We have a secret for you: all of those old math lessons are coming back to get you, and you better be prepared if you’re going to trade in the world of forex. Thankfully, it’s just theory that will repeat itself over and over, so it’s really not the end of the world if you aren’t catching on as fast as you would like at first.
Let’s go into today’s math concept real quick: the Fibonacci ratio. The term is named after Leonardo Fibonacci, a famous Italian mathematician.
Fibonacci discovered a series of numbers that corresponded to ratios that revealed the natural proportions of just about everything contained in the universe.
The number series was simply: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…well, you get the idea.
To repeat the numbers, you simply take one and then follow it with 2, then take 1 + 2 to make 3 — the third number in the series, then 2+3 to make 5 — the pattern just repeats itself to infinity and beyond. Not that we’re getting all cartoony on you!
What about that ratio issue? Well, let’s take two numbers from the series: 34 and 55. Fibonacci found that if you divide 34 by 55, you will get .618.
But you want to know what this has to do with your forex trading, right? Right!
These ratios turn into retracement and extension levels in the world of forex, and we use them as support and resistance areas. That’s really all you need to know, but we’ll go ahead and explain it a little better.
You see, you’re going to need to know when to back out of a trading position, and when to push forward. The more information you have, the easier it will be to push forward and get what you want in the long run. You also need to know when you have to back out of a trade in order to protect your profits.
The extension levels are designed to place profits before everything else.
Keep in mind that your charting software that comes with your forex package should be letting you set these Fibonacci points automatically. You don’t really have to calculate them by hand — the software’s job is to do that so you don’t have to worry about it.
As you get deeper into forex trading, you’ll see how all of these connections fit together. We’ll cover more on Fibonacci retracement levels next, so stay tuned!