Fibonacci Price Extensions

What is it?

Fibonacci price extensions are similar to Fibonacci price retracements. It is also support and resistance indicator that is used to determine possible support and resistance levels. Like Fibonacci fans, and Fibonacci Retracements, Fibonacci extensions are based on the mathematical relationships, expressed as ratios, between the numbers in the Fibonacci summation series. Unlike Fibonacci retracements, however, Fibonacci extensions seek possible support and resistance levels that are more than 100% of the previous price movement.

How is it calculated?

The key Fibonacci extension levels are found by performing various mathematical operations on the numbers in the Fibonacci summation series, and on the results of those operations.

  • The first ratio of 161.8%, which is the "golden ratio" or the "golden mean", is found by dividing a number in the sequence by the number that precedes it. For example: 21 ÷ 13 = 1.6154, 34 ÷ 21 = 1.6190 and 55 ÷ 34 = 1.6176.
  • The 261.8% ratio is found by dividing a number in the sequence by the number that appears two places before it. For example: 34 ÷ 13 = 2.425, 55 ÷ 21 = 2.619 and 144 ÷ 55 = 2.61818. It is also the square of 1.618 (1.618 x 1.618 = 2.618).
  • The 423.6% ratio is found 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. It is also the sum of 1.618 and 2.618 (1.618 + 2.618 = 4.236).
  • In addition to these three ratios, the 127.2% extension level is also used. This level is the square root of 1.618 (1.618 = 1.272).

How is it used?

Fibonacci extensions are used in a similar way as Fibonacci retracements but the opposite direction. The technical analyst identifies the trend, then waits for the market to turn against the trend and then waits for the market to start moving back in the direction of the dominant trend. The analyst then applies the extension ratios to the previous countertrend movement, or wave, starting from the previous low to the high in an uptrend and in the opposite direction in a down trend. Horizontal lines are then drawn at these levels and are used a possible resistance levels if the dominant trend is an uptrend, or as possible support levels if the dominant trend is a down trend. These thus become places at which the trader could use as price targets when trading in the direction of the dominant trend. The most significant levels are usually the 161.8% level followed by the 127.2% level. The 261.8% level and the 423.6% levels are also significant in strong markets.

Multiple Fibonacci extensions can also be drawn starting from different lows in an uptrend or different highs in a down trend. The end points for the different extensions are the same most recent turning point and can be used with Fibonacci retracement levels of larger price swings. This creates multiple levels with areas were two or more Fibonacci levels are in close proximity being more significant.

Chart Example

The following is a 1-hour chart of the GBP/USD with a Fibonacci Extension drawn on the countertrend rally from the lows made at 17:00 on November 8, 2013 to the high made at noon on November 11, 2013. The subsequent price movement back in the direction of the dominant down trend came within a few pips if the 261.8% extension level on November 12, 2013 before reversing.

GBP/USD chart with Fibonacci Extensions
Fibonacci Extensions on a 1 Hour GBP/USD chart

Wealth Warning

Trading equities, options, derivatives, currencies, commodities or any other financial security can offer significant returns BUT can also result in significant losses if the market moves against your position. It requires a strong commitment to skill development, knowledge acquisition, and emotional control. It should be treated as a business with a clear business plan, a risk analysis, and set of attainable goals. The risk associated with trading the vagaries of the stock markets is probably the most important consideration as it has a profound effect on emotional control. You should not trade the stock markets with money you cannot afford to lose as there is considerable exposure to risk in any stock market transaction.

Furthermore, the past success of any trading method, strategy, or system is only indicative of future success. Under no circumstances should past success be construed as a guarantee of future success!

How do you know if you've drawn the Fibonacci lines from the right levels?

When drawing Fibonacci extension lines, there are usually a number of swing highs and lows you could use for your extension study. Choosing which levels to use can be a challenge at first but here are a few simple guidelines that will eliminate most of the uncertainty.

In an extension study you would want to extend the levels of a countertrend move in the direction of the trend. You would thus want view the most recent swing low in an uptrend as the potential start of the movement back in the direction of the trend. The previous swing low before that would be the start of your extension study, and you would draw your Fibonacci levels up towards the swing high that followed that swing low.

Another useful trick is to check if the market respected those levels in earlier price movements, particularly the 100%, 161.8% and 261.8% levels. If the levels were respected previously, they would probably hold some significance going forward.

Related Indicators:

Support and Resistance Indicators

Support and Resistance
Support and Resistance

Support and Resistance indicators are usually drawing tools such as Andrews' Pitchfork, Gann Lines and Fibonacci Retracements that are drawn directly on the price chart. These indicators are usually a set of lines that attempt to forecast areas of support and resistance in an existing trend. They indicate where the trend could meet support or resistance. Most of these indicators also indicate the possible end of the existing trend. This occurs when the support or resistance line is broken.

When the support or resistance ...

Fibonacci Retracements

Fibonacci Retracements
Fibonacci Retracements

Fibonacci Retracements is a popular support and resistance indicator based on the proportional relationship between the numbers in the Fibonacci sequence. The Fibonacci sequence is the sum of the two numbers beginning with 0 and 1. The key ratios between these numbers are: 161.8%, 61.8%, 38.2% and 23.6%. These ratios, and the 50% ratio, are used to divide a price movement in a wave, and plot horizontal lines to determine where a retracement could find support or resistance before the trend resumes.

Fibonacci retracement levels are ...

Further Reading: