Fibonacci Extension Tool

The Fibonacci Extension Tool is one of the more versatile technical analysis tools that I use to analyze stock charts. Becoming familiar with its uses and applications is almost mandatory for consistent trading success. Why?

The Fibonacci Extension Tool can be used to calculate upside potential for a stock’s share price
The Tool can also be used to calculate the downside risk for a stock’s share price

It is crucial to be able to estimate the upside potential and downside risk before entering into a trade with a stock. Calculating a stock’s upside potential and downside risk is better known as calculating the Risk to Reward Ratio. A Fibonacci Extension Tool can help you calculate the Risk to Reward Ratio.

Placing the Fibonacci Extension Tool on a stock chart whose share price is trending upwards can help estimate the upside potential for the share price. This is the “Reward” part of the Risk to Reward ratio. Placing the Fibonacci Extension Tool on that same stock chart but on a downtrend can help estimate the “Risk” part of the Risk to Reward Ratio.

The most favorable trades have at least a Risk to Reward Ratio of 1:3 – if you can find one with a less risky ratio like 1:4, even better.

Components

Learning the components of the Fibonacci Extension Tool is important to help with its placement on a stock chart. So let’s start with the various components for the Fibonacci Extension Tool. A Fibonacci Extension Tool consists of the following components:

3 Anchor Points – Anchor Points are used to place the Fibonacci Extension Tool on a stock chart

Target Lines – Target Lines are automatically calculated and drawn after the 3 Anchor Points have been placed on the stock chart. The following Target Lines are automatically calculated and drawn:
- 23.6%
- 38.2%
- 50.0%
- 61.8% (phi)
- 78.6%
- 100%
- 161.8% (Golden Ratio)
- 261.8%
- 423.6% (not shown on the below illustration)

Target Lines are used to help estimate or project a stock’s future share price. Depending upon where a stock’s share price is in its overall Elliott Wave Pattern, expectations can be set to reach different Target Lines.

Once the Fibonacci Extension Tool is placed on a chart, the right side of the Tool will also show a dollar amount. I do not show dollar amounts on the above illustration since they would vary depending upon the individual stock chart.

If you are looking to calculate and project shorter-term price fluctuations, then a[s2If !current_user_can(access_s2member_level1)]…….

If you want to continue reading about the Fibonacci Extension Tool, including things like:

proper placement of the Fibonacci Extension Tool on both uptrends and downtrends
how to use the tool on both uptrends & downtrends to calculate price targets
tips and warnings when using the Fibonacci Extension Tool to estimate price targets

Then you must first log in.

If you are not a Trendy Stock Charts member, consider joining today! You will gain access to this great information and so much more![/s2If][s2If current_user_can(access_s2member_level1)] 5 minute, hourly or daily candlestick chart is best suited for the task.

Placing the Fibonacci Extension Tool on a weekly or monthly candlestick chart is best for calculating and projecting medium to longer-term share price movements.

The flexibility of the Fibonacci Extension Tool allows it to be used by day traders and investors alike. Let’s review how to place the tool first on an uptrend, then on a downtrend. Keep in mind this is the same theory to use on all charts, regardless of the timeframe.

Chart Placement – Uptrend

Pull up a candlestick chart for the stock that you want to analyze and find an uptrend that begins somewhere near the bottom of the chart. Select the Fibonacci Extension Tool from your trading platform’s list of charting tools.

Start by placing Anchor Point #1 at the very beginning of an uptrend on the stock chart you are analyzing. This is performed by left clicking the mouse at the price level and area you want the Anchor Point placed
Place Anchor Point #2 at the end of the uptrend from Anchor Point #1 (left mouse click)
The last Anchor Point, Anchor Point #3, is placed at the end of the pullback from the uptrend between Anchor Points #1 and #2

Proper Placement of a Fibonacci Extension Tool on Apple’s Candlestick Stock Chart

After all 3 Anchor Points have been placed on the stock chart, the Target Lines are then automatically calculated and projected on the chart.

It is extremely important that Anchor Point #3 never is lower than Anchor Point #1 when placing the Fibonacci Extension Tool on an uptrend – if it is, the Fibonacci Extension Tool is not properly placed on the chart.

I use the 100%, 161.8% and 261.8% Target Lines when I am projecting higher share prices for a stock. I typically use the 161.8% Target Line since statistically most Wave 3’s are longer than Wave 1’s. But then I also like to be conservative and only use the 161.8% Target Line and not the 261.8% Target Line during my initial calculations.

As a stock’s share price approaches the 161.8% Target Line, its chart can be re-analyzed and new price objectives, like the 261.8% Target Line, can be set if other indicators seem to be confirming the higher move for the stock’s share price.

Chart Placement – Downtrend

Pull up a candlestick chart for the stock that you want to analyze and find a downtrend on its chart. Select the Fibonacci Extension Tool from your trading platform’s list of charting tools.

Start by placing Anchor Point #1 at the very beginning of a downtrend on the stock chart you are analyzing. This is performed by left clicking the mouse at the price level and area you want the Anchor Point placed
Place Anchor Point #2 at the end of the downtrend from Anchor Point #1 (left mouse click)
The last Anchor Point, Anchor Point #3, is placed at the end of the pullback from the downtrend between Anchor Points #1 and #2

After all 3 Anchor Points have been placed, the Target Lines are then automatically projected on the stock chart. I typically use the 61.8%, 100% and the 161.8% Target Lines when I am projecting lower share prices for a stock.

It is extremely important that Anchor Point #3 is never higher than Anchor Point #1 when placing the Fibonacci Extension Tool on a downtrend; if it is, the Fibonacci Extension Tool is not properly placed on the chart.

