What are 'Fibonacci Extensions'
Fibonacci extensions are used in Fibonacci retracement to predict spaces of resistance and support in the market. These extensions involve all levels drawn past the basic 100% level; they are frequently used by traders to determine areas that will bring in profits. One popular extension, the 161.8% level, is used to set a price target on a breakout of an ascending triangle; this target is calculated by multiplying the vertical distance of the triangle by key Fibonacci ratio 61.8%, and then adding the result to the triangle’s upper resistance level.
BREAKING DOWN 'Fibonacci Extensions'A retracement movement of a stock is where the stock "retraces" a section of one of its previous moves. In most cases, a stock performs a retracement at one of three standard Fibonacci levels: 38.2%, 50% and 61.8%. When a stock retraces more than 100% of its prior move, a Fibonacci extension can be calculated. These extensions, used in combination with a variety of other indicators or patterns, are common practice for traders looking to determine one or multiple price targets.
It is best, and most practical, to calculate Fibonacci extensions when stocks are at new highs or new lows, and when there are no clear levels of resistance or support on the chart. If, for example, a trader is long on a stock and the stock begins to generate new highs, the trader can calculate Fibonacci extension levels to get a basic idea of where the stock is likely to fall and is more likely to make profits. The same is true for a trader who is short. Fibonacci extension levels can be calculated to give the trader a general idea of where the stock may begin to rally. The trader then has the option to decide if he wishes to cover his position at that level.
Keeping practicality, and basic common sense, in mind, decisions to buy and sell stocks should never be made based solely on Fibonacci extensions. It is wise for traders to wait and watch for candlestick patterns, such as price action, to become evident to confirm whether a stock is likely to reverse at the traders' target price.
Fibonacci extensions are applicable to any timeframe, such as monthly charts to one-minute charts, and are tools best used on price waves so projections of future price waves can be generated. It is also wise for traders to note that clusters of Fibonacci levels are indicative of a price area that will inevitably be significant. The most important aspect traders should know is Fibonacci extensions should never be the sole deciding factor when making trading and position choices.