Trend Based Fib Extensions use the Fibonacci ratios to estimate future price movements. These ratios, which are frequently found in nature, are now also believed to influence the price cycles of trading assets like stocks and cryptocurrencies.
Whether or not this theory holds true, many traders agree that the application of Fibonacci ratios in trading strategies has reinforced their predictive ability. Today let’s join FMCPAY to learn how to control this powerful tool.
1. What is Fib Extension?
The Fib Extension (Fibonacci Extension) is a tool used in technical analysis to identify potential price targets beyond the standard retracement levels. By projecting Fibonacci sequence ratios, such as 161.8%, 261.8%, or 423.6% onto the price trend, traders can estimate where the price might extend after a significant move.
The Fib Extensions are drawn right on a trading chart, marking the price levels of possible importance. These levels are especially useful when an asset reaches new highs or lows, providing a framework for identifying profit-taking levels or setting stop-loss orders.
2. What is Trend Based Fib Extension?
The Trend Based Fib Extension (or the Trend-based Fibonacci Extension) is an advanced version of the Fibonacci extension tool, focusing on specific market trends. This tool is applied by selecting three key price points:
- The start of the trend
- The end of the trend
- The retracement point
From these points, the Trend Based Fib Extension projects potential price targets in the direction of the trend. This method is particularly valuable for traders who want to identify key areas where the price might face resistance or support. Understanding the Trend Based Fib Extension can enhance your ability to pinpoint precise price targets and make more strategic trading decisions.
The primary difference between Fibonacci Extension & Trend-based Fibonacci Extension lies in their application. A standard Fib Extension is generally used for straightforward price projections after a significant price move. In contrast, the Trend-based Fib Extension is applied with more precision, considering a specific trend and using three reference points to make more tailored predictions about future price levels.
3. How to use Trend Based Fib Extension
The quickest way to understand how to use the Trend-based Fibonacci Extension is to draw them and try analyzing them right on a trading chart. Let’s walk through a practical example:
In the above chart, the price hit resistance twice around the ~$35.50 level, forming a double top – a classic reversal pattern. To help identify key support and resistance levels, we used the Low and two High points from the double-top pattern to draw the Trend Based Fib Extension. This generated the Fibonacci ratios displayed on the chart.
In this example, you can observe that the price action adhered to these levels quite closely until it encountered strong support near the potential bottom, aligning with the 200% extension level.
However, notice the yellow-highlighted area on the chart. This region lacks clear Fibonacci-based support or resistance.
In hindsight, the support around $12 (141.4%) in mid-November 2017 didn’t lead to a new bull market. However, at that time, the potential reversal in that region hinted at higher highs, prompting the creation of a new Trend Based Fib Extension, as shown below.
This new Trend Based Fibonacci Extension reflects the areas of a new uptrend that were not identified in the earlier extension.
Nevertheless, the price faced resistance at the 61.8% level and continued its decline until it broke through the 0% extension level, effectively invalidating this Trend Based Fib Extension.
Even though the upward trend didn’t hold, a local high formed, which allowed for the creation of another Trend Based Fib Extension to spot potential reversal points for the ongoing downtrend, as illustrated below.
In this new Trend Based Fibonacci Extension, the price respected the levels down to the 78.6% extension, where it eventually found support, forming a triple bottom reversal pattern.
It’s noteworthy that the 78.6% extension in this case is at $1.82, while the 200% extension from the first pull was at $1.95 (only $0.13 difference).
This overlap, known as a Fib cluster, often indicates strong support or resistance.
With the triple bottom forming and the price rebounding from this level, could this signal the end of the downtrend? Perhaps it’s time to draw a new Trend Based Fib Extension from a fresh Low/High/Low to identify future support and resistance levels.
Try it out and see what insights you uncover!
4. Advantages of Trend Based Fib Extension
Understanding the benefits of using Trend-Based Fib Extension can enhance your trading strategy. Here’s why this tool is valuable:
- Price Projection: Projects potential future price levels based on historical data, helping traders anticipate market movements.
- Reliable Turning Points: Fibonacci levels often align with significant market reversals, making them more reliable.
- Versatility: Can be applied across various asset classes like cryptocurrencies, stocks, and forex.
- Adaptability: Works across different time frames, catering to both short-term and long-term traders.
- Synchronism: When combined with other technical tools, it increases the accuracy of trade signals.
5. Limitations of Trend Based Fib Extension
Despite its benefits, the Trend-Based Fib Extension tool has some limitations that traders need to be aware of. Consider these points:
- Reliance on Historical Data: Assumes that past trends will continue, which may not always be accurate.
- Complexity: Requires accurate identification of starting points to draw the extension, which can be challenging for beginners.
- Less Effective in Non-Trending Markets: Tends to provide false signals in volatile or sideways markets.
Conclusion
The Trend-Based Fib Extension is a valuable tool for traders seeking to project potential price targets in trending markets. Its ability to extend beyond traditional levels and its adaptability across time frames make it a versatile tool for many trading strategies.
For the best results, traders should use the Trend Based Fib Extension combining with other technical analysis tools as RSI or MACD indicator to maximize its effectiveness. Don’t forget to stay tuned with FMCPAY for more interesting crypto insightful articles!