Jim Woods

What the Bleep is a Fibonacci?

by Jim Woods   04/10/09

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Applied to the market, this technical tool is used to help identify critical points that cause an asset's price to reverse. It's also used to monitor the direction of a prior trend and how likely it is to continue once the price of the asset has retraced to one of the key ratios.

In the chart below provided by the Investopedia Web site, we can see how a Fibonacci retracement is plotted on a stock chart.

Here we see how a stock's price tends to change direction as it nears key Fibonacci support and resistance levels. The most famous of these ratios is 61.8%, which is also referred to as "the golden ratio" or "the golden mean".

This ratio is determined by dividing one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.

Does it Really Work?

Now I know what you might be thinking right now. Does this Fibonacci thing really work? The answer to that question is yes and no.

Yes, using Fibonacci retracement patterns along with other technical analysis tools can work by giving you the edge when it comes to identifying key resistance and support levels in a stock. But no, relying solely on a Fibonacci retracement pattern or any single technical analysis measurement as the Holy Grail of investing does not work.

So, now that you know what the bleep a Fibonacci is, you can now move on to other simple questions such as the origins of life on earth, the Big Bang and quantum mechanics.

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Jim Woods is a Senior Editor for OptionsZone.com. To learn more about him, read his bio here.