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How you can trade the Golden Ratio

by , 01 October 2020
How you can trade the Golden Ratio
This might sound a bit ‘far-out'…

But, according to the world of mathematics, everything is connected. From the shape of a shell to the design of a guitar. From the way trees grow, to the spiralling arms of galaxies. Everything is connected by a single simple number: The Golden Ratio or 1.618.

This ratio is closely related to the work of Fibonacci. He was widely accepted as the most talented mathematician of the Middle Ages. He was instrumental in the adoption of the number systems we use today.

But, in the latest instalment of my technical trading series, I'm going to show you how his famous sequence (the Fibonacci sequence) is used by professional traders to determine when to buy (and when to sell) financial securities.

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But first, let us look at how the Fibonacci
sequence is constructed
 
 
Fibonacci described an amazingly simple sequence which looks like this:
 
 
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
 
 
To create this sequence, all you need do is add the last number to whatever number is to the left of it.
 
Let’s start:
 
There is no number to the left of 1, so you add 0, which will give you another 1.
Then you add 1 and 1, which will give you 2.
Then you add 1 and 2, which will give you 3.
Then you add 2 and 3, which will give you 5.
Then you add 5 and 3, and you get 8.
 
And so, you can keep going for as long as you want.
 
Now, the interesting part of this sequence is that, starting with 8, if you divide any number in the sequence with the number to its left, you will get roughly 1.618 or the golden ratio.  Likewise, if you divide any number in the sequence to the number on its right, you will get the inverse: 0.618.
 
You can also divide numbers in the sequence by numbers twice removed to get the ratios we use in technical analysis.
 
These ratios are 0.236, 0.382 and 0.764. The only outlier is 0.5 which has nothing to do with the Fibonacci sequence but still seems to be important when it comes to technical charting.
 
Predominantly, we use these ratios in a little thing called the Fibonacci retracement tool.
 
Any charting package worth its salt will have this tool included. And any good broker will likely include the tool as part of your standard online trading package.
 
So, how do you use it?
 
First, find either a bullish or bearish trend. Then, using your Fibonacci retracement tool, connect the start of the trend to the end of the trend (for more on trend lines you can read our previous articles here).
 
So, if it is a bearish trend, connect the top of the trend to the bottom of the trend, like I did in the chart below.
 
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How to connect the trend
 

 
The top and bottom lines are equal to the top and bottom of the trend. The lines in between represent the important technical ratios 0.236, 0382, 0.5, 0.618 and 0.764.
 
As you can see, these ratios consistently indicate where you can expect to find support and resistance.
 
And if you can tell when a stock is about to turn, this is a massive help in deciding where and when to open new trades or close existing ones.
 
These ratios are extremely valuable when used correctly. Hence the reason your trading platform should always have Fibonacci tools included.
 
Technical analysts understand their worth!
 
If you’re ready to apply the laws of the universe in your trading, and would like to open an account, send me an email on support@randswiss.com and I’ll help you get set up!
 
You might also be interested to know, Rand Swiss this week collected the award for being South Africa’s Top Online Broker. No doubt, one of the reasons is because our trading platforms include useful items like the Fibonacci Retracement Tool.
    
Kind regards,
 
Christo Krog,
Private Client Trader


How you can trade the Golden Ratio
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