"How to Trade Fibonacci Extensions
This week’s Forex Trading Floors “How To Trade” follows on from last week’s blog “Combining Fibonacci with Trend Lines”.
The next use of Fibonacci will be using them to find targets.
n an uptrend, the general idea is to take profits on a long trade at a Fibonacci Price Extension Level. You determine the Fibonacci extension levels by using three mouse clicks.
First, click on a significant Swing Low, then drag your cursor and click on the most recent Swing High. Finally, drag your cursor back down and click on any of the retracement levels.
This will display each of the Price Extension Levels showing both the ratio and corresponding price levels. Pretty neat, huh?
Let's go back to that example with the USD/CHF chart we showed you in the previous lesson.
The 50.0% Fib level held strongly as support and, after three tests, the pair finally resumed its uptrend. In the chart above, you can even see price rise above the previous Swing High.
Let's pop on the Fibonacci extension tool to see where would have been a good place to take off some profits.
Here's a recap of what happened after the retracement Swing Low occurred:
Price rallied all the way to the 61.8% level, which lined up closely with the previous Swing High.
It fell back to the 38.2% level, where it found support
Price then rallied and found resistance at the 100% level.
A couple of days later, price rallied yet again before finding resistance at the 161.8% level.
As you can see from the example, the 61.8%, 100% and 161.8% levels all would have been good places to take off some profits.
In a downtrend, the general idea is to take profits on a short trade at a Fibonacci extension level since the market often finds support at these levels.
Let's take another look at that downtrend on the 1-hour EUR/USD chart we showed you in the Fib Sticks lesson.
Here, we saw a doji form just under the 61.8% Fib level. Price then reversed as sellers jumped back in, and brought price all the way back down to the Swing Low.
Let's put up that Fib Extension tool to see where would have been some good places to take profits had we shorted at the 61.8% retracement level.
Here's what happened after price reversed from the Fibonacci retracement level:
Price found support at the 38.2% level
The 50.0% level held as initial support, then became an area of interest
The 61.8% level also became an area of interest, before price shot down to test the previous Swing Low
If you look ahead, you'll find out that the 100% extension level also acted as support
We could have taken off profits at the 38.2%, 50.0%, or 61.8% levels. All these levels acted as support, possibly because other traders were keeping an eye out for these levels for profit taking as well.
The examples illustrate that price finds at least some temporary support or resistance at the Fibonacci extension levels - not always, but often enough to correctly adjust your position to take profits and manage your risk.
Of course, there are some problems to deal with here.
First, there is no way to know which exact Fibonacci extension level will provide resistance. Any of these levels may or may not act as support or resistance.
Another problem is determining which Swing Low to start from in creating the Fibonacci extension levels.
One way is from the last Swing Low as we did in the examples; another is from the lowest Swing Low of the past 30 bars. Again, the point is that there is no one right way to do it, but with a lot of practice, you'll make better decisions of picking Swing points.
You will have to use your discretion in using the Fibonacci extension tool. You will have to judge how much longer the trend will continue.
Next Week on "How to Trade" we will be covering Placing Stops with Fibonacci.
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