What Is a Fibonacci Fan?
The Fibonacci ratio can be used to describe the proportions in things from nature's smallest building blocks, such as atoms, to the most advanced patterns in the universe, like unimaginably large celestial bodies. Nature relies on this innate proportion to maintain balance, but the financial markets also seem to conform to this "golden ratio."
- A Fibonacci fan is a method of plotting support and resistance levels based on the ratios provided by the Fibonacci series.
- Trendlines are drawn at intervals of 23.6, 38.2, 50, and 61.8 percent apart to predict retracements.
- The Fibonacci ratio, also known as the "golden ratio," is roughly 1.618. This ratio is found throughout natural and social sciences.
Understanding Fibonacci Fans
Fibonacci fans are sets of sequential trendlines drawn from a trough or peak through a set of points dictated by Fibonacci retracements. To create them, a trader draws a trendline off of which to base the fan, usually covering the low and high prices of a security over a given period of time.
To reach retracement levels, the trader divides the difference in price at the low and high end by ratios determined by the Fibonacci series, typically 23.6 percent, 38.2 percent, 50 percent, and 61.8 percent. The lines formed by connecting the starting point for the base trendline and each retracement level create the Fibonacci fan.
Traders can use the lines of the Fibonacci fan to predict key points of resistance or support, at which they might expect price trends to reverse. Once a trader identifies patterns within a chart, they can use those patterns to predict future price movements and future levels of support and resistance. Traders use the predictions to time their trades.
Fibonacci Ratio Investment Strategies
The Fibonacci sequence begins with the digits zero and one, then proceeds infinitely with the next number in the sequence equal to the sum of the two numbers preceding it (e.g., 0, 1, 1, 2, 3, 5, 8, 13, 21, 35, etc.). The proportion of any adjacent terms equals approximately 1.618, represented in mathematics by the Greek letter phi (Φ), and coincidentally underlies a huge number of naturally occurring patterns. For unknown reasons, stock prices appear to behave in patterns consistent with the Fibonacci ratio as well.
Technical analyses based upon Fibonacci ratios exist for both the price and time axes of charts. Analysts can also use retracements to produce arcs or fans using arithmetic or logarithmic scales. Nobody appears to know whether these tools work because stock markets exhibit some form of natural pattern or because many investors use Fibonacci ratios to predict price movements, making them a self-fulfilling prophecy. In any event, key support and resistance levels tend to occur frequently at the 61.8-percent level on both uptrends and downtrends.
To derive the three key ratios typically used in technical analysis based upon the Fibonacci series, you simply find the proportion of one number in the series to its neighbors. Adjacent numbers produce the inverse of phi, or 0.618, corresponding to a retracement level at 61.8 percent. Numbers two places apart in the sequence yield a ratio of 38.2 percent, and numbers three places apart yield a ratio of 23.6 percent.
Fibonacci Fans vs. Gann Fans
Gann fans are another form of technical analysis based on the idea that the market is geometric and cyclical in nature. A Gann fan consists of a series of trend lines called Gann angles. These angles are superimposed over a price chart to show potential support and resistance levels. The resulting image is supposed to help technical analysts predict price changes.
Gann fans are named after their creator W.D. Gann. Gann believed his angles could predict future price movements based on geometric angles of time versus price. Gann was a 20th-century market theorist. However, instead of relying on Fibonacci's golden ratio of 1.618, Gann believed the 45-degree angle to be most important. The Gann fan subsequently draws additional angles at 82.5, 75, 71.25, 63.75, 26.25, 18.75, 15, and 7.5 degrees. The Gann fan thus incorporates angles based on price-to-time moves in the following ratios: 1:8, 1:4, 1:3, 1:2, 1:1, 2:1, 3:1, 4:1, and 8:1.