Does Golden Ratio Work for the Stock Market?
Original post by Sue-Lynn Carty of Demand Media
The Golden Ratio is a natural phenomenon of proportion and symmetry resulting from a pattern of numbers called the Fibonacci sequence. You can apply the Golden Ratio, also referred to as Phi, to anything from the human face to a snowflake. In the stock market, analysts use the Golden Ratio to examine major price movement trends for the market as a whole or for a particular stock.
The Fibonacci Sequence
The Fibonacci sequence is a series of numbers in which the next number in the series is the sum of the two preceding numbers of the series. The Fibonacci sequence, by its definition, always begins with a zero or one. This is why there are always two number ones in the beginning of the sequence. Here's what it looks like: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, etc. Here's how it works: 0 + 1 = 1, 1 + 2 = 3, 3 + 2 = 5 and so on.
The Mathematical Numbers
If you take two successive numbers in the Fibonacci sequence and divide the second number by the first number, you will come extremely close to the Golden Ratio's largest positive value of 1.618. If you do the opposite and divide the first number by the second number in the Fibonacci sequence, you will come extremely close to the Golden Ratio's smallest positive value of .618.
The Market Numbers
When applying the Golden Ratio to stock market movements, analysts use the smallest positive value of .618, expressed as a percentage or 61.8 percent. Analysts then divide one number in the sequence by the number that is two spaces to the right. For example, 21/55=38.18 rounded up to 38.2 percent. Analysts then divide one number in the sequence by the number that is three spaces to the right. For example, 21/ 89 = 23.6.
Analysts use the Golden Ratio numbers to analyze the support and resistance of stock prices, referring to it as Fibonacci Time Zones, Retracements, Arcs and Fans. When plotting these numbers on a chart, analysts include a low number of 0 percent and a high number of 100 percent. The support level is when the price of stock should stop decreasing and the resistance is when the stock price should stop increasing. The theory behind this application is that once a stock experiences a significant price increase or decrease, its resistance and support levels will be at or near the Golden Ratio numbers
- ForexBoost: Forex Fibonacci Studies, Retracements, Arcs and Projections
- Elliot Wave International: The Fibonacci Sequence and its Application
- TradingMarkets.com; Stock Market Analysis and Fibonacci; John Jagerson; May 2010
About the Author
Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University.