In a previous blog of mine, I explained the importance of the Fibonacci sequence named after the famous Italian mathematician of the same name. Fibonacci introduced the Hindu system of writing numbers in Europe (0,1,2,3,4,5…..)in place of Roman numerals. However, what he really achieved fame for was the Fibonacci sequence of numbers. The way it works is that each number is made up of the sum of the two preceding numbers meaning that the sequence of the first 10 numbers is 1,1,2,3,5,8,13,21,34,55.  This seemingly insignificant series of numbers is in fact enormously important.  Its creation contributed to Fibonacci being considered to be the most talented mathematician of the Middle Ages.

 

The reason why the Fibonacci number sequence is so important is because it shows patterns in all aspects of life especially in stock markets and in nature. The Fibonacci sequence is significant because of the golden ratio of 1.618 or its inverse 0.618.  In the Fibonacci sequence, any given number is approximately 1.618 times the preceding number, ignoring the first few numbers. Each number is also 0.618 of the number to the right of it, ignoring the first few numbers of the sequence. The golden ratio is ubiquitous in nature where it describes everything from the number of petals on a flower, the arrangement of leaves on a stem, to the design of a peacock’s feathers. It is so remarkable to be nothing short of uncanny how much Fibonacci’s number sequence occurs in nature including birds, animals and marine life. So much so, whatever your religious beliefs, there must be a “God” looking over planet earth and its inhabitants.  You only have to observe the patterns on a peacock’s wings when they are open to be awestruck.  Something like this doesn’t just happen but I digress…..

What does all of this have to do with predicting the stock market’s movements you may wonder. Well, it’s because Fibonacci numbers play an important role in forecasting and measuring the stock market’s rises and falls because, as in nature, the rises and falls of stock markets have consistent patterns too.

The Elliott Wave Theory was developed by Ralph Nelson Elliott in the 1930s. After being forced into retirement due to an illness, Elliott needed something to occupy his time and began studying 75 years worth of yearly, monthly, weekly, daily, and self-made hourly and 30-minute charts across various indices.

The theory gained notoriety in 1935 when Elliott made an uncanny prediction of a stock market bottom and has since become a staple for thousands of portfolio managers,  traders and private investors.

R.N. Elliott described specific rules governing how to identify, predict and capitalise on these wave patterns. These books, articles, and letters are covered in “R.N. Elliott’s Masterworks,” published in 1994. R.N. Elliott was careful to note that these patterns do not provide any kind of certainty about future price movement, but rather, serve in helping to order the probabilities for future market action.

Elliott Waves basically consist of five upward waves and three downward waves. Numbers from the Fibonacci sequence surface repeatedly in Elliott Wave structures. Elliott developed his market model before he realised that it actually reflects the Fibonacci sequence.

Before you get too excited about your uncanny newfound skills in predicting the rise and fall of the stock market I have a confession to make. I chose the title purely to get your interest. Elliott Waves and Fibonacci numbers are indeed accurate but the challenge with them is getting the exact timing right when these patterns change and there’s the rub. R.N. Elliott’s own comments that these patterns do not give certainty about future price movements but instead help in calculating the probability of them stands true today. Nonetheless, such predictions are fascinating and do have a role to play in managing portfolios today.

Such strategies, along with many others, form part of Wealth And Tax Management’s investment process. We continually strive to improve our investment strategy for the benefit of our clients. You know it makes sense*.

*The value of investments can fall as well as rise. You may not get back what you invest. The contents of this blog are for information purposes only and do not constitute individual advice.