Fibonacci Extension
Tue, Apr 15Fibonacci extensions, often referred to as "Fib extensions," are utilized to establish price targets once the prevailing trend has resumed. They are akin to Fibonacci retracements and are employed to identify potential support and resistance levels. Both Fibonacci extensions and retracements are grounded in the mathematical relationships, represented as ratios, among the numbers in the Fibonacci sequence. However, while Fibonacci retracements focus on levels up to 100% of the previous price movement, Fibonacci extensions aim to identify support and resistance levels that exceed 100%.
How is Fibonacci Extension calculated? The primary Fibonacci extension levels are derived through various mathematical operations applied to the Fibonacci series and their results. The first key ratio, 161.8%, known as the "golden ratio" or "golden mean," is calculated by dividing a number in the sequence by the number that precedes it. For instance, 21 ÷ 13 = 1.6154, 34 ÷ 21 = 1.6190, and 55 ÷ 34 = 1.6176. The 261.8% ratio is obtained by dividing a number in the sequence by the number that appears two places before it, such as 34 ÷ 13 = 2.425, 55 ÷ 21 = 2.619, and 144 ÷ 55 = 2.61818. This ratio is also the square of 1.618 (1.618 x 1.618 = 2.618). The 423.6% ratio is calculated by dividing a number in the sequence by the number that appears three places before it, for example, 55 ÷ 13 = 4.2308, 89 ÷ 21 = 4.2381, and 144 ÷ 34 = 4.2353. Additionally, this ratio can be expressed as the sum of 1.618 and 2.618 (1.618 + 2.618 = 4.236). Alongside these three ratios, the 127.2% extension level is also significant, being the square root of 1.618 (√1.618 = 1.272).
How to trade Fibonacci Extensions? Fibonacci extensions are applied similarly to Fibonacci retracements, but in the opposite direction. First, identify the dominant trend and wait for the market to reverse against it. Then, observe for the market to begin moving back in the direction of the dominant trend. Apply the extension ratios to the previous countertrend movement, starting from the previous low to the high in an uptrend, and vice versa in a downtrend. Horizontal lines are drawn at these levels, which serve as potential resistance levels in an uptrend or support levels in a downtrend. These levels can act as profit targets when trading in the direction of the dominant trend. The most critical levels are typically the 161.8% level, followed by the 127.2% level. The 261.8% and 423.6% levels also hold significance in strong markets.
Moreover, multiple Fibonacci extensions can be drawn from different lows in an uptrend or different highs in a downtrend. The endpoints for these various extensions are based on the most recent turning point and can be combined with Fibonacci retracement levels from larger price swings. This approach results in multiple levels, with areas where two or more Fibonacci levels are in close proximity being particularly significant.
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