the Fibonacci extension is considered an effective market analysis tool. If you are a newbie who is not familiar with this indicator, let’s join Forex Trading to explore the definition and use of the Fibonacci extension to make optimal profits in the Forex market.
Overview of the Fibonacci indicator
The first thing that newbies need to learn is what the Fibonacci number sequence is and what is the Fibonacci extension.
What is the Fibonacci sequence?
The Fibonacci sequence is a sequence of numbers starting = 0;1 or 1;1. The following numbers are determined by the sum of the two preceding numbers. So the formula of the Fibonacci sequence is as follows:
F(n) = F(n-1) + F(n-2)
In which, F(n) is the nth number in the Fibonacci number sequence. Here is an example of the Fibonacci number sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144,…
In the above sequence of numbers, the first number is 0, the second number is 1. Subsequent numbers are calculated by adding the two numbers before them. For example: 1 + 1 = 2, 1 + 2 = 3, 2 + 3 = 5, and so on.
The Fibonacci sequence has many applications in mathematics and other fields, such as technical analysis in stock trading, lotus flower patterns in nature, and many problems involving ratios and proportional patterns.
See more: Profession forex trade thanks to Fibonacci applying
What is the Fibonacci extension?
Fibonacci Extension is a development of Fibonacci. The main function of the Fibo extension is to calculate the optimal time to take profit in each trade. Using the Fibonacci Extensions effectively helps investors maximize the profits of their trading plans accurately and easily.
When the price approaches the Fibonacci Extension levels it is a signal to close the trade and take profits. This helps investors make trading decisions based on a more accurate way of capturing profits.
In addition to the Fibo extension, you can learn more about Fibonacci retracement to help investors find reasonable entry points in trading.
Pros and cons of Fibonacci extensions
Join Forex Trading to learn the pros and cons of the Fibonacci Extension indicator.
Advantage
- Determine potential price levels and set profit targets in trading. This helps investors set profit goals and clearly define profit-taking points in transactions.
- Predict the next trend and support trading decisions. It provides a hint about the next direction of price movement when a correction is completed.
- Provides specific price levels that the price continues to move towards. From there, there is an accurate framework for making trading decisions and managing risks
- Use in combination with other tools and indicators in technical analysis. This helps provide comprehensive insight and support trading decisions.
Defect
- Fibo extension is a historical-based indicator, so 100% accuracy cannot be guaranteed.
- Fibonacci Extension is very useful in market analysis but is not the only deciding factor
- Applying the Fibonacci requires a certain understanding and experience with the market.
- There may be some cases where the price does not react as expected at extended Fibo levels. There is no guarantee that the market price will follow a fixed direction. There are still cases where the price can move through many Fibonacci levels.
- Fibonacci Extension is a prediction tool, the trading decision is up to the investor
Potential Fibonacci Extensions Levels in Forex
Fibonacci Extension levels are applied to determine the potential price levels that a market wave can reach after forming a significant top or bottom.
The default levels of the extended Fibo indicator include the levels: 0, 0.236, 0.382, 0.5, 0.618, 0.764, 1, 1.236, 1.618, 2.618, 3.618, and 4.618. These levels correspond to a percentage of the original wavelength according to the Fibonacci sequence. As the market moves and continues to trend, Fibonacci Extension levels provide potential price targets for investors.
Potential take-profit levels are usually between 0.618 and 1.618. These are the price levels that a market wave can continue and reach before a reversal occurs. Levels below 0.618 typically indicate low profits and are not attractive for profit-taking, while levels above 1.618 are typically high and difficult to reach, possibly requiring long periods and volatility for the market to reach. Okay.
However, it should be noted that the Fibonacci Extension is just an analysis tool. It does not guarantee 100% accuracy in price prediction. To make smart trading decisions, investors need to combine the Fibonacci indicator with other analyses. Traders can combine it with Japanese candlestick patterns and other technical indicators to have a more comprehensive view of the market. The investor then makes a decision based on many different factors.
How to use the Fibonacci extension to effectively take profits
Using Fibonacci extensions helps investors effectively take profits by taking advantage of potential price levels determined based on the Fibonacci number series. Below are 3 ways to use the Fibonacci Extension that investors need to know
How to use Fibonacci Extension in combination with support/resistance zones
One of the effective ways to use it is to combine it with support/resistance zones. As the price moves to the Fibo extension levels, traders can observe whether the price reacts at these levels. If the price reacts at the Fibonacci levels, it could be a good trading opportunity.
