The Fibonacci extension tool is used mainly for finding possible profit targets. These levels are based on the Fibonacci ratios and the two main extension levels are the 1.272 and the 1.618. Generally, when the price reaches those targets it pullbacks following the classic ebb and flow of the market. The corresponding technical tool is called “fibonacci expansion” on the popular MetaTrader platform or “trend-based fib extension” on Tradingview.
This tool is better used in clear uptrends or downtrends and not in a ranging market. To use it, you just need to find an impulse leg that will be taken as the base for the extension and then click on the swing points of the leg to project the levels. So, in an uptrend you click on the swing low, then drag to the swing high and finally back to the swing low. In a downtrend you click on the swing high, then drag to the swing low and finally back to the swing high.
Needless to say that Fibonacci extensions are not fool proof as any other technical tool but they can be used as a guide for profit targets, maybe for some position squaring while you hold a position for longer for fundamental reasons. You shouldn’t exit a trade unless the fundamental reasons change or you lose conviction in a trade, but for a short-term trader the price pullbacks can be annoying as you may get stopped out and lose the gains that you may have got if you closed a trade earlier. At the end of the day, you are responsible for your own decisions and trading style.
This article was written by Giuseppe Dellamotta.