I don’t have a trading background and am not a mathematician, but just went down a rabbit hole. Somehow, someway, someone sent me a Fibonacci T-shirt and I went WTF? Thanks to the t-shirt I stumbled across the Fibonacci principles, and my world changed.
What’s that all about?
Well, let’s start with asking: Who was Fibonacci? He actually was someone called Leonardo Bonacci, an Italian mathematician from Pisa, Italy, and considered to be the most talented mathematician of the Middle Ages. He was generally known as Fibonacci, which was a nickname meaning son of Bonacci, and came up with a math idea that is now the core of trading in the investment markets.
What was the idea?
Well, it is a mathematical sequence where you add the last two numbers together, starting with 0 and 1. So you then get a sequence that goes 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 and so on. As the sequence develops, if you divide the previous number by the one before, you get a ratio and, as the sequence develops, the ratio gradually approaches 1.618. That ratio number is known as The Golden Ratio, and it is used by investment bankers to work out when to enter and exit markets.
The Golden Ratio, also known as phi, and its inverse (0.618 or phi -1) are used in trading to identify when the market has reached its summit or zenith. It’s all very mathematical and complicated but, thanks to modern day computing, you can just put the whole lot into an algorithm and let the system do it all for you.
This is something I learnt about paired trading years ago. Paired trading is linking two stocks or currencies, and automating the buy and sell of such trades based upon price movements. That became algorithmic trading and then flash trading.
It also was the time of the rise of quantum trading analytics, and it makes you realise how complicated and rocket science trading in investment banking can be. No wonder they get six figure+ salaries and bonuses.
Anyway, back to the Fibonacci sequence and the Golden Ratio, there’s a thing called The Golden Pocket. The Golden Pocket is a specific area between the 38.2% and 61.8% retracement levels. WTF?
Well, in the realm of financial markets, a retracement refers to a temporary turnaround in the direction of an asset’s price that goes against the prevailing trend. For example, in an uptrend, a retracement might see the asset falling slightly before it resumes its upward trajectory. Similarly, in a downtrend, it may temporarily rise before continuing its descent.
There’s also a reversal trend that traders look for. These are more important as retracements mean a temporary blip against the current trend, whilst reversals signify a fundamental change in direction. A reversal occurs when the price movement shifts so significantly that it alters the established structure, indicating a change in sentiment.
All of this dictates how to invest at prime-time. Entry and exit points based on Fibonacci sequence’s, Golden Ratio and Gold Pocket indicators using retracement and reversal maths to maximise reward.
Pretty dense stuff, huh?
In practice however, it’s all programmable. After all, you can build all of that math into an algorithm to calculate the best entry and exit points. For example, when the Golden Ratio reaches the 61.8% level then that is a great retracement level and used by most traders as the best support (entry) or resistance (exit) point.
The 65% level is another retracement level that, when combined with the 61.8%, creates the Golden Pocket or, in layman’s time, the best time to buy or sell. This combination of levels is believed to create a high-probability area for price reversals and potential entry points for traders and, yes, it can now all be programmed which is why you don’t need traders.
After all, think about what I just outline
This video will provide a tutorial on the Fibonacci Golden Ratio Trading Strategy:
If you want to work out the Golden Pocket scenario and have followed this blog so far, here’s a great video that explains more.
Meanwhile, if you like this sort of stuff, I’ll come back to blog more about Collatz Conjecture, Goldbach’s Conjecture, the Riemann Hypothesis, Fermat’s Last Theorem and more.
Postscript:
I'm fairly sure that the Golden Ratio and Golden Pocket are NOT related to the Golden Dome!
Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal's Financial News. To learn more click here...