The Fibonacci extensions, like Fibonacci retracements, are used to establish support and resistance levels, with the difference that the former are generally used as potential targets for profit taking, while retracements are often used as possible points of entry. For this reason, they are included in many trading systems to determine the best levels to exit the market. They are especially useful when markets are widespread.
This market analysis tools is widely included in modern trading platforms like Metatrader 4 and are used in much the same way as the retracements are used, as we saw in the article on Fibonacci retracements. Even some trading platforms allow to draw extensions and retracements in the same chart.
The three points to calculate Fibonacci extensions
First of all, you must identify the market trend in the price chart that you are using for the analysis, that means that you must take into account the timeframe in which you intend to work. Once we have detected the trend, we will begin to use the extensions tool. The time frame of the price chart that you want to analyze (5min, 15 min, 30 min, 1H, 4H, daily, etc.) will determine if the current trend is really a trend cycle or you are simply within a subcycle, that is, you are making a analysis within a much larger whole. You must understand this, since many traders perform their analysis for very short term trades and use very small timeframes such as 5 or 15 minutes, this makes their trend analysis only valid in very short periods of time.
To draw or calculate Fibonacci extensions we need 3 points: maximum, minimum and the so called point C. Point C is the minimum or maximum level reached by the pullback that occurs after a trend movement. For example, during a bullish trend the price will reverse producing a bearish pullback and point C is the minimum reached by this pullback before the price continue the uptrend. The opposite occurs for a downtrend.
In other words, the point C marks the end of the pullback that occurs after the price movement for which the Fibonacci extensions are calculated. What if there is no pullback? If there is no pullback it means that the trend movement continues and therefore we can not calculate any Fibonacci level or extensions or retracements, because in this case these levels have no sense.
Very often point C match any retracement level, especially the 50% and 38.2 retracemets. For example, we want to draw Fibonacci expansions for a movement that was from 1.5000 (minimum) to 1.6000 (maximum); from 1.6000 the price made a pullback that reached a low at 1.5500, this minimum at 1.5500 would be the point C which coincide with the Fibonacci retracement of 50%.
Example of Fibonacci extensions
In the previous image there is a D1 price chart for the GBP/USD in which we can see a clear downward trend. For this chart we use the Fibonacci tools of Metatrader 4 to draw Fibonacci retracements and extensions such as 38.2%, 50%, 61.8%, 100%, 161.8% and other.
These levels became targets after the end of the bullish pullback and resumption of the dominant downtrend. In this example you can also see how the price found support / resistance at Fibonacci extensions.
By itself, theFibonacci levels are not going to make you a millionaire as usual ss with all technical analysis tools. However, Fibonacci levels are very useful as part of an effective trading method that includes other types of analysis and trading techniques. As you can see, the key to an effective trading system is to integrate several indicators (but not many because it would become too complex) to be applied in a way that is not obvious to most observers.
All successful traders in the Forex currency market know that it is the way that indicators are used and integrated that makes the difference. The lesson learned with this article is that Fibonacci levels can be a successful tool, but you should open any position based solely on this tool.