In previous articles, we’ve how traders can use Fibonacci ratios and Fibonacci retracements. Today, we’ll cover Fibonacci extensions.

As a refresher, Fibonacci ratios are widely used to develop price targets for retracements on countertrend moves. A Fibonacci retracement, meanwhile, will help spot support levels in an uptrend or resistance in a downtrend.

Fibonacci extensions apply the same idea to price moves that are in the direction of the primary trend. They can be useful to identify targets for price advances in an uptrend and downside targets in a downtrend.

As we covered, these numbers were first identified by mathematician Leonardo Fibonacci. Centuries later, traders still use them — particularly as Fibonacci ratios.

Fibonacci numbers are found by adding two numbers to find the next number. The Fibonacci series is: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, etc…

When looking at retracements, traders generally use the 38.2% and 61.8% Fibonacci ratios. Extensions will usually be associated with the reciprocals of those two ratios, or 1.618 (1/0.618) and 2.618 (1/0.382).

How Traders Use Fibonacci Extensions

The initial price move is used to find the target for ConocoPhillips (NYSE: COP) in the chart below. The usual Fibonacci retracement levels are shown below with an extension target added.

Just as with retracements, the common extensions are 1.38 and 1.61 (traders also use 1.5 even though this isn’t a Fibonacci ratio). Whereas Fibonacci retracements help traders establish targets following a breakdown from highs, extensions help traders establish targets following a breakthrough in price levels.

Your charting software may produce extensions in the same way as retracements, so we’ve only included the 1.618 (expressed as 161.8%) in the chart above. But you can see in the example that this level did serve as a reliable target for the rally in COP following the breakdown. Once the price dropped below the target, however, that Fibonacci extension level became resistance before breaking through that resistance later on. Important price levels that serve as resistance often become support at a later time on price charts, just as support often becomes resistance once it is broken.

This same general idea could be applied to long-term targets by using the 2.618 ratio.

Why This Matters To Traders

Traders often use Fibonacci ratios to identify retracements. But they also help traders find price targets when applied as an extension to the price trend. They are particularly useful when there may be no discernable pattern on an emerging breakout. In that case, traders have few tools to determine the trend or price target.

Still, as we’ve noted with previous discussions of Fibonacci ratios, it’s usually best to test multiple tools and approaches. This also applies to many indicators and technical patterns.

As we have noted a few times before, there’s no real basis for why Fibonacci ratios should work. But markets seem to respect them, and thus, they are worth your attention as a trader. Knowing the key levels can help traders understand the long-term trend, spot potential short-term moves against that trend, and establish price targets.

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