Fibonacci retracement levels are horizontal lines on a trading chart that indicate where possible future price support levels and price resistance levels are likely to occur. Fibonacci retracement levels exist only between past low and past high price level zone. But, can we draw Fibonacci levels above the previous high and below the previous low?
Fibonacci Expansion Levels
Fibonacci Expansion Levels are technical analysis lines, calculated as the percentage between high and low price, which can be drawn above the highest high or below lowest low price level. The most common Fibonacci Expansion levels are 161.8%, 200%, and 261.8%. Fibonacci projection levels are the second name for Fibonacci expansion levels because price levels go beyond 100% level.
Fibonacci Expansion Levels or Fibonacci Extension levels follow the same logic as Fibonacci retracements. Metatrader platform has fib extension and fib retracement (standard) indicator, and it draws automatic lines on the chart after the user picks high and low levels.
The most common levels used for Fibonacci retracements are 23.6%, 38.2%, 61.8%.
Fibonacci extension levels facts:
- Fibonacci ratios are derived from the Fibonacci sequence and are seen universally in varied natural elements.
- Fibonacci extension levels show the extension of a trend move.
- Fibonacci extension levels are 161.8%, 200%, and 261.8%, etc.
- Fibonacci extension levels show how far the next price above 100% wave could move.
- Extension levels are just important hypothetical levels, and there is no guarantee that price will react to them.
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The indicator will automatically draw only levels that can be seen on the chart. If the price level is too far, it will not be visible. In the chart below, we see only 161.8% expansion Fib. level and 261.8% and 423.6% are not visible because they are too far.
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Main Facts about Fibonacci Expansion (Extension) levels and Fibonacci retracements
When it comes to technical analysis, the term that refers to any area of resistance of support is known as a Fibonacci retracement. It will also use a horizontal line to point where there might be resistance or support, and each of those levels will be labeled using percentages. That percentage amount is a pricing amount that has moved and been retraced. The levels that happen within Fibonacci retracements are 78.6%, 61.8%, 38.2%, 23.6%, while even though it may not be official, 50% can be used.
Fibonacci extension levels
The Fibonacci extensions show how far the next price wave could move above 100%. Common Fibonacci extension levels are 161.8%, 200%, 261.8% and 423.6%.
This is considered to be useful due to it being able to show highs and lows between different price points, and this creates the known level between the selected points.
For instance, if the price started at $10, and it suddenly drops to $3.82, it has done a retrace, and this percentage is a retraced 38.2%, which is a number of the Fibonacci retracement. These particular sets of numbers can be found everywhere in nature, so it is believed that these particular numbers are relevant within the financial market.
Formula Used to Find the Fibonacci Expansion (Extension) and Retracement Levels
An indicator will not have a formula, so whenever a trader applies an indicator to charts and two points are picked, the lines drawn will show the moving percentage once selected.
For instance, if there is a price that goes from $15 to $20, and the two prices have been selected to find the indicator, multiply the amount difference between the two prices by the Fibonacci Retracement percentages to find the levels. Therefore, you would take $20 – ($5 X 0.5) = $17.50 and so on.
If a trader wanted to calculate the levels, you would follow the formula listed above and use the percentage of a particular price range that has been selected.
However, many ask where these particular sets of numbers originate from. They are all based on what is known as the Golden Ratio.
If a person was to create a specific number sequence that began with the number zero, then added one, and eventually just continuously adding the first two numbers, this string of numbers would continue indefinitely. For instance, it would look something like this:
0+1 = 1, 1+1=2, 1+2 = 3, 3+2 = 5, 5+3=8, 8+5 =13, 13+8=21, 21+13 = 34, 34+21=55, 55+34=89, and it would continue on just like this. The sums would make up the entire string of numbers and would go on indefinitely.
