Fibonacci price extensions are techniques and tools that traders use to set profitability targets. They are also used to calculate the extent that prices will move after a retracement movement. Typically, these extensions will be placed in a chart and show areas of significance and the actions tied to those levels being reached.
Understanding Fibonacci Price Extensions
Fibonacci price extension levels are 61.8 % and stretch up to 261.8%. There is no formula for calculating Fibonacci price extensions. Traders instead choose three points and any movement is mapped as a percentage relative to those points. Fibonacci retracement levels are calculated by taking the vertical distance between the highest and lowest price point and dividing it by the Fibonacci ratios.
The Fibonacci ratios themselves are derived from the golden ratio of mathematics. The golden ratio, in turn, is derived from the Fibonacci sequence, a famous mathematical sequence where numbers are derived from the sum total of the two preceding numbers. The Fibonacci sequence occurs in numerous random processes in the natural world. It is thought to have an impact on stock price movements as they are also based on the mass psychology of stock traders.
Interpreting Fibonacci Price Extensions
Fibonacci extensions help traders understand and therefore make predictions about how a stock price will move. For example, if a trader observes the stock price moving past a given extension level, it is a reasonable prediction that the price will reach the next extension level. It might also reverse and retrace back. The trader can then make a decision to cover either one or both of these areas. The convergence of Fibonacci extensions around a price level might tell a trader that there is something significant about that price level.
How Extensions Differ from Retracements
Extensions generally show the direction that the price will go after a retracement. Retracements on the other hand measure how far the retracement will go. When you are assessing if you should keep or sell a stock, one must use Fibonacci price extensions in conjunction with other methods. This way, you eliminate any bias that any one method can give. When working with price extensions, there are a number of tools that are used to help traders predict stock price movements and the time frame when these movements might occur.
Fibonacci Channel
When using Fibonacci price extensions, a closely related tool is the Fibonacci channel where support and resistance lines travel diagonally rather than horizontally. The channel is also part of a trader’s arsenal when making trading decisions.
Fibonacci Arc
Fibonacci Arcs are used to obtain support and resistance levels on price and time. They are typically drawn as semicircles that connect a high and low-price level.
Fibonacci Time Zones
These are time-based indicators that give a trader an idea of when a reversal could occur. These tools are useful in helping a trader calculate how long to hold a stock and when to let it go.
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