The markets are constantly moving in different directions. As a trader your making money when you are able to identify high probability zones where price will continue to move or reverse in the direction you anticipate. To assist in your accuracy you use various tools.

These tools may include moving averages, volume, overbought and oversold indicators and the like. For a select few, at the very top of the list of indicators is the Fibonacci tool-set. Not a replacement for anything you currently use, but a fantastic confidence builder when looking for low-risk entry.

lets cover Fibonacci extensions and retracements in this article as these are the two most popular tools to use in the Fibonacci toolset for trading. If your goal is better entry and a more accurate exit then the Fibonacci tools are going to give you exactly what you’re looking for.

Fibonacci retracements refer to a corrective wave, and extension refer to an impulse wave. Meaning with the Fibonacci retracement tool we are measuring where price will retrace to before resuming the previous trend, and with extensions we are measuring where price will make a new high or low beyond its most recent high or low.

When we say retracement we literally mean retracing old territory. As it relates to a bull market a retracement is a measure of where price will fall to before resuming into the prevailing trend, or back into the impulse wave. With a bear market where measuring where price will move up to before resuming the trend.

If your in a bullish cycle and price has made a new high and is correcting or falling we want to measure the low and the high and pinpoint potential retracement levels. The next step is to watch and see which level becomes support for price. The most common and most used Fibonacci evels are:

* 23.6 – You might call this level 1, as its the first level price will hit, but usually pass through. If price does reverse here it indicates a pretty strong market in that direction. * 38.2% – This level is also I would say uncommon. But a reversal here indicates a strong undertone as well. * 50% – This is half of the impulse waves move. It is a common reversal zone and needs to be watched closely. * 61.8% – This level is the point of no return in my opinion. If we move beyond 61.8% chances are the original trend is over or seriously losing strength. * 100% – Reaching this point simply means we are right back where we started and are no longer making higher highs and higher lows.

Once we measure the low and the high a typical Fibonacci retracement tool will lay out the retracement levels starting with 23.6 and ending at 100%. This makes it easy to see the levels and wait and see what price does at these levels.

Now if price let’s say retraces to 38.2% and we see a clear and strong reversal, the question then becomes when do we get out and this is where extensions come in.

In most cases when you lay down your retracements 2 extensions will automatically be laid out. You may have to adjust the screen to see them. Again we look to extensions for reasonable expectations provided we are still in the trend. Look to at least 161.8, and often 261.8 in stronger trends. A move from a 50% retrace to a 161.8 extension is generally a darn good trade.