As the stock market shifts from bear to bull and exponentially rises to the stratosphere, defying P/E ratios that never had any logic, the offers to sell fail-safe trading systems grow in tandem until greed gives way to fear, which is a well known cycle. Then after the wounds have been licked, and a new cycle ensues, the repackaged failed systems of yesteryear are once again peddled to unsuspecting people because there’s one born every minute.

If one has ever payed attention to technical analysis, the plethora of indicators is overwhelming, and the imagination is the only limit to the insanity of trading schemes and forecasts based on vapor, unicorns, and arbitrary, yet sexy geometric shapes that map the future.

I visited Tradingview.com on October 1, 2020, an excellent resource for stock charting, and came across the following chart with the headline “BITCOIN Fibonacci alignment shows a $200000 Cycle Top!”

It was an extremely amusing and useless piece of pseudo financial/trading artwork that triggered a need to address the issue about technical analysis. We’ll look at Fibonacci because that’s the one that has always fascinated me to no end, and please keep in mind that Bitcoin was introduced in 2009 and the chart starts at the end of 2010.

It happened one day in the early 13th Century, when Italian mathematician Leonardo Pisano Bigollo, as he was known among other names, had this burning rabbit population growth question. Apparently the solution generated a sequence of numbers where each number is the sum of the previous two. So it goes 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, etc. To illustrate, the number 13 is the sum of the previous two numbers, 8 and 5. But to give credit where credit is due, this sequence had been used some 600 years before him. I have no reason to doubt Leonardo’s number skills, and we was a bright individual, having realized how the Hindu-Arabic numbering system was superior to the Roman Numeral system, that is formed by the letters in the alphabet but has no zero. Can you imagine going to the local supermarket and seeing that steak costs $VIII.X per pound. They didn’t have decimals either, so I made up the roman equivalent of $8.10. A little side question: How could the Romans not have the concept of zero, when the Roman Empire ended up with zero power?

But as bright as Fibonacci was, he didn’t know jack about rabbits. Rabbits have a gestation period of 30 days and pop out between five and eight rabbits at a time, and then in 6 months it starts all over again, but now at least 8 rabbits are going at it. But we don’t know the number of males and females! Well, we’ll assume that out of the minimum 5, 2 are females and 3 are males. If each female gives birth to 5 new little rabbits, and the mother gave birth to 5 as well, the sequence is 2, 7, 17 including the old father, but even then 17 is not the sum of 2 and 7. I give up.

Rabbits aside, the Fibonacci sequence is fascinating in itself, because as you get further along, if you divide a number by the previous in the sequence, you have a rounded 1.61, such as 21/13. Then inverting the numbers like 13/21, the rounded result is 0.61. Pretty cool! But why is it important? Because the Golden Ratio, an irrational mathematical constant, is 1.61803 and change, and according to some that is the basis of life and for the last 2,400 years everyone has been fascinated by the ratio because it’s everywhere you look — geometry, your face — and is also named the “Divine Proportion.” That’s riveting!

But Fibonacci Retracement doesn’t rely on the famous sequence, rather concentrating on the relationships between numbers, and while I am at a loss as to whom invented the retracement tool, you will see how the origin is not important. One takes two extreme points on a stock chart — a peak and a trough — and divides the vertical distance by the Fibonacci “imaginary” ratios of 23.6%, 38.2%, 50%, and 61.8%. Now we go back to the famous golden ratio, but we are somewhat selective and only choose the 0.618 portion of it, and refer to it in percentage terms — 61.8%. This nice 0.618 number, minus the extra decimals, only appears for the first time when we divide 34 by 55, but for all purposes it is the key Fibonacci ratio of 61.8% because it fits what the retracement is trying to accomplish.

What about the other numbers? Well, the 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right, or 55 divided by 144 is 0.3819. Then the 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example, 8 divided by 34 is 0.2352, or 23.6%. The 100% is the top of the scale, and 0% is the trough, or bottom. Now, the 50% is obviously in the middle of the extremes, and just looks nice.

As you can discern, Fibonacci in his infinite wisdom never thought of the sequence like this, and being a mathematician he would have hated the rounding of numbers to fit a purpose, because precision is at heart of the science. But what do all this numbers do? They establish support and resistance levels within a price range and plenty of traders rely on them for buy/sell decisions, thus why it works—sometimes. Intriguing! “But why 2 and 3 numbers to the right, and not 5 numbers to the left?” you may ask. “And how does the 50% fit?” Well that’s a story for another time about gophers and polar bears and how they are unrelated.

Technical analysis works only because there’s a consensus that abides by the rules, much like mostly everyone adheres to traffic law when driving. Having said that, keep it simple and don’t waste your time diving into complex formulas and silly charts that rival a Picasso on weed. Why? Always remember LTCM and how PhDs almost brought down the banking system with their foolproof complex mathematical formulas and arbitration, courtesy of one thing: lack of understanding of human psychology which is the major problem faced by economics and central banks. For the record, the Russians did do it to LTCM.

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