What Are Fibonacci Extensions?
Let me explain Fibonacci extensions directly: they're a practical tool you can use in trading to set profit targets or gauge how far a price might move once a pullback ends. These extension levels also highlight potential spots where the price could reverse direction.
You draw them as lines connecting points on your chart, all based on Fibonacci ratios expressed as percentages. The most common ones you'll encounter are 61.8%, 100%, 161.8%, 200%, and 261.8%.
Key Takeaways
- Fibonacci ratios appear in everyday life and nature, leading some traders to believe they hold meaning in financial markets too.
- There's no formula for Fibonacci extensions; you simply draw them using three chosen points on a chart to mark potentially important price levels.
- These extensions indicate how far the next price wave might extend after a pullback.
- Common levels, derived from Fibonacci ratios, include 61.8%, 100%, 161.8%, 200%, and 261.8%.
- While they signal areas of possible significance, don't rely on them alone for your trading decisions.
Creating Fibonacci Extensions
You might already know Fibonacci ratios show up everywhere—from galaxy shapes and architecture to shells, hurricanes, and certain plants. That's why some traders think they apply to financial markets as well.
Fibonacci extensions skip the formula; instead, when you apply the indicator to your chart, pick three points. Start with the beginning of a price move as your first point, the end of that move as the second, and the end of the retracement against it as the third. From there, the extensions project where the price might head next, drawing lines at percentages of that initial move.
These lines mark key price levels on your chart, based on Fibonacci percentages and the scale of the price move you're analyzing.
How to Calculate Fibonacci Extension Levels
Calculating these isn't complicated—here's how you do it step by step. First, multiply the difference between your points one and two by the ratio you want, like 1.618 or 0.618, to get a dollar amount.
If you're projecting an upward move, add that amount to the price at point three. For a downward projection, subtract it from point three.
Take this example: suppose the price goes from $10 to $20, then back to $15. You'd set $10 as point one, $20 as point two, and $15 as point three. The extensions project above $15, showing where the price might climb next. If the price drops further, redraw the indicator to fit the new low at point three.
In that setup, with the price rising from $10 to $20 (points one and two), the 61.8% level adds $6.18 (0.618 times $10) to $15, hitting $21.18. The 100% level adds $10, reaching $25.
These ratios stem from the golden ratio. Start a sequence with 0 and 1, adding the previous two numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, and so on.
Extension levels come from this sequence. Divide later numbers by the one before to approach 1.618 (like 233/144). Divide by two places back for about 2.618, or three for 4.236. Key levels include 23.6%, 38.2%, 50%, 61.8%, 78.6%, plus 100%, 161.8%, 200%, and 261.8%. Note that 100% and 200% aren't strict Fibonacci but useful for projecting equal or double moves.
What Do Fibonacci Extensions Tell You?
Fibonacci extensions give you price targets or areas of potential support and resistance, especially when other methods don't apply or aren't clear.
If the price breaks one level, it might push to the next. Remember, these are just zones of interest—the price might overshoot or fall short before reversing.
If you're long on a stock hitting a new high, use extensions to estimate upside potential. For shorts, they help set profit targets where you might exit.
You can apply them to any timeframe or market. When multiple Fibonacci levels from different waves cluster at one price, that spot becomes crucial for decisions.
Extensions work across timeframes and markets, and clusters of levels from various waves can signal highly significant prices for you and other traders.
The Difference Between Fibonacci Extensions and Fibonacci Retracements
Extensions project where the price heads after a retracement, while retracements measure how deep that pullback goes. Put simply, retracements look at pullbacks in a trend, but extensions focus on the trend's continuing impulses.
Limitations of Using Fibonacci Extensions
Don't make Fibonacci extensions your only guide for buying or selling. Combine them with other indicators or patterns to set targets. Candlestick patterns and price action are particularly helpful for spotting reversals at those levels.
There's no guarantee the price will hit or reverse at an extension level. It might breeze through several or skip them entirely, so you won't know which one matters until it's happening.
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