Tips & Warnings

Learn The Complete 8 Wave Pattern

Before Attempting to use the Fibonacci Extension Tool, I strongly recommend that you have at least a general understanding of Elliott’s Complete 8 Wave Pattern.

Having a basic understanding of the ebbs and flows that a stock’s share price goes through during the development of a Complete 8 Wave Pattern can help increase your accuracy when placing the Fibonacci Extension Tool on a stock chart.

So exactly how does the Fibonacci Extension Tool intertwine with Elliott Wave Patterns? Well, let’s start with the distance between Anchor Point #1 and Anchor Point #2 of the Fibonacci Extension Tool.

The distance between Anchor Point #1 and #2 of a Fibonacci Extension Tool measures the length of a potential Wave 1 in an Impulse Wave Pattern
The distance between Anchor Points #2 and Anchor Point #3 measures the length of Wave 2 in the Impulse Wave Pattern; Wave 2 is a Corrective Wave Pattern of some sort
The Fibonacci Extension Tool then projects possible end points (Target Lines) for the ends of Wave 3 and/or Wave 5 in the Impulse Wave Pattern

It is imperative to watch for other reversal indicators at projected wave end points.

Remove Some Target Lines

Unless you are a day trader, consider removing the 23.6% and the 78.6% Target Lines from the Fibonacci Extension Tool’s template.

Eliminating these 2 Target Lines helps me focus on the Tool’s main Target Lines (in my opinion) rather than getting caught up with every little Target Line and Resistance Area. Also, I have read a lot about phi (61.8%) and phi’s inverse (38.2%) in my Fibonacci books, but not as much about the other percentages of 23.6% and 78.6%, so I remove them from my Fibonacci Extension Tool’s template.

Start With A Conservative Approach

Being too aggressive with the Fibonacci Extension Tool can lead to losses quickly. Therefore, look for an uptrend that begins with the lowest share price you find on the stock’s chart. Use that uptrend as the starting point for placing Anchor Point #1. It is better to start too low on a stock’s chart than too high with this Charting Tool.

My Favorite Target Lines

The Target Lines that I find most useful for both upwards and downwards price projections when using the Fibonacci Extension Tool are as follows:

61.8% (phi)
100%
161.8% (Golden Ratio)
261.8%

Use Multiple Fibonacci Extension Tools

After placing the first Fibonacci Extension Tool in a conservative manner, look to place the second Fibonacci Extension Tool in a slightly more aggressive manner. That means placing the Tool on an uptrend that is higher on the stock’s chart than the uptrend where the first Fibonacci Extension Tool was placed.

Special notice should be given to price areas where there are Target Lines from several different Fibonacci Extension Tools that converge all in one area.

When placing multiple charting Fibonacci Extension Tools on a stock chart, I recommend using different colors for each Tool in order to distinguish between the different Target Lines calculated from all the Tools. Using different colors becomes even more important when mixing and combining several different types of Fibonacci Charting Tools. Different colors make it easier to analyze the different Retracement Lines, Target Lines and Trendlines from all the various Charting Tools.

Improper Placement Can Be Disastrous

Improper placement of a Fibonacci Extension Tool on a stock chart can lead to estimated share price targets and expectations that will never be reached. Taking a conservative approach as I mention above can help to mitigate some of this improper placement risk.

Failures Typically Happen at the 61.8% Target Line

If the price cannot advance through the 61.8% Target Line, you may have just identified a Zig-Zag wave pattern instead of an Impulse wave pattern. Proceed trading your current trend with extreme caution.

Practice With Old Chart History

One of the best methods that I used to when learning how to use the various Trading Tools was to practice with old chart history. Placing the Fibonacci Extension Tool on dozens and dozens of older charts and then seeing how a stock’s share price interacted with the Tool’s Target Lines has provided me with tremendous insight. If you practice on a few charts, I bet you might just agree!

Real Chart Examples

So now that you have an understanding of the components of the Fibonacci Extension Tool, let’s use the Tool on an actual stock chart. I selected one of my favorite stock charts for this purpose – Facebook. It is the same chart I used above to show the placement of the 3 Anchor Points on a chart – it is a 5 year monthly candlestick chart.

Facebook (FB) Fibonacci Extension Tool Example

Observe the Placement of the 3 Anchor Points

Here are the steps I followed when placing the Anchor Points on Facebook’s chart.

The beginning of Facebook’s uptrend was $17.55, so that is where I placed Anchor Point #1
Facebook’s share price hit an intra-day high of $32.51 before it started to pullback. The intra-day high of $32.51 is where I placed Anchor Point #2
After peaking at $32.51 (where Anchor Point #2 is placed), Facebook’s share price ended up pulling all the way back to $22.67 before starting its uptrend, so that is where I placed Anchor Point #3

There are some very interesting observations that can be observed from Facebook’s chart, like how its share price and candlestick patterns relate to the “important” Target Lines of 100%, 161.8% and 261.8%. For stocks experiencing explosive growth, as Facebook was, the 423.6% Target Line even comes into play. Facebook’s chart illustrates the predictive power of the Fibonacci Extension Tool when placed properly on a chart.

So let’s pretend to be reading Facebook’s action in real-time, starting with the beginning of its uptrend after just placing the Fibonacci Extension Tool on the chart. By breaking through the 100% target line on strong buying volume, that is usually an indicator that the stock’s share price is going to reach for the 161.8% or 261.8% Target Lines, which was the case for Facebook.

From an Elliott Wave perspective, when a stock’s share price makes a strong push through the 100% Target Line, it usually indicates that Wave 3 will be longer than Wave 1. Wave 3’s are typically either equal to the length of Wave 1 or 161.8%-261.8% times the length of Wave 1. That knowledge can be very useful when trying to determine share price levels to lock in some trading gains at.

[/s2If]