level of support or resistance.
Breakout of Fibonacci level suggests that the price can further go to the next level of the grid, which means that the trend will continue for some time.
This phenomenon can be explained by the fact that when the price approaches the boundary of the grid, the strength of both bullish and bearish movement is weakening. This is the moment when future trend is determined; therefore, it is advisable to refrain from trade.
Explanation 2: collective unconscious
We know that price movement in the Forex market is driven by the aggregate number of the opened trades in one or the other direction. Superiority of either sellers or buyers affects the strength of the trend.
We can say that Forex is graphical display of collective unconscious. Although all traders are different and they are located in different parts of the world, they all experience the same sensations of fear, euphoria, greed and despair.
We can also add that most of the traders use Fibonacci indicator, regardless of the amount of money they invest in trading.
When the price approaches the grid level, many traders immediately experience one and the same feeling. They fear that since the price has approached the level, it can reverse. The fear forces them to take precautions and they close the trade.
This thought forces thousands of people to perform the same action at the same time. As a result, the price really stops at one of the Fibonacci levels.
This is a pivot point. Now, some of the traders open positions to sell, as they believe that the price will reverse; others begin to place buy orders as they believe that the halt in price was just a temporary stop and the price will go up.
This is the time when mathematics comes to force: the majority of trades will determine trend direction in the market. At the same time the chart has depicted the halt of the price in the area of the Fibonacci level and the theory of the Golden section was proved to be correct.
It is recommended to use Fibonacci grid at the higher timeframes. Note that the timeframe should be by one or two positions higher than the timeframe on which the trade is conducted. That is, if trade is on the 15 —minute or 30-minute timeframe, the grid should be stretched for the hourly time frame.
If you trade on the hourly time-frame, it is better to stretch a grid for 4 —hour time-frame or more. The lows and the highs are the main points. The grid can be either ascending or descending depending on the direction of the trend. Changes to the layout of the indicator are made only after the change in the global trend. It means that once installed, the indicator usually works for at least a week.
Fibonacci is not a full-scale indicator. It does not give entry or exit signals. The grid is used mainly to observe the behavior of traders. A trader can use other indicators on the chart with a grid, while the boundaries of the grid will be used as the levels of support and resistance.