THE SHORT VIEW By John Authers - Fibonacci sequences

THE SHORT VIEW By John Authers
Published: October 3 2006 03:00 | Last updated: October 3 2006 03:00
Copyright The Financial Times Limited 2006


Fibonacci sequences, where each number equals the sum of the two that precede it (for example 1, 1, 2, 3, 5, 8…) are much beloved by technical market analysts. Such sequences have proved to have many applications since the 12th century Italian mathematician Fibonacci used them while studying rabbits.

Beyond the stock and currency markets, they areheld to occur in nature, architecture and aesthetics, and even in US baseball results.

The belief that markets move in waves or "retrenchments", which typically factor in some way the Fibonacci "golden ratio" of 0.618, has been around for roughly a century.

When a market hits a peak, it will then "retrench" until it has reached some "resistance level". When it recovers, it might meet a similar point of resistance on the way up. Applying Fibonacci, "resistance" might come when the market has fallen equal to 0.618 times its previous fall.

Nobody has ever explained this, but manybelieve it.

This column's recent e-mail correspondence from brokerage houses and banks includes references to "Fibonacci support levels," "Fibonacci resistance" and "Fibonacci targets".

Sadly, a recent research paper from the City University's Cass Business School in London shows that all of this research is a complete waste of time.

Looking at the peaks and the troughs in the Dow Jones Industrial Average from January 1915 to June 2003, City University's researchers found that the number of times the ratios between those peaks and troughs was anywhere close to a Fibonacci ratio was less than would have been predicted if the pattern were random.

The case that Fibonacci sequences do not, after all, have any relevance to the stock market appears to be overwhelming. Rationally, everyone should shelve their attempts to apply such magic numbers. But people instead look for arbitrary ways in which to anchor decisions.

As the City researchers say: "It is simply human nature for traders to take the technical support and resistance levels as starting points for thinking about price targets, regardless of their logic".