Trend-Based Fibonacci Extensions

Table of Content

What Are Fibonacci Extensions?

A Trend-Based Fibonacci Extension is a tool that traders can use to establish profit targets or estimate how far a price may travel after a pullback is finished. Extension levels are also possible areas where the price may reverse.

Drawn as connections to points on a chart, these levels are based on Fibonacci ratios (as percentages). Common Fibonacci extension levels are 61.8%, 100%, 161.8%, 200%, and 261.8%.

Fibonacci Extensions

Important Points To Remember:

  • As Fibonacci ratios are common in everyday life, some traders believe these common ratios may also have significance in the financial markets.
  • Fibonacci extensions don’t have a formula. Rather, they are drawn at three points on a chart, marking price levels of possible importance.
  • The Fibonacci extensions show how far the next price wave could move following a pullback.
  • Based on Fibonacci ratios, common Fibonacci extension levels are 61.8%, 100%, 161.8%, 200%, and 261.8%.
  • Extension levels signal possible areas of importance, but should not be relied on exclusively.

Creating Fibonacci Extensions

Fibonacci ratios are common in everyday life and nature, seen in galaxy formations, architecture, shells, hurricanes, and some plants. Therefore, some traders believe these common ratios may also have significance in the financial markets.

Fibonacci extensions don’t have a formula. When the indicator is applied to a chart, the trader chooses three points. The first point chosen is the start of a move, the second point is the end of a move and the third point is the end of the retracement against that move. The extensions then help project where the price could go next. Once the three points are chosen, the lines are drawn at percentages of that move.

Extensions are drawn on a chart, marking price levels of possible importance. These levels are based on Fibonacci ratios (as percentages) and the size of the price move the indicator is being applied to.


What Do Fibonacci Extensions Tell You?

Fibonacci extensions are a way to establish price targets or find projected areas of support or resistance when the price is moving into an area where other methods of finding support or resistance are not applicable or evident.

If the price moves through one extension level, it may continue moving toward the next. That said, Fibonacci extensions are areas of possible interest. The price may not stop or reverse right at the level, but the area around it may be important.

For example, the price may move just past the 1.618 level, or pull up just shy of it, before changing directions.

If a trader is long on a stock and a new high occurs, the trader can use the Fibonacci extension levels for an idea of where the stock may go. The same is true for a trader who is short. Fibonacci extension levels can be calculated to give the trader ideas on profit target placement. The trader then has the option to decide whether to cover the position at that level.

Fibonacci extensions can be used for any timeframe or in any market. Typically, clusters of Fibonacci levels indicate a price area that will be significant for the stock, and also for traders in their decision making. Since extension levels can be drawn on different price waves over time, when multiple levels from these different waves converge at one price, that could be a very important area.


Difference Between Fibonacci Extensions & Fibonacci Retracements

While extensions show where the price will go following a retracement, Fibonacci retracement levels indicate how deep a retracement could be. In other words, Fibonacci retracements measure the pullbacks within a trend, while Fibonacci extensions measure the impulse waves in the direction of the trend.


Limitations Of Fibonacci Extensions

Fibonacci extensions are not meant to be the sole determinant of whether to buy or sell a stock. Investors should use extensions along with other indicators or patterns when looking to determine one or multiple price targets. Candlestick patterns and price action are especially informative when trying to determine whether a stock is likely to reverse at the target price.

There is no assurance price will reach or reverse at a given extension level. Even if it does, it is not evident before a trade is taken which Fibonacci extension level will be important. The price could move through many of the levels with ease, or not reach any of them.