What is Fibonacci extension?
Fibonacci extensions are tools that use by traders to determine profit targets
And measure how far prices will move in the direction of the main trend, after getting a retracement.
Thus it can be said that if a trader uses the Fibonacci retracement level to determine when to enter the market and whether it is the best area to open a position, the Fibonacci extension is to determine the profit target.
Extensions levels are also important points where the possibility of a price will reverse.
How to draw Fibonacci Extensions is to draw at important price levels using the Fibonacci golden ratio,
The common levels of Fibonacci extensions are 61.8%, 100%, 161.8%, 200%, and 261.8%.
Fibonacci extensions also called as Fibonacci expansion.
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How to attach Fibonacci Extension on the MetaTrader Platform?
On the popular trading platform Metatrader (MT4 / MT5) there is a tool for creating Fibonacci Expansion levels.
It’s easy, you can access the tool by clicking on the dropdown menu in the following order: Insert -> Fibonacci -> Expansion
To draw a Fibonacci extension following step
- The first steps drag the cursor on the Chart, then determine the location of the main trend by identifying points 1 and 2.
- Second, set points 2 and 3 to determine the location of the Retracement.
- Then Fibonacci extensions levels will appear on the chart.
Take a look at the image below
The image above is an example of how to draw Fibonacci extensions to EURUSD.
Drawing Fibonacci Expansion levels is easier than Fibonacci Retracement.
Although for beginners they can draw Fibonacci extension easily.
How to calculate Fibonacci extension and retracement levels
Read also Support resistance candlestick patterns
Take a look at the image below on uptrend market
Let’s look at the picture above.
In the example above, market conditions are in an uptrend. The lowest swing-point A-is 120.75; the highest swing-point B-121.44.
To calculate the Fibonacci retracement level to buy at a point C we do the following
Uptrend and Buy order calculations
B - A =? 121.44 - 120.75 = 0.69 38.2% = 121.44 - 0.69 x 0.382 = 121.18 50.0% = 121.44 - 0.69 x 0.500 = 121.09 61.8% = 121.44 - 0.69 x 0.618 = 121.01
Fibonacci retracement level formula for Uptrend:
C = B- (B-A) x N%
Now we need to calculate the level of extension.
61.8% extension = 121.44 + 0.69 x 0.618 = 121.87 1,000 extensions (100.0%) = 121.44 + 0.69 x 1,000 = 122.13
138.2% extensions = 121.44 + 0.69 x 1.382 = 122.39 1,618 (161.8%) extension = 121.44 + 0.69 x 1.618 = 122.56
Fibonacci extension level formula for an uptrend
D = B + (B-A) x N%
The next example is in a Downtrend condition
Take look at the image below
The highest swing-point A-is 158.20; the lowest swing-point B-is 156.44.
The calculation for the downward trend and sell signals are;
A-B =? 158.20-156.44 = 1.76 Because to decrease we need to add to the lowest point b find the retracement. 38.2% = 156.44 + 1.76 x 0.382 = 157.53 50.0% = 156.44 + 1.76 x 0.500 = 157.32 61.8% = 156.44 + 1.76 x 0.618 = 157.11
Fibonacci retracement level formula for downtrend:
C = B + (A-B) x N%
Now let’s look for Fibonacci level extensions (Downtrend markets):
61.8%) extensions = 156.44-1.76 x 0.618 = 155.35 100% extensions = 156.44-1.76 x 1,000 = 154.68 138.2% extensions = 156.44-1.76 x 1.382 = 154.01 161.8% extensions = 156.44 - 1.76 x 1.618 = 153.59
Fibonacci extension level formulas for downtrend are:
D = B- (A-B) x N%
How to use Fibonacci extensions
Furthermore, the use of Fibonacci is to find profit targets.
The main idea of an uptrend is to take advantage of a long trade at the Fibonacci extension level.
We can determine Fibonacci extension levels by performing three ‘click’ steps with our mouse.
- First, click on a flashy swing low, then drag the cursor and click on the most recent swing high.
- Finally, drag the cursor back down and click on any retracement level.
- If these steps have been taken, the price extension levels will appear showing the ratio and related price levels.
Example trading uptrend
We will again use the example with the USD/CHF pair which is also an example in the previous chapter, take a look image below
The USD / CHF example chart above we discussed in the previous lesson.
Take a look that the 50% Fibonacci level is formed strongly due to the support level, after three tests, and the pair finally resumes its uptrend again.
In the chart above, we can even find out that prices are rising above the previous swing high.
Now let’s draw the Fibonacci extension tool to see where a good place to take profit is.
What are the things that will happen after the retracement at the swing low is formed as follows:
- The price of the rally on its journey towards the 61.8% level, which lined up near the previous swing high.
- Then the price fell back to the level of 38.2%, where it reached support.
- The price then rallies and reaches the resistance at the level of 100%
- A few days later, the price rallied again before reaching the resistance at the 161.8% level.
From this example, all 61.8%, 100%, and 161.8% extensions levels are the right place to take profits.
Example trading downtrend
Now, let’s look at an example of using Fibonacci extension levels on a downtrend.
If there is a downtrend like this, we take profits from short trades at Fibonacci extension levels, because the market usually reaches support at these levels.
The following is an example of a EUR/USD downtrend chart that we have used on Fib Stick material.
In the image above we have a candlestick Doji shape just below the 61.8% Fibonacci level.
The price then reverses as a result of sellers returning and dragging the price back down to the swing low.
Now let’s draw the Fibonacci extension tool to see where the best point is to make a profit if we put it at the 61.8% retracement level.
Furthermore, these things occur after prices reverse from Fibonacci retracement levels:
- The price reached support at 38.2%
- The 50.0% level is formed as initial support, and then becomes an interesting area
- The 61.8% level also becomes an interesting area before the price closes to test the previous swing low.
- If we look ahead, we will find that the 100% extension level also acts as a support.
We can take profits at the level of 38.2%, 50.0%, or 61.8%.
These levels act as support, probably because other traders are paying attention to the same profit-taking levels as us.
The example illustrates that prices meet at least support or resistance at Fibonacci extension levels, which is not always the case, but it is usually enough to make it easy for us to take profits and install risk management.
However, the example above only explains how to use Fibonacci extensions to determine profit targets.
In practice, you should have more experience with varied market conditions, so you will be more familiar with how to use these Fibonacci extensions.
Don’t forget, every tool trading in technical analysis usually has a weakness.
In the case of Fibonacci extensions, the problem is that there is no way to find out Fibonacci extension levels that provide resistance.
Some of these levels may or may not be support or resistance.
Another problem is determining the swing low to start installing Fibonacci extension levels.
One way is to use the last swing low as we did in the example; the other way is from the lowest swing low in the last 30 bars.
The other thing, the point is there is no one method that is really right, but if we practice often, we certainly will easily find the gap and determine the Swing points.
In essence, in using Fibonacci extensions, we must be wise in assessing how much longer the trend will continue.
So, let’s learn how to determine the strength of a trend.