How to Trade Using Fibonacci Retracements and Time Extensions

Leonardo Fibonacci was a 13th century mathematician who, among other things, noted that there are certain ratios that tend to reoccur in nature.   The common ones that he identified were 38.2%, 50%, and 61.8%.  For example, the distance from your fingertips to your wrist is 38.2% of the distance from your fingertips to your elbow.  There is overwhelming evidence of Fibonacci ratios operating throughout nature.

We can us these naturally recurring ratios to help us anticipate stock market activity.  What we can do is watch for retracements to these levels.  For example if a stock has just completed a 10 point run, say from $90 to $100 and is now pulling back.  We would expect the stock to retrace to $96.18 (38.2% retracement from $100) if it does not turn there we would next watch at $95 (50% retracement from $100) and the next level would be $93.82 (61.8% retracement from $100).

These are not always perfect, but you may be surprised at how often they work!!  Many people have debated about why these work, but my opinion is that all the large institutions use them, so you might as well buy or sell at the same levels that they do and if these levels don't hold you can get out with a small loss.  The key to trading is to take small defined risks (know when to get out if you're wrong) and have winning trades that are 2 or more times your average loss.  In my experience Fibonacci rations work much more than half the time, and when Fibonacci ratios align with Fibonacci Time Extensions they seem to work 80+ percent of the time!

Fibonacci Levels Will:

  1. It will show you the most likely retracement levels for you to buy or sell from.

  2. It will give you very accurate price targets from the swing highs and lows (Fibonacci Extensions).

  3. It will give you very accurate price targets using the swing high, swing low, and first pullback area (DiNapoli Style Fibonacci Extensions).

  4. It will also give you Fibonacci Time Extensions which give you very accurate time areas where the markets OFTEN make big moves.

EXAMPLE #1


Example of 5 min chart with our Pro Chart Fibonacci Tool.  Stock  MEDI (6/01/2001)

 This chart shows a strong up move, and a retracement to the first Fibonacci level of 38.2%.  As you can see, this stock retraces to this level at the exact Fibonacci time extension level which is displayed on the bottom of the chart.  When stocks retrace to Fibonacci levels at Fibonacci based times, there is a VERY high probability of the stock reversing and making new highs.  In this example, the stock does go on to make new highs and stops within 1 penny of our Fibonacci Extension Price Target!

 

 

EXAMPLE #2


Example of 5 min chart with our Pro Chart Fibonacci Tool.  Stock  TMPW (5/23/2001)

This is a good example of where a stock makes a large up move, and quickly blows through all Fibonacci support areas and illustrates why it is important to watch the overall market before taking any trades.


Example of 5 min chart.   NASDAQ Futures ND01M  (5/23/2001)

As you can see, the NASDAQ had gapped down from the previous day and was continuing to go down.  It's usually not wise to buy stocks when the overall market is falling!  It can be very damaging to your account.  In examining all of your trades, keep an eye on the NASDAQ and S&P futures and also watch the Dow.  If the market was going up on this day instead, the Fibonacci levels above probably would have held and produced a profitable trade.


Example of 5 min chart with our Pro Chart Fibonacci Tool.  Stock  TMPW (5/23/2001)

Since the market's trend is down, lets look at the same stock for a possible short sale.  The stock rallys up to the 38.2% from the low, and reverses going on to make new lows for the day.  You should look for the stock to hit the first Profit Target which it does.  It then precedes to consolidate at this level.  Depending on the strength or weakness of the overall market you would decide either to cover your short or wait for the stock to breakdown to new lows which it does.  It comes close but doesn't quite reach the second Profit Target.  If you are using trailing stops you would probably have exited the trade somewhere between the first and second Profit Target.

 

 

 

EXAMPLE #3


Example of 5 min chart with our Pro Chart Fibonacci Tool.  Futures  SP01M (6/03 and 6/04 2001)

In this example of the S&P 500 futures, the market makes a large leg up and retraces to the first Fibonacci level, continues the rally, and then has a deeper pullback to the 50% level of the prior up swing.  This coincides exactly with a Fibonacci Time Extension.  When Fibonacci retracements line up with Fibonacci time extensions, large and very predictable moves OFTEN occur.

 


Example of 5 min chart with our Pro Chart Fibonacci Tool.  Futures  SP01M (6/04/2001)

This chart occurs later in the same day.  After this leg up, the SP500 pullback to the 50% Fib level, rally about halfway of the down leg, and then begin their new wave up at the exact Fibonacci Time Extension!  Using Fibonacci retracements without time extensions is not nearly as accurate.  This software will pay for itself for an entire year with just one profitable trade.  Once you are in the trade, look to the Fibonacci extension points above to decide where to exit the trade.  If the stock or futures appears to be very strong, expect it to break through and stop at the second price target.  Very rarely will prices get all the way to the third price target without a significant pullback first, but in the example above the market is very strong and has no trouble reaching this level.  Notice the immediate and swift pullback at this level as traders everywhere quickly take profits at this level.

 

 
Example of 5 min chart with our Pro Chart Fibonacci Tool.  Futures  SP01M (6/05/2001)

The amazing thing about Fibonacci retracements and time extensions is that you can use them over and over, multiple times per day and they work a very large percentage of the time.  This chart is a continuation of the one above, notice how after this leg up, the futures retrace to the first Fibonacci price level before resuming their uptrend.

 

 

EXAMPLE #4


Example of 5 min chart with our Pro Chart Fibonacci Tool.  Stock ADBE (6/05/2001)

 

Here is another example.  The stock makes a very nice rally and retraces to the first Fibonacci level at an exact Fibonacci time extension point, and resumes its strong trend.  A key to using Fibonacci retracements is to gauge the strength of the original move.  If it is a large thrusting move with small or NO pullbacks on the way up, odds are that the first Fibonacci level will hold.  If it is a gradual move with many stops and starts, the first Fibonacci level is less accurate.  In these cases you should wait to buy or sell short until after the level appears to hold.  In the example above, because the rally up is so strong, and the pullback coincides with a Fibonacci time extension, there is a higher probability that this pullback level will hold.  There are two ways to trade Fibonacci levels.  You could take the trade with your stop immediately under this level and hope the level holds.  Or you can wait for the level to hold and buy a breakout of the high of the previous 5 min bar for example.  Here your stop loss would be farther away from the price you are filled, thus you are risking more, but the odds are higher that the trade will work.
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