In any trading setup, there are 3 key levels you must identify:
- Entry level
- Stop Loss level
- Take Profit level
Of the 3 key levels, identifying your Take Profit level is by far the most challenging because it’s a combination of art and science.
And where you place your Take Profit levels can have a drastic effect on your trading system’s performance.
In fact, it can mean the difference between a losing system and a winning one.
The problem with most traders is that they are focused on the point of entry.
They want to get in at the “best price”.
However, the “best price” is relative to where you exit your trade.
For example, Trader A might go Long on EURUSD at 1.1100 and get out at 1.1120 for 20 pips profit.
But Trader B might go Long at 1.1110 but get out at 1.1160 for 50 pips profit.
So even though Trader A got in at a “better” price, Trader B got out for a bigger profit.
With that said, I’m not saying that where you enter your trade and where you place your Stop Loss is not important…
What I’m saying is that it’s not nearly as important as identifying where you should place your Take Profit level.
So how do you identify the right Take Profit level?
There’s no right or wrong answer, but there’s one tool that can significantly help you with it…
And that is using Fibonacci Extension.
What Are Fibonacci Extensions & Why Use Them
Fibonacci Extensions are levels using the Fibonacci ratios to determine where the market might travel to, or even likely to reverse.
There are many different ways to set your Take Profit levels but I categorize them into 2 types:
Systematic Take Profit levels are when your Take Profit levels are fixed regardless of what the market is doing.
For example, setting a fixed 2R Take Profit level is considered a Systematic Take Profit level because you’re not concerned about whether there is a support/resistance level that might cause the market to reverse before reaching your Take Profit level.
So let’s say you’re Long at 1.1000 on EURUSD and you have a 2R Take Profit level 50 pips away at 1.1050.
However, there is a strong resistance level at 1.1040 and there’s a likelihood of the market reversing at that level.
But since you’ve already fixed your Take Profit level at 2R, you don’t care about the resistance level.
Either you hit your Take Profit, or you get stopped out.
That’s a Systematic Take Profit level.
Discretionary Take Profit levels, on the other hand, are based on what the market is doing.
An example would be to place your Take Profit level just before the next nearest support/resistance level where the market might reverse.
So in the same example as above, instead of placing your Take Profit level at 2R, you might either place it before the resistance level or even forego the trade if the risk-to-reward ratio isn’t favorable.
That’s the difference between Systematic and Discretionary Take Profit levels.
I consider the Fibonacci Extension levels Systematic because it’s based on fixed Fibonacci ratios.
And by using a Systematic Take Profit level, you can easily test the effectiveness of it over a number of trades.
If you’re doing intraday trading, you can quickly place your Take Profit levels without having to manually calculate where it is.
And if you’re scalping the markets, you will most likely need to calculate your trade setup’s 3 key levels quickly or the market may run away before you’re able to enter into your trade.
That’s where the Fibonacci Extension levels can come in handy to quickly identify your Take Profit levels without doing any calculation.
How to Use the Fibonacci Extensions
Fibonacci Extensions are primarily used to identify where the market might head to based on the Fibonacci levels and use those levels as Take Profit areas.
But there are a few other ways to use it as well.
Here are 3 methods to use Fibonacci Extensions:
Method 1: Wave Extension
The markets move in waves whether it is in an uptrend, downtrend, or going sideways.
But when using Fibonacci Extension, we want the market to be either in an uptrend or a downtrend.
When the market is in an uptrend, it forms higher highs and higher lows.
And when the market is in a downtrend, it forms lower lows and lower highs.
These are called wave patterns.
Now, to get the Fibonacci Extension levels, there are two ways to do it.
The first way is to use the Fibonacci Extension tool.
The second way is to use the Fibonacci Retracement tool where it will also show the Fibonacci Extension levels.
I prefer to use the Fibonacci Retracement tool because not all trading platforms have the Fibonacci Extension tool…
And also because the Fibonacci Retracement tool is much easier to use.
With the Fibonacci Extension tool, you will need to identify 3 points on a wave to get the Fibonacci Extension levels and this can cause confusion for many traders.
But with the Fibonacci Retracement tool, you only need to identify 2 points on a wave and you also get the same Fibonacci Extension levels.
So throughout this post, I will only be using the Fibonacci Retracement tool.
Now, to use the Fibonacci Retracement tool to find your Fibonacci Extensions, what I like to do is remove the retracement levels from the tool so that it just shows the extension levels.
On TradingView, which is the charting platform I use, there’s the option to uncheck all the retracement levels:
Most trading platforms should have the option to not show the retracement levels as well.
Now, to find the Fibonacci Extension levels in an uptrend, you need to first identify the top and bottom of the wave that you want to extend.
Then you drag the Fibonacci Retracement tool from one end to the other end.
Now you might be wondering, should you drag the Fibonacci Retracement from the top to the bottom, or from the bottom to the top.
The answer is that it depends on your trading platform.