All of the levels are going to come from this string of numbers. However, this excludes the first very few numbers, so when the string is going, if the number is divided by the number that comes next, you will end up with the level numbers. However, taking time to explore these options carefully, a person would notice that all of these percentages, except for 50%, will be considered a true Fibonacci number as 50% is not seen to be an official percentage. All of these percentages will be based on math calculations based on this particular number string.
Another interesting thing about the Golden Ratio is that 1.618 or 0.618 can be located within galaxy formations, historical architecture, artifacts, shells, and even sunflowers.
What Do the Levels Say?
The Fibonacci retracements can be used to determine the levels of stop-loss, help set target prices, and place entry orders. If a trader notices that a stock is moving up and after it moves, it ends up with a 61.8% retrace, and then it begins to bounce once again. Because the bounce was considered to be at a level on the Fibonacci scale, and if the trend stays for a long time, then a trader may decide to buy. This means that a trader could create a stop loss within the 78.6% level or 100% where it originally started.
These levels can also be utilized in various types of technical analysis. For instance, they are seen in the Elliott Wave theory and Gartley patterns. After a price has moved down or up significantly when a price starts to retrace its path, it always seems to do; these analyses will find the retrace and notice that it reverses to certain levels.
These levels are often at a static price that will not often change, unlike a moving average. To easily and quickly identify price levels, a static nature will be needed. This allows investors and traders to react and anticipate when a level may be tested. The levels will often be an inflection point, which may indicate where a price action could be expected, whether it be a break or a rejection.
How to use the Fibonacci extension on MT4?
To use the Fibonacci extension on MT4 you need to choose Insert/Fibonacci/Expansion tool and then select the highest high and lowest low price level on the chart. At that moment, Fib levels will be added to the chart (see image below):
If you pick Fib, levels retracements, or Expansion levels, you will get in both cases expansion levels. The expansion levels tool will give you only the 2 most common levels for your target.
How to trade with Fibonacci retracements and extensions?
After we draw Fib levels on the chart (retracements and extensions), we need to define the entry and exit strategy. Fib. Levels we can use as exit and entry levels. Example :
So your strategy can be for SELL TRADE :
Step 1: Pick low and high on the chart.
Step 2: If you see that the hourly close price is below 61.8% Fibonacci retracement, then make a SELL trade.
Step 3: Put stop loss on High Price.
Step 4: Set your target to be either 161.8% expansion level or 200% expansion level, or 268.1% expansion level.
You can cut a small number of lots on each target and move stop loss whatever you like.
Differences Between Expansions (Extensions) and Retracements levels
The Fibonacci extensions are the percentages that go back to a trending direction, while the retracements are the percentages that pullback. For instance, if you have a stock that increases from $5 all the way up to $10, but then it goes back down to $6.75, then it is considered to be a retracement, but if that price happens to increase up to $16, then it is called an extension.
Even though retracement levels can show where a price may potentially find resistance or support, there are not any assurances that this particular price will stop at that point. This can be seen as a reason why a trader should look for other signals that may be utilized, such as prices bouncing off a particular level.
Another argument against a retracement level is that, due to several levels, the price could reverse near one of these levels, which can happen a lot more often than it would not. The overall problem is that a trader could struggle to locate which one would be useful during any retracement that may be happening and analyzed.
The Key Takeaways
An indicator connects two points that a trader will view as relevant, often a low and high point. Once an indicator has been selected and drawn on the chart, these levels will be considered fixed and will not change. The percentages that are provided will be locations where pricing may reverse or stall. A trader should not solely rely on the levels. For instance, it is detrimental to assume that a price will reverse after hitting a particular Fibonacci level. It could, but then it may not.
A Fibonacci retracement level can be used to show areas of interest that may show potential. If traders are looking to buy, they will watch to see if the price stalls at a Fibonacci level and wait for it to bounce off that particular level before deciding to buy at all.
The ratios that are the most commonly used will include 78.6%, 61.8%, 38.2%, 23.6%, while 50% is seen to be an unofficial retracement level. These percentages will show how much of a previous move was made, whether retracted or corrected.