Prices often react to these important price zones, meeting support areas will turn up, and meeting resistance areas will turn down. Fibonacci Extension levels located near important price zones will be more effective profit-taking levels.
For example GBP/USD on the H4 frame
After drawing the Fibo extension, observe important price zones in the past. There are 2 Fibonacci Extension levels located in these 2 zones – level 0.764 at the bottom of the downtrend, and level 1.236 at the previous bottom (strong support zone).
If you make a profit at 0.764, your profit will be lower than at 1.236. But it is not certain that the price will reach 1,236 before turning around.
If there are many important price zones with strong resistance, you can take partial profits. For example, half at 0.764, half at 1.236. This strategy will bring more optimal profits.
How to use the Fibonacci Extension to combine Japanese candlestick patterns
If you understand how to find effective entry points with Fibonacci retracement, then using the Extension Fibonacci will not be difficult.
Fibonacci Extension combined with Japanese candlestick patterns helps find reversal points of the main trend. If a reversal candlestick pattern appears at a potential Fibonacci level, the price will likely reverse and end the main trend. This helps determine optimal profit-taking prices.
For example, when the price rises to the Fibonacci 0.764 level and forms the Tweezer Top candlestick pattern, this may be a reversal signal. At this time, it is best to close the buying position to take profits. As a result, prices have turned around.
How to use the Fibo extension in combination with the price channel model
Price channels are two parallel lines, of which one line is the trendline of an up or downtrend. The remaining line is parallel and passes through the first peak/trough of the trend.
In the rising price channel, the price often fluctuates between two trendlines. The upper trendline is the resistance level, the lower trendline is the support level. You can buy at the lower trendline and sell at the upper trendline.
When combining the Fibonacci Extension with the price channel, the Fibonacci level located in the resistance or support zone will be a more effective profit-taking point.
For example: In an uptrend, the Fibonacci Extension level of 1.618 is in the resistance area of the price channel. You should be able to take profits here.
So the result is that you have reached your profit target at 1,618. Although the price then continued to rise to 2,618, there is no need to be too greedy.
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Instructions on how to draw Fibonacci Extension
There are 2 ways to draw a Fibo extension: following the uptrend and following the downtrend.
How to draw Fibonacci extension in an uptrend
To draw the Fibonacci Extension, first drag the cursor from the lowest point (1) to the highest point (2). Next, double-click on the line connecting 2 points (1) with (2). Next, you drag the number (3) to the position of the reversal point.
Fibo extension levels in an uptrend include 0.0, 0.236, 0.382, 0.5, 0.618, 0.764, 1.0, 1.236, 1.618, 2.618. In particular, the levels from 0.618 to 1.618 are the most potential profit-taking levels.
Levels below 0.618 are usually not ideal entry points because of the low profit-taking rate. Levels above 1,618 are difficult to achieve unless this is a long-term up-and-down market wave.
How to draw Fibonacci Extension in a downtrend
First, drag the cursor from the score (A) to the lowest point (B) on the chart. Then, double-click the line connecting (A) and (B), and drag the score (C) to the reversed position.
Similar to the uptrend, the Fibonacci in the downtrend also provides the ratios 0.0 – 0.236 – 0.382 – 0.5 – 0.618 – 0.764 – 1.0 – 1.236 – 1.618 – 2.618 from top to bottom. Effective take profit levels are between 0.618 and 1.618.
Note that drawing the Fibonacci is not only based on one price segment but can be used on many different time frames to have a more comprehensive view of the market.
summary
In short, the Fibonacci extension is a powerful technical analysis tool. This helps traders make more effective trading decisions. Combining the Fibonacci with other indicators and models will create a more comprehensive and reliable trading strategy. Follow Forex Trading to add useful knowledge about investing and trading in the Forex market.
FAQs:
How is the Fibonacci Extension used in technical analysis?
Fibonacci Extension helps identify potential price levels for profit-taking during an up/down trend.
What are the most important Fibo extension levels?
The Fibonacci Extension levels from 0.618 to 1.618 are often considered the most potential profit-taking levels.
How is Fibonacci Extension different from Fibonacci Retracement?
Fibonacci retracement identifies support/resistance levels during corrections. Fibonacci Extension identifies price targets for the main trend.