For example, on the Oanda trading platform, you would have to pull from the bottom of the wave to the top.
Whereas on TradingView, with the default setting, you would have to pull from the top of the wave to the bottom.
However, if you check the “Reverse” box option, you can change it so that you can start pulling the Fibonacci Retracement tool from the bottom of the wave up.
I’d also check the “Extend Lines” box so that the Fibonacci Extension levels stretch to the left-hand side of the chart to clearly see when the market has reached those levels.
So it just comes down to the trading platform you use.
As long you’ve identified the right wave on the trend, then it doesn’t matter whether you drag it from the top to bottom or from the bottom to the top.
Now, the next thing is to only check the box of following Fibonacci Extension levels:
These are the Fibonacci Extension levels that we want to look at.
Once you’ve pulled the Fibonacci Retracement on the wave you want the Fibonacci Extensions on, it should look like this:
And in a downtrend, by pulling from the top of the wave to the bottom, it will look like this:
By doing so, you will get an extension of the wave creating the 4 Fibonacci Extension levels.
These 4 levels are possible Take Profit levels.
Now, you might be wondering…
“Okay this is great, but how do I use these Fibonacci Extension levels, and which levels should I use?”
Here are a few ways to use these levels:
1) Split your Take Profit into 4 different levels.
So if you are trading 4 Lots, you can set each lot to Take Profit at each of the Fibonacci Extension levels.
2) Have a fixed Take Profit target at either of the Fibonacci Extension levels.
For example, if the 1.414 Fibonacci Extension level is near a previous support/resistance level, there’s a possibility that the market might reverse there.
In that case, you want to set your Take Profit level either at the 1.414 level or just before it.
3) Wait for the market to push through to each level then decide whether to close your position.
For example, if the market reaches the 1.272 and 1.414 levels but does not stall, you continue to hold on to your position.
However, if it reaches the 1.618 level and starts to stall and form a reversal pattern, then you might consider closing your position there.
Method 2: Identify Pre-Defined Take Profit Level
The next way to use the Fibonacci Extension tool is to use it to quickly identify your predefined Take Profit level.
Let’s say for example you have a fixed 2R for every trade, so instead of pulling the Fibonacci Extension tool from the start of the wave…
You start pulling it from your Stop Loss level to your Entry level.
When you do this, the Fibonacci Extension tool at 100% will mean a 1R Take Profit level, and a 200% will mean a 2R level.
Therefore, instead of using a manual calculation to identify your Take Profit level, just use this tool to quickly help you identify it.
So let’s say, for example, you have defined your Take Profit level to be at 2R.
The first thing you want to do is set your Fibonacci Extension levels to just 0, 1, and 3:
Let’s say, for example, you have a trade setup on the EURUSD and have decided that if the market goes down to 1.1140, you will go Long.
So you place a Buy Limit Order at 1.1140 and place your Stop Loss just below the previous swing low at 1.1100.
To identify exactly what your 2R Take Profit level is, all you have to do is drag the Fibonacci Retracement tool from your Stop Loss level to your Entry Level and it will show that your Take Profit level is at 1.12200.
So if you want to have a 3R Take Profit level, then you just have to tick the “4” box.
And if you want to have multiple Take Profit levels, just tick the boxes that you want the Take Profit levels at.
This will help you easily identify where your Take Profit levels should be.
Method 3: Identify Possible Reversal
The third way that I see some traders use the Fibonacci Extension, is to identify possible reversal areas.
So for example, they might look at the extension levels and see if it coincides with any previous support levels.
If so, then if then that might be a possible reversal level.
And if you’re in a trade, you might want to consider placing your Take Profit level just before the possible reversal level.
For example, if I’m currently in a Long trade, I will see which Fibonacci Extension level is near a previous support/resistance level, then place my Take Profit level just before it.
In the chart above, after identifying the wave that I want the Fibonacci Extension levels on, I use the Fibonacci Retracement tool to identify where my Extension levels are at.
You can see that after getting the Fibonacci Extension levels, the 1.414 Extension level is near the previous swing high.
In this case, what I want to do is place my Take Profit level there or a few pips before that.
So with the Fibonacci Extension levels, it can help you identify where to place your Take Profit levels more effectively.
The Fibonacci Extension levels can be very useful when used correctly.
And it can definitely help you identify your Take Profit levels quicker than calculating it manually.
However, it may not be for everyone.
Sometimes, it may cause more confusion by wondering which wave should you be using.
And sometimes, it may cause you analysis paralysis when you too many considerations when taking a profit.
But if there’s anything you should take away from this post, then it’s that identifying your Take Profit levels are more important than finding the optimal Entry or Stop Loss level.
Because even if two trading systems have the same Entry and Stop Loss level, one could be very profitable and the other could be struggling to even breakeven.
Now it’s your turn.
Do you find using the Fibonacci Extensions useful or even practical for your trading?
Let me know in the comments below.
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