The Foreign Exchange market, also known as the currency markets, is a liquid global market where participants exchange one currency for another. The market is active 24 hours a day, six day a week. Investors who participate in the FOREX market use a number of statistical tools, such as the Fibonacci series, to forecast the future direction of a currency exchange rate. As of 2013, the validity of using Fibonacci numbers to predict the behavior of the FOREX market has not been proved.
The FOREX Market
The securities that are traded in the FOREX markets are referred to as currency pairs. A currency pair is evaluated by its exchange rate, which is the relative value between one country's currency and another country's currency. The exchange rate is the price at which an investor can trade one currency for another. For example, the USD/JPY currency pair tells an investor how many Japanese yen need to be exchanged to purchase one U.S. dollar.
Leonardo Pisano Bogollo, also known as Leonardo Fibonacci, is one of the greatest mathematicians from the Middle Ages. He lived in Italy from 1170 to 1250. Fibonacci created a number series where each number in the sequence equaled the sum of the prior whole numbers. For example, the sequence 0,1,1,2,3,5,8,13 . . . is the beginning of the Fibonacci series. The quotient of each adjacent term is known as a "golden ratio" and is used by technical analysts to target future prices. Each number within the series with the exception of the first two are linked by the golden ratio. For example 5 * 1.618 = 8, 8 * 1.618 = 13.
Fibonacci Price Targets
The “golden ratios” provide investors with tools to assist in targeting price retracements. A retracement is a rebound in exchange rate levels, either from a price increase or decline. Investors can use a graph to predict where the price of a currency pair will move, or how much it will rebound once it has declined. The benchmark Fibonacci golden ratios that are often used in currency trading are 38.2 percent, 50 percent and 61.8 percent, which are calculated from the golden ratios.
Calculating Retracements Levels
Fibonacci retracement can be analyzed by evaluating the exchange rate of a currency pair on a graph. For example, if a currency pair such as the USD/JPY falls by 10 yen over a period of time, from 100 to 90, the Fibonacci retracement levels could be calculated by multiplying 38.2 percent by 10, 50 percent by 10 and 61.8 percent by 10 and adding those amounts to 90. The target retracement levels in this example are 93.82, 95 and 96.18. These levels can be used by FOREX traders to target price levels on a graph and assist in evaluating whether to exit or enter currency positions.
David Becker is a finance writer and consultant in Great Neck, N.Y. With more than 20 years of experience in trading, he runs a consulting business that focuses on energy hedging and capital market analysis. Becker holds a B.A. in economics.