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Part VII. Fibonacci Extensions

Fibonacci Extensions - Forex School

Commander in Pips:
 Greetings. In all previous parts of the current chapter we’ve talked about Fibonacci retracement – levels that could hold the market during retracement in the opposite direction to the initial swing. As you know, we use these levels for opening positions in the direction of the initial thrust with the hope that the market will continue this move after retracement. Today we will talk about how to estimate the target of this possible move after retracement.

Pipruit: Good morning, Sir. Let’s assume that we have an initial thrust up, then retracement where we’ve opened Long position from some Fib level and market continues its move up, as we’ve expected. And now we have to estimate the possible target of this continuation move up, right?​

The target could be estimated with applying Fibonacci Extensions or Expansion - Forex School
Commander in Pips: Yes, that’s correct. The target could be estimated with applying Fibonacci Extensions or Expansion – sometimes this tool is called like that. These are, in fact, the same.

Pipruit: And why do we need that?​

Commander in Pips: We may use this tool to estimate the area where the market could show some pause in a move, retracement or even a reversal. So, if we have position open already – this tool can show us level where we can take our profit or place a “Take profit” order. Also this tool has some advanced application – using extensions for estimation support and resistance levels and in combination with Fib retracement tool.

Pipruit: Cool! So, in a simple approach (without your brain cracking advanced parts) we use Fib retracement for entering and Fib extensions for exiting, right?​

Commander in Pips: In a simple approach – yes. Ok let’s start with that and use a 4-hour chart of EUR/USD. Suppose you see this picture – thrust up is developing currently, you see that looks like market takes a pause and possibly will show some retracement down. So you intend to join this thrust up and enter Long from one of retracement level. So, how do you intend to do that:

Chart#1 EUR/USD 4-hour chart
So you intend to join this thrust up and enter Long from one of retracement level - Forex School
Pipruit: Well, we need to draw Fib retracement levels. Also I see the trend line, I think that I will use it in combination with Fib support level, just to get more confidence.​

Commander in Pips: This sounds logical. Let’s see, where you’ve entered:

Chart#2 EUR/USD 4-hour chart 
You have had a nice entry – in combination of 0.618 Fib support and trend line - Forex School
You have had a nice entry – in combination of 0.618 Fib support and trend line. But major question now is where to fix profit?

Pipruit: And where?​

Commander in Pips: Now let’s remember the ratios for Fib extensions – we’ve studied them in the first part of current chapter.

Pipruit: Ok, just one second, Sir, I remember – 0.618; 1.0; 1.272; 1.618; 2.0; 2.618.​

Commander in Pips: Brilliant. Now let’s see how we could apply them here. The major idea here is as follows:

- During an uptrend we should enter Long from retracement level and take profits at Fibonacci Price extension levels;

- During downtrend we should enter Short from a retracement level and take profits at Fibonacci Price extension levels.


To estimate and draw these extension levels you should accomplish three-click procedure:

In uptrend:

1. Click on significant swing low. For example, this could be any X point, according to our terminology;

2. Drag your mouse to significant swing high. It could be an “A” point, for instance, - most recent swing high, but this is not absolutely necessary;

3. Then drag your mouse to the most recent low, from which recent up move has reestablished – this will be the low of the market that usually stands around deepest retracement level that has held market during retracement.

(NOTE: In MT4, you must first select Insert, Fibonacci, Expansion.)

Look at this chart:

Chart#3 EUR/USD 4-hour chart 
“B” point is a low from which up move reestablishes – it stands around deepest retracement level - Forex School
See – I use as swing low our initial low, that is also is “X” point, the swing high – our “A” point for swing estimation, as we’ve discussed in advanced comments. “B” point is a low from which up move reestablishes – it stands around deepest retracement level that has held market during retracement. AS you remember this is around 0.618. All markings are according to rules. Bingo – software shows us extension levels – 0.618 at 1.3687, 1.0 at 1.3796, on later chart you’ll see 1.618 also.

Pipruit: And why are all extension levels except 0.618 above the market during uptrend (and I suppose they will be below the market during down trend)?​

Commander in Pips: To better understand it, let’s look at formula for their calculation:

Extension = (A-X)*ratio + B

For instance, if we want to calculate 0.618 extension, then it turns to (A-X)*0.618+B. So, estimate for me 0.618 and 1.0 extensions from our chart #3.

Pipruit: Ok, let’s see. X=1.3411, A=1.3697 and B=1.3510. So –

Extension “0.618” = (1.3697-1.3411)*0.618 + 1.3510 = 1.3687, and

Extension “1.0” = (1.3697-1.3411)*1.0 + 1.3510 = 1.3796… Cool.

Wow! I think I’ve got it! Extensions stand above the market because we start to count extension not from “X” point, but from “B” that is higher. So, we calculate the length of the whole swing by (X-A), then apply the extension ratio – 0.618, 1.0 or whatever and then count it higher from “B” point.​

Commander in Pips: You’re absolutely right. “1.0” and other above 1.0 Extensions will be always above the “A” point of initial swing, but 0.618 could be as higher then A as lower. Can you tell me why?

Pipruit: Hm, the only answer that I have is a depth of retracement. If retracement was deeper than 0.618, then 0.618 Extension will be below A, if rather it was upper than 0.618 or equal to it – then 0.618 extension will be higher or equal A point.

