What are 'Fibonacci Extensions'

Fibonacci extensions are used in Fibonacci retracement, which is a common method of technical analysis used to forecast potential areas of resistance and support in the market. Retracement is based on the concept that stocks will a retrace a predictable portion of a move. Typically, a retracement occurs at one of three standard Fibonacci levels: 38.2 percent, 50 percent and 61.8 percent. 

BREAKING DOWN 'Fibonacci Extensions'

Fibonacci extensions can be calculated when a stock retraces more than 100 percent of its prior move. For example, to set a price target on the breakout of an ascending triangle, traders typically use the 61.8 percent level. Multiplying the vertical distance of the triangle by the key Fibonacci ratio and adding the result to the triangle’s upper resistance level can yield the target price.

The most effective way to calculate Fibonacci extensions is when stocks are at new highs or new lows, and when there are no clear levels of resistance or support on the chart. If a trader is long on a stock and new highs begin to occur, the trader can find the Fibonacci extension levels to form an idea of where the stock is likely to fall and where it is 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 start to rally. The trader then has the option to decide whether to cover the position at that level.

Key Considerations When Using Fibonacci Extensions

Fibonacci extensions are not meant to be the sole determinant of whether to buy or sell a stock. It is advisable for investors to use these extensions along with a several different indicators or patterns when looking to determine one or multiple price targets. Candlestick patterns, such as price action, are especially informative when trying to determine whether a stock is likely to reverse at the target price.

Fibonacci extensions can be used for any timeframe, no matter how long or short; whether used for a chart that spans a month or one that spans a day or a minute, Fibonacci extensions are a proven methodology. They are most effective when applied in instances of price waves, so as to increase the accuracy when forecasting the likelihood of future price waves. Typically, clusters of Fibonacci levels indicate a price area that will be significant for the stock and traders in their decision-making. 

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