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Finding Profits Beyond 100% – Fibonacci Retracement Part 3
Education | 16 August 2013
By: Shane Goh
Articles (99) Profile

Thus far, we have conducted our analysis based on retracement levels between 0% – 100%. However, being confined to these values, we are only able to identify pivot points within the previous price movement. What if we could use Fibonacci to predict potential support/resistance levels beyond this range?

Meet the Fibonacci Extension, an indicator that stretches beyond the boundaries of the retracement levels we have been accustomed to. The extension lines project potential support/resistance levels that fall outside of the present price movements. The extension levels work on the same premise as the retracement lines, with similar percentage figures. As we are venturing out of the range used to define the retracement levels, we will be adding the difference between 100% and the golden ratio (Fibonacci) percentages to 100%, i.e. 161.8% [(100% - 38.2%) + 100%], 150% [(100% - 50%) + 100%], 138.2% [(100% - 61.8%) + 100%], 123.6% [(100% - 76.4%) + 100%].

For Fibonacci Retracement, 0% begins from the end of the movement, however, in Fibonacci Extension, 0% will commence from the start of the move while 100% will be positioned at the end.

In Table 1, we have portrayed potential extension levels the stock price will be headed towards based on the retracement levels it initially attained. If a share has pulled back to its 38.2% retracement level in an uptrend movement before continuing its original path, we would expect the price to rise to a 161.8% level and beyond. You would notice that the farther back it retraces, the lower the likely extension would be. The rationale behind this effect lies in the demand and supply of the stock; in a bull environment, buyers will be quick to enter the market to take advantage of any pullbacks, resulting in a smaller retracement level and providing strength to push it up and beyond its previous high. The reverse is true in a bearish market, where sellers will be quick to offload their shares.

Table 1: Potential Extension Targets

Figure 1: Day Chart For CapitaCommercial Trust

Source: ChartNexus

In the day chart for CapitaCommercial Trust (Figure 1), we observed a downward trend from point A to point B before a rebound occurred from point B to point C. While we are unsure if the price would continue its descend and attain new lows or experience a boost and test the current retracement levels once more, we can paint some scenarios in advance so that we may be prepared when the opportunity arises. Using the Fibonacci extension, we observed potential resistance levels at $1.442 (123.6%) and $1.406 (138.2%). Based on Table 1, as the rebound stopped at the 50% retracement level (point C), we would be expecting a continuation to the 138.2% level, as witnessed at point D, where the price came close to our target before reversing.

One neat trick of utilising Fibonacci Extensions will be a combination of the various extension values based on a couple of moves in the share price. In the day chart of Singapore Press Holdings (Figure 2), we observed several uptrend moves as identified by the arrows. Using X as our low, Y as our high and Z as our pullback for each of the movement, we have input the information into Table 2. As highlighted in red, we remarked that the 161.8% level ($4.202) for the first move and the 123.6% level ($4.207) for the second move are relatively close, providing an indication of a potential resistance. As time passed, we noted at points A and B that the share price faced a ceiling at $4.20 twice, before successfully breaking out to new highs. When using charting software, you may simply apply Fibonacci Extension to each movement and spot any overlap of the extension levels.

Figure 2: Day Chart For Singapore Press Holdings

Source: ChartNexus

Table 2: Fibonacci Extension Targets

Although the extension levels provide possible exit points, it is by no means a be-all-end-all solution where the prices will reverse at. As you would have noticed by now, Fibonacci Extension works best in a trending market condition as traders chase prices to new highs or new lows. However, that is not to write off the indicator during a ranging situation, but it means that you might wish to play it close to the chest by taking profit at the lower end of the range in each expected extension level as mentioned in Table 1.

One method of consideration is to use Fibonacci Retracement to plot probable entry levels while using Fibonacci Extension to gauge potential take profit targets. In the finale of our series, we will present a complete picture combining both the retracement and extension aspects of Fibonacci with other indicators for a robust analysis.

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

Please click here for more information about this author.

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