Can You Help Me Understand Basic Fibonacci Terminology

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Can You Help Me Understand Basic Fibonacci Terminology

With regard to fibonacci trading, I often hear investors and traders use the words "retracements," "extensions," "expansions," and "projections," but I am unclear on whether these are four distinct words or whether one or some are synonymous with another.

In order to focus my question and move away from the abstract to the specific, I'd like to offer a basic hypothetical to serve as a framework for the discussion.

Let's say a stock moves from $1 to $11. As many people do, I'll call this the (A) to (B) portion of the move. Thereafter, the stock pulls back from $11 to $6 -- the (B) to (C) part of the move. The initial up move, therefore, was $10 and the correction was $5. I understand that this correction is what is meant by a 50% "retracement". Simple enough.

The words "extensions," "expansions," and "projections," however, leave me confused.

"EXTENSIONS"

1. I heard one person say that an "extension" is measured using only the (A) to (B) part of the move. So, a 127.2% "extension" of the (A) to (B) move would provide a price target, after the retracement to $6, of $12.72 -- ($11-$1) x 127.2%. In other words, according to this person, the retracement isn't involved at all in the calculation of the "extension" target. The "extension" target is simply a continuation of the (A) to (B) move -- 127.2% of $10.

2. I heard another person, however, say that an "extension" is measured using the (B) to (C) part of the move. Therefore, he took ($11 - $6) x 127.2% which is $6.36 and added it to the $6 retracement level, for an "extension" price target of $12.36. So, in other words, this person is saying that an "extension" is a retracement that exceeds 100% -- in this case, a 127.2% retracement of the initial (B) to (C) retracement.

Which, if either, of these two explanations are correct -- 1 or 2?

"PROJECTION"

The only explanation I've heard of a "fibonacci projection" is that a trader takes some fibonacci percentage of the (A) to (B) move and adds it to the (C) retracement, and that these "projections" are often 100% or 161.8%. In the example above, therefore, $10 (100%) would be added to the $6 retracement price, for a 100% fibonacci projection target of $16.

Is this correct?

EXPANSION

I've have no idea what is meant be a "fibonacci expansion" although I hear the phrase used often.

Thanks in advance.

Nancy

The following user says Thank You to NancyJ7 for this post:

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Everything you described is more or less correct but actually matters not. If I were you I would not trouble my mind with words and their meaning to others as long as you know the story around the 0,1,1,2,3,5,8,13...numbers and their crunching. Just take any trading platform, and I really mean any trading platform, open a chart and use each Fibonacci tool in there see what happens and figure it out. It matters not how you or others call them all it matters if you will find any use in any one of them.

The following user says Thank You to paul79 for this post:

My expectation is that there is a consensus among experienced traders about how price targets are established using fibonacci percentages.

As previously suggested in my example, basic retracements of .236, .382, .5, .618, .786 (including their mathematical derivation) are easy enough to understand.

How to properly use 1.272, 1.618, 2.618 etc., to me, is conceptually more difficult.

What matters most to me, of course, is not necessarily the nomenclature but that I'm calculating potential price targets according to what experienced traders consider best practices.

Think of them in situations where you want to use the reverse swing size (instead of the forward moving swings) and also where you are interested in relationships between successive waves or swings.

I was hoping that my hypothetical example would help place the matter into a practical ("numerical") context.

For something so ubiquitous, I'm really stunned that I've yet to come across a single online resource that clearly explains how to calculate fibonacci price targets (beyond the standard countertrend retracement). I must have went to at least 40 websites and otherwise watched 10 videos -- the problem is either poor resolution of the images and videos or a failure to run through the simple math.

That's why I came here and offered a hypothetical.

I would suggest using the tools provided by your trading platform. Most platforms at minimum have one for fibonacci retracement and another for fibonacci extensions. If you play around with both you can get a general idea of how they work.

The plain fibonacci tool can be used to measure possible retracements of an INITIAL move. For example if you have a upward move that goes from $0 to $10 then you would use the tool to connect the high and low of the move. Inside the high and low you would get the basic 23.6% ($2.36), 38.2% ($3.82), 50% ($5.00), 61.8% ($6.18) and and 76.4% ($7.64) levels. If price turns downward after $10 you would expect price to stop falling at one of these levels. Also if you use the plain fibonacci tool and draw you connection from high to low (in an upward move) you'll see 123.6% ($12.36) and 161.8% ($16.18) projections.

Once price falls to one of these points then you could use the extension tool to try to figure out where the next leg up will rise to. For example, after price falls from $10 down to $5 then you could connect $0 (low) to $10 (high) and back to $5 (retrace). The platform will plot levels based on this move which represents and ABC type move. In my opinion extension and projection are interchangeable terms. The values you get from using the extension tool are going to be different than if you used the plain fibonacci tool. You'll see 100%, 123.6% and 161.8% but the values will differ from those numbers if using the plain fibonacci tool.

So the question is when to use which?

For me, I use the plain fibonacci tool to look an an INITIAL move or Wave 1 or A. You have to understand Elliott Wave principle to really understand what that's about. Price will "usually" retrace to one of the levels mentioned above which would be Wave 2 or B. Once that happens you get the beginning of the next upward wave which can run to the 161.8% of the first wave (in strong uptrends) using the plain fibonacci tool. If you use the fibonacci extension tool a good place to look for the the wave to end is the 100% mark or the 161.8% mark. It all depends of the strength of the move you're trying to measure and none of the retrace levels are etched in stone which makes plain fibonacci trading so frustrating. The key is to identify important highs and lows and place your fibonacci calculations off of those. Just about all charting platforms make this simple to do. The problem is that "important" is a subjective term and leaves a lot of room for error.

As a bit of advice I would look into trying to understand the basics of Elliott Wave to go along with practicing fibonacci levels. EW makes using fib levels a bit easier in my opinion. You don't have to be an "Elliotician"but knowing just the basics of wave structure goes a long way to better using fibonacci levels.

What trading platform are you using? I've found the best way to learn is to just put some charts up and play with the tools. Then see if price bounces of the levels you've drawn. Keep in mind that you're using past moves to try and predict something in the future which is damn near impossible. Fibonacci only provides a framework for looking at market moves. You really have to have a basic understanding of wave structure to apply it profitably. Understanding wave structure gives you a basic understanding of price action which in my opinion is far more important when making decisions. I've been burned quite often trying to use it to make trades in a fast paced market. You have to incorporate other indicators that measure momentum and volume also.

A good book to read is Applying Elliott Wave Theory Profitably by Steven A. Poser. You can go to this link also: Elliott Wave Basics - ChartSchool - StockCharts.com. Using fibonacci with basic Elliott Wave is much easier to understand and follow. Hope this helps!

The following 3 users say Thank You to mmandi for this post:

Well, I can sympathise in as much as there are a hundred different ways of doing it and just as with any part of the TA universe there are as many flavours as there are practitioners. It wouldn't actually solve the problem if you thought you had found 'The Bible of Fibs', you still have to work out what you want to do with them. And in any case from my point of view most treat the lines as having some sort of magic power when in fact they have none - unless you are factoring in the current trend series and market structure and context in several timeframes. Otherwise, just like allegedly magical Elliott targets, they too get blown through or ignored just as often, but then that is equally true of all bands or trendlines I have ever seen.

Here is a simple example of the reverse swing 127.2 showing its balls in the recent ES series:

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