4.22 How to Use Fibonacci Extensions as Profit Taking Targets

 

We studied Fibonacci retracements to help us get into the main trend at a good price point. Fibonacci extension levels come into picture when the price action breaks above the recent high, to continue in the ongoing trend direction, after completing the retracement.

 

Before we go ahead, probably you may like to ask "What is the difference between Fibonacci retracement and Fibonacci extension levels?". The difference is quite simple. Fibonacci retracement levels suggest the entry zones for trade positions and Fibonacci extension levels suggest the profit taking target zones or exit zones. 

 

The important extension levels, which you can consider as profit taking targets, are 138%, 150%, 161.8%, 200% and 261.8%. Please not that 150%, 200% and 261.8% are not really Fibonacci levels but are important extension levels because of psychological point of view and are grouped together with Fibonacci extension levels.

 

Just to jog your memory a bit, take a look at the chart below. There was a downtrend from A to B and the retracement took us back to C to complete 38.2% retracement level. Let’s assume you got a short position in at that level and now are looking to book profits on the short trade. The question is at what price should you cash in the pips?  

Fibonacci extension levels as profit targets during downtrend.  

 

Again, in the chart below, look at the up trend from P to Q, and the retracement from Q to R, where the price-action completed 50% retracement and found support just ahead of the 61.8% level. You were quick to pull the trigger and got in a long trade around R levels. Now you want to book profits on the long trade, and want to know a suitable price level to encash the trade.

 

Fibonacci extension levels during uptrend. 

 

The answer to both the situations is: "use Fibonacci extensions". Extensions are basically price targets around which we can parachute out of a trade, happily with some pips tucked away!

 

How do we calculate the Fibonacci extension levels? As usual, we’ll just be lazy and let our computer package do it. Here’s how.

 

In a downtrend – cashing chips on a short trade

 

Your trading platform may or may not have a separate Fibonacci extension tool. In case you have it handy then select the option to insert Fibonacci Extension. Let's take the example of the first chart above i.e. the chart with the downtrend. Bring the cursor to point A in the chart, click, drag cursor to point B, click and then again drag cursor to point C and click again. You’ll immediately see a series of horizontal lines starting at 0% i.e. the start point. These are the extension levels at which you can book profits on the short trade which you hopefully entered at C. Isn’t it nice to have your road map all laid out for you?

 

Drawing Extension Levels by Duplicating Retracement Levels

 

In case you do not see any tool named Fibonacci extension then also relax. Your Fibonacci retracement indicator must be having at least a couple of extension levels built in. In many cases those will be 161.8% and 261.8% levels. However in slower trends even shallower extension levels like 138.2% and 150% and are also important. Do not worry! Fibonacci extension levels are nothing but mirror images of retracement levels. You may just draw your retracement levels for the main trend then right click to see the options. Select "Duplicate", bring the starting point to the end point of the trend and click. The duplicated lines are the mirror images of the retracement levels and represent 138.2%, 150%, 161.88% and 176.4% extension levels. The following two charts explain how you can draw the extension levels if your trading platform does not offer this functionality:

 

Step 1 for duplicating fib retracement to create fibonacci extensions. 

 

Step 2 for duplicating fib retracement to create Fibonacci extensions.

 

In an uptrend – cashing chips on a long trade

 

Select the option to insert Fibonacci Extension. Then bring the cursor to point P in the chart, click, drag cursor to point Q, click and then again drag cursor to point R and click again. You’ll immediately see a series of horizontal lines starting at 0% and ending at  100%. These are the extension levels at which you can book profits on the long trade which you may have entered around R. In case your platform does not offer Fibonacci extension tool, you may use the workaround of duplicating the retracement levels to get the desired extension levels, as explained above. 

 

But…….

 

The Fib extension levels do work, and offer excellent guideposts to where you might want to take some or all the money off the table and thereby reduce your risk. Remember, however, that these lines are not cast in stone! Price may just vroom! through these levels or it may  find resistance just ahead of one of these. Use these extension levels as guide lines for the target zones and not exact target levels for profit taking.

 

Again, traders may differ in identification of the swing high and swing low points from which the extension levels are drawn, so there is some subjectivity involved here. But the best way around these problems is to practice….practice! Gradually you will get a feel for the trend and the overall technical picture, and then you will be a true Fib artist!

 

Which Extension Levels to Target?

 

Well, the clue comes from one the following:

 

  1. The strength of the trend prior to the retracement.
  2.  

  3. The extent of the retracement.
  4.  

  5. How long the trend before the retracement is going on?
  6.  

 

If the trend strength was strong and the retracement was not a big one, say limited to 50% then the possibilities to achieve higher extensions are high. In case the trend strength was weak and price-action had gone for greater retracements say 61.8% or 76.4% then you should expect the extension levels to be limited to shallow levels, say 138.2% or 150%.

 

However, if a strong trend has been in place for a very long time then the retracement may be greater and in such case extensions would also be expected to him bigger.

 

    

 

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