Fibonacci Extension Tool
The Fibonacci Extension Tool is one of the more versatile technical analysis tools that I use to analyze stock charts. Becoming familiar with its uses and applications is almost mandatory for consistent trading success. Why?
- The Fibonacci Extension Tool can be used to calculate upside potential for a stock's share price
- The Tool can also be used to calculate the downside risk for a stock's share price
It is crucial to be able to estimate the upside potential and downside risk before entering into a trade with a stock. Calculating a stock's upside potential and downside risk is better known as calculating the Risk to Reward Ratio. A Fibonacci Extension Tool can help you calculate the Risk to Reward Ratio.
Placing the Fibonacci Extension Tool on a stock chart whose share price is trending upwards can help estimate the upside potential for the share price. This is the "Reward" part of the Risk to Reward ratio. Placing the Fibonacci Extension Tool on that same stock chart but on a downtrend can help estimate the "Risk" part of the Risk to Reward Ratio.
The most favorable trades have at least a Risk to Reward Ratio of 1:3 - if you can find one with a less risky ratio like 1:4, even better.
Learning the components of the Fibonacci Extension Tool is important to help with its placement on a stock chart. So let's start with the various components for the Fibonacci Extension Tool. A Fibonacci Extension Tool consists of the following components:
- 3 Anchor Points - Anchor Points are used to place the Fibonacci Extension Tool on a stock chart
- Target Lines - Target Lines are automatically calculated and drawn after the 3 Anchor Points have been placed on the stock chart. The following Target Lines are automatically calculated and drawn:
- 61.8% (phi)
- 161.8% (Golden Ratio)
- 423.6% (not shown on the below illustration)
Target Lines are used to help estimate or project a stock's future share price. Depending upon where a stock's share price is in its overall Elliott Wave Pattern, expectations can be set to reach different Target Lines.
Once the Fibonacci Extension Tool is placed on a chart, the right side of the Tool will also show a dollar amount. I do not show dollar amounts on the above illustration since they would vary depending upon the individual stock chart.
If you are looking to calculate and project shorter-term price fluctuations, then a.......
If you want to continue reading about the Fibonacci Extension Tool, including things like:
- proper placement of the Fibonacci Extension Tool on both uptrends and downtrends
- how to use the tool on both uptrends & downtrends to calculate price targets
- tips and warnings when using the Fibonacci Extension Tool to estimate price targets
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