## Thursday, December 20, 2007

### Fibonacci: Lesson From the Past

An ancient knowledge unlocks the mysteries of the Universe as well as the secret of market behaviour.

CAN AN ITALIAN MATHEMATICIAN'S 13th century discovery really make you money? Most professional traders would agree. Fibonacci was an obscure mathematician born into a family of merchants who wrote a number of texts, which played an important role in reviving ancient mathematical ratios. One of these timeless ratios is the foundation for behavioural technical analysis. It is the Golden Ratio first mentioned by philosophers such as Aristotle of ancient Greece and known by builders of the Egyptian pyramids.

This ratio was demonstrated with many examples from nature in his mostimportant text known as Liber Abaci, written in 1202. In this book, Fibonacci detailed the mathematics and revealed the mysteries behind the construction of the ancient pyramids of Egypt. He proved that the Golden Ratio was applied by the engineers, developers and building contractors to every stage of pyramid construction.

What is more amazing is that the finished pyramids were in actuality manifestations of golden ratios.

The Golden Ratio is the heart of Fibonacci analysis. It is based on the ratio 1.618. And is based on the number sequence, which is known as the Fibonacci sequence: 1,1,2,3,5,8,13,21,34,55,89,144 and so on.

Each number is added to the preceding number. For example 1 +1 =2, 2+1 = 3, 3+2 = 5.

As the sequence expands, dividing two consecutive numbers will give the ratio .618, the reciprocal of the golden ratio 1.618. For example, dividing 89/ 144 = .618.

WHAT IS THE SIGNIFICANCE OF THIS RATIO?

It is found in nature in the structure of flowers. The sunflower is a good example. The seeds are distributed over the flower's disk in Fibonacci numbers. The human body has 1000s of Fibonacci ratios and numbers. For example, our hands have five fingers and three joints in each finger, which are Fibonacci numbers.

The Golden Ratio can also be found in the shells of soft-bodied mollusks such as snails and oysters. The Golden Ratio patterns on their shells reflect the changes in their annual growth rates. Application to stock markets also show this Fibonacci growth pattern

FIBONACCI AND NATURE

The Fibonacci sequence can be found in the universe. Each arm of a galactic spiral has a logarithmic shape, which conforms to Fibonacci numbers. Nature finds it easiest both to structure itself and grow in a manner specified by the Fibonacci sequence. In fact DNA is structured in a Fibonacci sequence.

Nature implants in all living organisms the Fibonacci sequence. Trees and plants exhibit this Fibonacci growth pattern as branches and leaves grow one at a time.

THE MARKET AS A LIVING ORGANISM.

As markets reflect the hopes and fears of human beings, it is reasonable to say the Fibonacci sequence of numbers and the golden ratio could be found in markets.

Fibonacci math works through crowd behavior. A rally builds a common structure of participation. When it finally ends and starts to unwind, shareholders try to predict how far price might fall before the underlying trend resumes. The unconscious mind first sees the proportional one-third retracement as a good reversal point. New buyers do emerge here, but the subsequent bounce often fails through the prior intermediate low. This terminates the crowd's greed phase and begins a period of reason.

W D GANN'S 50% RULE.

The great master trader and multimillionaire W. D. Gann described in 1930 a trading rule that can be applied to get rich.

It was after he had gone to India to study the secrets of numerology from prominent wizards and gurus. From this instruction he gained wisdom about the mysteries of human nature and how they could be measured and applied to earning profits in the market.

When he returned from India to the US he applied these methods to his trading and became more rich.

It was the 50% rule. He advised to wait for markets to make new highs and correct 50% from these highs and then buy. He also mentioned the .618 level as a buying opportunity. He also advised to place a stop loss level under the swing low.

Conceptually this is a powerful method and is in fact used by most professional swing traders as it defined a small risk under the Fibonacci retracement with the opportunity of a large profit to be taken at the swing high.