- When do you earn money?
- Why are the Fibonacci projections so important?
- Tool 1: The Fibonacci expansion
- How to draw the expansion levels?
- Tool2: the Fibonacci extension
- The Fibonacci extension in practice
- Which extension levels are most important?
- It is all about probability
When do you earn money?
There are two similar tools to project where the price move can end:
1. The Fibonacci Extension
2. The Fibonacci Expansion
It is confusing at the beginning, but I am going to explain the main differences so you can have a good understanding of the subject matter.
Why are the Fibonacci projections so important?
I have seen many cases when people opened the trade at the right moment, for the next few hours or even days the trade was profitable, but they hesitated to close it and ended up with a loss.
The most important thing to remember is that you earn money when you close the trade and book profit from it! If your position was opened two days ago and it is profitable then good for you. But until you close the trade and take the profit, it is virtual profit. It changes all the time. There might be some big news, the price will move against you and in a couple of minutes, you will be counting how big your loss is.
This is the reason why closing trades is so important in trading. For me, closing trades is far more important than opening them. Even a poorly executed trade can turn out to be profitable if you exit at the right moment. But when is it the right time and place to take the profit?
The Fibonacci projection is very helpful in solving this problem and I am sure you are going to enjoy it.
Tool 1: The Fibonacci expansion
Let’s start with the Fibonacci Expansion, which is based on three points. To draw it we have to identify the swing and correction. Yes, it is exactly like it was with the retracements and looking for points A, B and C. We use the same ABC points. As you remember, we have to identify the swing and correction. Points A and B are marked at the swing ends, C is at the point where the correction ended.
How to draw the expansion levels?
In Metatrader, from the top menu select Insert → Fibonacci → Expansion. Run a trend line from point A to point B.
Next, you have to click on the end of the second line and move it to point C – where the correction ends.
Now you have the possible levels where the move may end or stop for a while. The three most popular are: 61.8, 100 and 161.8. According to this example, it worked very well:
The move stopped at two points: the 100 and 161.8 expansion.
How is it calculated?
The expansion levels are drawn from point C:
• Target 61.8 is 0.618 times of the distance between Points A and B
• Target 100 is 1.000 times of the distance between Points A and B
• Target 161.8 is 1.618 times of the distance between Points A and B
That is why in the above example the first target (61.8) is below point B. The correction was deep.The 61.8 target from point C ended below point B. Why? Because there ended the 0.618 distance between A and B.
In another example, we will try to find the expansion in a downtrend. First, we need to make sure that the downtrend is strong, and then we wait for a swing AB and a correction to C.
We start from drawing the expansion from A to B:
Next, we move the second line to point C (where the correction ended):
The expansion levels are now drawn correctly. In this example, the price moved down to the 161.8 expansion, but as you can see after the next correction, the downtrend has continued. It was a great opportunity to use the expansion levels on the next waves of that move.
It gets easier when you practice it yourself. Remember, you have all this historical data to practice with!
Tool2: the Fibonacci extension
The Fibonacci extension is based on the first move (A to B). Point C is not used for calculation here.
The extension levels are calculated basing on the distance between points A and B.
The levels are drawn from point B.
For example, the 138.2% extension level equals the 38.2% distance between A and B, which is drawn from point B. Look closely at the chart below, where I marked the distance:
For the 161.8% extension line, we take the 61.8% distance between A and B and add it to point B.
Now you can see that point C (where the correction ends) does not matter in the calculation. We only care about the swing from A to B and this is our base to calculate the extension lines.
It may seem that this method is less accurate because for the expansion we use 3 points. The truth is that it is also very accurate despite differences in calculation. Personally, this is my favorite way to look for the price projection and later in this guide I will mostly use this method.
Before we go further and learn more about the extensions, you may want to add them to your Metatrader chart. Look for instructions at the end of the guide.
This way you will be able to draw the retracement and extension at the same time! It is handy and saves you a lot of time.
