Who Was This Fibonacci Guy?

Fibonacci was a famous mathematician born in Italy in 1175. His real name was actually Leonardo Bonacci. “Fibonacci” (meaning “son of Bonacci”) was a nickname he acquired several centuries later thanks to the historian Guillaume Libri, which has since become the dominant nomenclature. Fibonacci is widely credited with introducing the Hindu-Arabic number system we use today to the Western world. Born into a family of merchant traders, Fibonacci traveled extensively throughout the Mediterranean throughout his youth, which is where he was introduced to this system of arithmetic.

The shift from a Roman numeral system to the Hindu-Arabic system popularized by Fibonacci’s work had major implications for the development of accounting, bookkeeping, and banking practices in the Western world. He is also credited with discovering a sequence of numbers known as the “Fibonacci sequence”, whose wide-ranging applications has been a subject of intrigue for centuries.

What are Fibonacci Numbers?

Fibonacci numbers are integers that form a sequence where each number, except the first, is the sum of the two preceding numbers. An example is:

1, 1, 2, 3, 5, 8,13, 21, 34…

Although he didn’t realize it at the time, the Fibonacci sequence also contains another unique property: the ratio of each consecutive pair of numbers gets progressively closer to a particular number, ~1.618, which is known as phi, or more commonly “the Golden ratio.” So, each number is about 1.618 times bigger than the one before it. The Golden ratio is found in nature, expressed in the structure of romanesco broccoli, nautilus shells, and according to some even in the structure of human DNA. It is also found in human creations, such as architecture, music, and visual art, as well as in mathematics.

You might be thinking, “Ok, that’s interesting, but what does this have to do with Bitcoin?” Well, many investors have noticed that these same mathematical properties can also be applied to financial markets.

Fibonacci Trading Tools

There is an aura of mystery around what it is, exactly, about the Fibonacci sequence and the Golden ratio that accounts for its ubiquity throughout such a diverse array of natural and manmade structures. Likewise, when it comes to applying Fibonacci analysis techniques to financial markets, there is some debate as to whether these tools work due to some innate “metaphysical” principle, or whether they work as a self-fulfilling prophecy simply because almost everybody uses them. As one writer put it, “Pretty much every trader uses them, and that’s probably the reason why they are so powerful.” If everyone is responding to the same indicators, market behavior inevitably becomes more predictable.

So, how does Fibonacci analysis work? The long answer is fairly complicated and mathematical. Fortunately, most of the heavy lifting is routinely taken care of by even the most basic charting and technical analysis software, and we can focus primarily on the interpretation, rather than the implementation. The most popular indicators in technical analysis using Fibonacci numbers are retracement levels, which are “created by pairing a major peak and trough and then dividing the vertical distance by the Fibonacci ratios of 23.6 percent, 38.2 percent, 50 percent, 61.8 percent and 100 percent.”

Understanding Retracements

Retracements infer a correlation between past and future price movement. Investopedia explains that, “Although the reasons why are uncertain, a stock’s trend tends to retrace a prior trend once its price hits one of the key Fibonacci retracement ratio points.” This tendency applies to Bitcoin and other cryptocurrencies, as well, and it is used by many traders to pinpoint levels of support and resistance, set price targets and place limits and stops on orders. When you’re looking market behavior in particular timeframe, for example the 6-hour chart, Fibonacci retracements are calculated using the high and low for that period.

For example, in the chart below, the price of Bitcoin moves between a high of $11780 and a low of $6426.7 on a 6-hour chart (each candle represents a 6-hour period). Towards the right side of the chart, in particular, you can see how the price correlates to the Fibonacci retracement lines. After hitting the low, the price moves up to the 23.6% line at ~$7690. From there, there is a climb up to the next point at 38.2% (roughly $8471). The price moves down, but it doesn’t retest the 23.6% support line.

A Fibonacci trader might use as this as an indicator that the market will continue upward to the next retracement point, which in this example it does, moving up to right around the 50% retracement line at ~$9100. The move from the low up through the succession of retracements might signify an uptrend, suggesting that the price will continue to climb towards the 61.8% retracement point. Again, in this example, it does. However, we can see that the price just touches the 61.8% line (around $9735), and then falls back down, crossing back below the 50% line. Here, we see some movement between these two levels, and a another attempt to climb up over 61.8% that ultimately doesn’t gain enough support. A trader using Fibonacci retracements might see the failure of the price to maintain support above 61.8% as a sign of a reversal, suggesting the market will move back down.

A trader might incorporate this into their strategy, perhaps by selling at the 61.8% level with the assumption that the price will drop, and setting a buy order based on one of the lower retracement levels, assuming that the price will retrace back down to hit one of those lower points before it starts to move upward again.

Of course, it’s always possible that the uptrend in this example could have continued past the 61.8% point and blasted up to one of the next levels. In that case, exiting at 61.8% would have missed out on pretty major potential profits, and 61.8% would have become the new support level, rather than the next point of resistance. It’s clear in retrospect what the best moves would have been, but there is no way to know what will happen in advance. As with all types of technical analysis, there are no guarantees, but many trading strategies use Fibonacci levels to inform decisions about hedging risk and reward.

It is important to note that market behavior does not always move in sync with Fibonacci levels, or conform seamlessly to any of the other myriad indicators that traders use to predict behavior. While not a crystal ball, Fibonacci retracement levels can be a valuable tool for traders to incorporate into a larger strategy, particularly when looking at price movement in volatile markets like Bitcoin, where ups and downs tend to be quite dramatic.