Fibonacci Extensions and Price Projection

Yesterday's action on SPY gave us some really good examples of how you can spend a few seconds drawing Fibonacci grids to give you an edge in figuring out where to enter a trade, where to place a stop, and where to exit your trade. There are entire books written about entries, exits and stop placement and most traders really struggle with all three causing psychological mistakes that diminish and even eliminate trading edges.

Fibonacci numbers aren't magic, but if used properly, they can give you the ability to avoid emotional pitfalls and help you make trading decisions that are based on data rather than feelings.

Let's go through yesterday's trade to see how drawing two Fibonacci grids could have have saved you racking your brain throughout a trade that lasted several minutes. This trade happened in the last hour of the trading day on January 26th.

On the first chart I've drawn a Fibonacci price retracement grid. There were a ton of reasons that this was a trade that was going to work. Price made a strong impulse down and then retraced to several moving averages which were all converging together creating a huge amount of resistance. It would have taken a lot for buyers to push price through that level. As price began its retracement, I drew the Fibonacci grid from the start of the impulse down to the end of the move.

A grid like this gives me an unemotional decision making tool. First I look for price to retrace to a Fibonacci number--preferably 50%. Next I look for indecision to appear in the form of a candle on the chart. A doji candle (the "cross" at the blue arrow) is often my trigger and one appeared and touched the 50% retracement. Next, I wait for price to run past the doji low (in this case) for my entry which happened in the next 5 minute candle. Notice there is no "freaking out" about the best entry--it's plotted for me on the chart.

Next I set my stop. Again, the Fibonacci grid does that for me. I know that if price breaks the 61.8% level that I was wrong about the trade and the odds of the trade continuing are greatly diminished. I placed my stop just beyond that level. Again, it's not based on a dollar amount or a "gut feel". I can see where the stop goes right on the chart.

Once the trade is triggered I spend another few seconds drawing a Fibonacci Price Extension. The price extension grid gives me my targets for the trade. I can choose whether I want to be aggressive or conservative in the targets I choose and the grid lays them out for me.

Notice in yesterday's action how price reacted to the different levels in the grid. I've highlighted them with blue arrows. Noticed how price paused at each level in the grid and then crashed through. You could have conservatively targeted the 61.8% level or gotten a little more aggressive at the 100% level (notice the pause there), or even gotten real aggressive and targeted the next two levels.

So, instead of racking your brain trying to manage this trade after you took it, you could just calmly draw a grid and place an order at the level that you feel comfortable with.

This is just one example of trades that are happening every day. Of course not every Fibonacci grid is going to work out this perfectly, but enough of them do to give you a distinct edge in your trading with emotionless entries, stops and targets.

Using Fibonacci on my final trade

I wanted to point out how I used Fibonacci numbers to make my final trade today. Initially I was playing for an Elliott Wave pattern as price plummeted and then violently retraced. However, I noticed that price pretty much stopped at Fibonacci's 50% retracement level. This gave me a concrete area to place my stop once I was in the trade which I took as price hovered around that 50% level.

I placed my stop just beyond the 61.8% level because I knew that if the price broke out from there, the edge on this trade had disappeared. After placing my trade I used a tool in Tradestation to determine my target for the trade called the Fibonacci Price Extension.
This is capture of my actual trade at the end of the day including the Fibonacci Price Extension. I plotted the extension from the beginning of the swing down and then up into the swing high--or the "flag". Tradestation plotted the "extension" of the price from that point giving me Fibonacci targets for my trade.

I expected a larger move than actually happened. But when price stopped right on the 61.8% extension twice, I knew it was time to take my profits and run. Price hung out there for one more bar before heading up the rest of the day.

Normally, my target for a "flag" like that is the 100% extension. But when you see price fail to break levels above, it might be time to take your profits and run.