The Fibonacci extension in practice
In the example below, you should be able to find points A and B. We can use them to draw the retracement levels as you remember from the previous chapter.
In this case we do not pay attention to where exactly the correction ends. Point C will be somewhere between A and B, but in order to calculatethe extension we need only A and B. This is what happens next:
The correction ended at the 78% retracement level and the price went down to the 127% extension line. It closed almost exactly at this level and right after we noticed a very strong bounce up.
In another example, we can also spot a correction down to the 78% retracement. From that point, buyers showed up and the price moved up strong up to the 138% extension where it stopped for a while. Later the price moved up to the 161.8% extension which was a very strong resistance for a long time.
Actually, the price did not move above that level and sellers took control.
Later I will present more examples of trades and signal confirmations. For now, it is important for you to understand the difference between the Fibonacci extension and expansion:
Expansion -> 3 points (ABC) to calculate the expansion levels
Extension -> 2 points (AB) to calculate the extension levels
Both tools are great. You can plan your exit points and book profits thanks to them. My favorite one is the Fibonacci extension, so in the next trade examples, I focus mostly on that tool. If you like the Fibonacci expansion better, feel free to try it out and build your own trading plan on it. The expansion is used by many traders as well, so maybe it is the right tool for you?
Which extension levels are most important?
There are so many projection levels that you might be confused which ones are the best in practice. To tell the truth, there is no single rule, such as “always close at the extension of 138%”.
Some traders like to draw only a few levels on their charts to keep things clean, but they are aware of the fact that the price might stop at other levels.
The most common extension levels are: 127%, 138.2%, 161.8%, 261.8%.
Other levels, such as 118%, 150% or 200% are also important and can stop the price action. Over time, you will decide on your own if it is a good idea to keep them all on the chart or only a few. For now, you may stick to the most common extension levels.
It is all about probability
It is important to learn to watch closely how the price reacts with the projection levels.
You do not know in advance where the price will stop. The projection levels are only levels where there is a POSSIBILITY that the price may stop.
It also does not mean that the move will definitely end at the projection level. Sometimes the price stops for a while, and later, if the trend is strong, the move continues.
In other cases, the move will end at the price projection and it may even be the end of the current trend. That is why you should learn how to watch for the price reaction with the projection levels and to your signals.
Still, you are in a much better situation than other traders. You know in advance the possible levels where the price may stop. You will learn in Part 6 how to use it to your advantage.
The advanced guide to fibonacci trading - parts:PART 1. INTRODUCTION
Basic information about Fibonacci numbers and why it is good to know how to use them.
PART 2. THE FIBONACCI RETRACEMENT LEVELS
How they are build and how to draw them to find possible leveles during correction.
PART 3. THE FIBONACCI PROJECTIONS
How to predict where is the best place to exit trade - Fibonacci Extension and Expansion will be helpful here.
PART 4. THE FIBONACCI CONVERGENCE
Learn what convergence is and how to spot it.
PART 5. WHEN TO ENTER A TRADE – A SAFE SCENARIO
Here we put knowledge into practice - you will learn a safe way of opening positions.
PART 6. WHEN TO ENTER – A RISKIER SCENARIO
Little bit riskier scenario of opening trades where possible profit is bigger.
PART 7. WHEN TO EXIT A TRADE
Closing trade is very important, but where is the best place? This should help you to find the best place to exit.
PART 8. MY TEMPLATE
Few examples of different templates you can use in Metatrader software.
PART 9. A FEW IMPORTANT THINGS YOU SHOULD KNOW
How to define trend, the importance of the higher time frame and how to trade the news with Fibonacci tools.
PART 10. FIBONACCI AND PIVOT POINTS
How to combine Fibonacci tools and pivot points.
PART 11. MONEY MANAGEMENT
Proper money management is very important - without it you will be loosing money fast.
PART 12. MORE EXAMPLES OF TRADES
More exapmles where we put together knowledge from guide.
13. THE “HOW-TO” ARTICLES
Few helpful articles about installing templates and using Fibonacci tools.