Trading Fibonacci Expansions

Wednesday, 30 March 2011 02:12

Most traders know and have used Fibonacci retracements at one point or another in their careers, but Fibonacci expansions are less commonly found in charts. Drawing them only takes a few seconds and their results can significantly improve your trading.

Fibonacci expansions (FE) work by predicting the third wave of a move using the concept of Fibonacci ratios.

In order to use it, we first need to identify two waves in a price, typically a breakout and a short retracement. A FE tool requires the trader to position three points which delimit each of the two first waves. The tool then automatically draws “expansion” levels where the third wave is likely to end.

For each level, the FE tool multiplies the length of the first wave with one of the Fibonacci ratios (61.8%, 100%, 161.8%, ...) and then adds the result to the second wave end point.

Fibonacci expansions can be used on any time frame and are particularly useful to determine profit targets. Moreover, they force traders to trade in the same direction as the trend.

A typical trading setup consists of entering an order right after a rebound off the retracement, with a profit target at one of the FE levels and a stop loss right under the last inflection point.

Determining which FE level to set as a target profit depends on previous price action. It is a good idea to match the expansion level with a known resistance or support. Moreover, it is common for the price to consolidate at one FE level before continuing its way to next one.

In many cases, using Fibonacci expansions allows us to exit the trade at the right time and generate better gains than a fixed profit target.