Commander in Pips: Very good. You’re absolutely right. Just to simpler understand the nature of expansion, treat it like follows. Imagine that you jump on trampoline. First, you just stand on it and then make the first jump up – this is initial thrust up, i.e. “X-A” swing. Then you move down under gravity and tramp is forcing and stretching under your weight – this is “A-B” move. Then the trampoline straightens out and moves you up again – this is extension. Extension could be different, depending on how strong your initial jump up was. So, let’s take a look at next chart – here you will see 1.618 target level:

Chart#4 EUR/USD 4-hour chart
The trampoline straightens out and moves you up again – this is extension - Forex School
Pipruit: Wow, I see. By the way, Commander – here we see that 0.618 expansion target (marked with blue dash line) is below A. So, “A-B” retracement was a bit lower than 0.618 Fib support, wasn’t it?​

Commander in Pips: Yes, take a look at chart #2 – the low at point B is a bit deeper than 0.618 Fib support.

Pipruit: Commander, it’s amazing, how market reacts on reaching these targets! When it has hit 1.0 extension – it has shown retracement. Market has hit 1.618 and then has formed an Evening star and reversed down – unbelievable!​

Commander in Pips: Yes, extension is a really powerful tool. Here you can see, by the way, that extension also could be used together with other tools – here we use candlesticks with an extension, but trend lines and support/resistance lines could be used as well.

Pipruit: Now I see why any of these targets is very important and could be treated as profit taking point. I’m shocked!​

Commander in Pips: Ok, now, let’s take a look at a down thrust. But here I want you to mark Fib retracement and expansions.

In a downtrend:

During a downtrend we should enter Short from Fibonacci resistance level and take profits at Fibonacci Price extension levels. To estimate and draw these extension levels you should accomplish three-click procedure:

1. Click on significant swing high. For example, this could be any X point, according to our terminology;

2. Drag your mouse to significant swing low. It could be an “A” point, for instance, - most recent swing low, but this is not absolutely necessary;

3. Then drag your mouse to the most recent high, from which the recent down move has reestablished – this will be the high of the market that usually stands around highest retracement level that has held market during retracement.

Pipruit: Ok, I’ll try.​

Commander in Pips: Here is your chart – let’s assume, that you’ve seen this evening star and followed the swing down. So you intend to enter short:

Chart#5 EUR/USD 4-hour chart 
You’ve seen this evening star and followed the swing down. So you intend to enter short - Forex School
Pipruit: Ok, here are the Fib retracement levels:​

Chart#6 EUR/USD 4-hour chart 
Fib retracement levels - Forex School
Pipruit: And when I am sure that we’ve got our “B” point – the highest point of retracement up - we draw expansions:​

Chart#7 EUR/USD 4-hour chart 
The market has turned up precisely at the 1.0 extension level - Forex School
Pipruit: Commander, I’m stunned again – the market has turned up precisely at the 1.0 extension level.​

Commander in Pips: You did all things correctly. But here some important notifications to Fibonacci extensions:

1. You never can say definitely where the market will show a major reversal - at 0.618, 1.0 or 2.186 level. All that you can say, that there is a solid probability that any of these extension levels will act as support or resistance (depending on direction), at least temporally.

2. Still there are some methods that exist which allow us make some assumption about how far the market could move – 0.618, 1.0 or even 2.618. It depends on trend strength. We will talk about it in later chapters;

3. There is some uncertainty existing about which points to use as “X”, “A” and “B”. But after some time when you will get more experience you will better understand how to recognize the most important of them;

4. Still… 

- The extension from major low of the swing (X point) always significant;

- The extension from strong thrust move is more significant than an extension from a slower move;

- It is preferable (but not absolutely necessary), that B point should be at least at the 0.382 retracement levels. Other words, AB retracement move should be easily viewed.

- The most recent expansion very often becomes important.

- “B” point should be always inside XA swing and after the “A” point in time, when you are dealing with expansions for profit taking.

Some more information we will uncover in the advanced part that is dedicated to Fib expansions.

Comments

robinlbird
7 years ago,
Registered user
Not sure I understand the reason to show more than one fib level on one chart, you can't tell which numbers refer to which drawing. For instance if I draw X-A and then A-B you can't tell which fib levels apply to the XA and which ones are for the AB. How do I know what I am looking for? The XA levels or the AB Levels....seems like we are just throwing lines out everywhere. Can't figure out what I need to focus on to make a trade.....?
Sive Morten
7 years ago,
Registered user
> Not sure I understand the reason to show more than one fib level on one chart, you can't tell which numbers refer to which drawing. For instance if I draw X-A and then A-B you can't tell which fib le..

Hi Robinlbird,
direction of XA swing and AB are opposite, so you can't apply the same levels to both of them.
mrVynes
7 years ago,
Registered user
This is awesome.
WaveRider
7 years ago,
Registered user
Hello Sive,
In Pesavento's "Trade What You See", he advises you enter at the D point, opposite the trend, figuring the pattern was complete and the market due for a major turn. He does the same for the "222" pattern, enter opposite the trend because the end of the pattern is a reversal signal (pg65). You seem to try to get into the pattern at C and TP at D. Why the discrepancy? I think Dinappoli does it the way you describe. Is there any merit to the counter trend entry?
Sive Morten
7 years ago,
Registered user
> Hello Sive,
In Pesavento's "Trade What You See", he advises you enter at the D point, opposite the trend, figuring the pattern was complete and the market due for a major turn. He does the same for t..

Hi Wave Rider,
this calls as "Different contexts and trading systems".
Pessavento context for trading is harmonic patterns, while DiNapoli trades trend and use extensions to find entry points and targets in advance. But the context is trend. Pessavento could take profit at point, where DiNapoli will enter in opposite direction. This is just different systems, but they do not exclude each other. For example, Butterfly could appear at top of some AB=CD pattern. Personally I use them both.
Hamza Samiullah
2 years ago,
Registered user
Good work...

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