One of the things I will repeat over and over again is that many moves in securities terminate at Fibonacci extensions of prior price swings, even if that halt is only temporary. Now, I don't expect you to just blindly accept this. I want to show you why this happens -- and why I'll typically suggest that you ratchet up stops on any positions that are technically extended.
When a stock meet extensions, it means that the name is also in position to embark on a deeper correction at the very least. Again, this does not mean the stock will definitely do so, nor does it mean its larger trend will end. It just means odds are higher for it to occur at that time -- and I would rather be safe than sorry! If you don't want to sit through these corrections, you are better off using a trailing stop, and if you get stopped out, you can look for another entry after the stock undergoes a deeper correction.
What exactly is a Fibonacci price extension? I find these by measuring a prior low-to-high rally or high-to-low decline, and applying the following ratios to it: 1.272 (square root of 1.618); 1.618; and 2.618. When any move approaches the 1.272 level or higher, I watch for a possible termination of a move. Like I said, it does not always happen there, but it happens often enough to watch that area closely. Sometimes a stock will extend 2.618 of the prior swing, or even further.
Let's run through some examples, starting with a daily chart of Apple (AAPL).
After Apple hit the 1.618 extension of the decline between the July 29 high and the Aug. 8 low, the stock did indeed sink $7.60 from that high before the price resumed the rally.
In this second Apple daily chart, you can see where some deeper corrections have unfolded when the stock had been up at extensions of prior swings.
Currently, Apple is very close to the 1.618 extension of another prior major swing -- the pullback between the Sept. 2 high and the Oct. 15 low. Now, even though I have higher bigger-picture targets in place for this stock, this is one of those times when I'll suggest my traders ratchet up their stop-loss on any current long positions in this one.
This next example is a daily chart of Tesla (TSLA).
When Tesla met the 1.272 extension of an $87.78 swing -- at the $288.88 area -- a healthy decline started up shortly thereafter. Into the last low, made in October, the stock declined by $74.10. Now, if you were long Tesla, it would have been a good idea to trail up stops at that point, right?
This next example -- a 30-minute chart of Baidu (BIDU) -- illustrates that this same phenomenon occurs on the lower time frame charts.
After this stock met the 1.618 extension of the prior swing, there was a relatively quick $10.11 decline before the stock's larger rally resumed. Depending on your time frame, you may be OK sitting through corrections like this. But if not, remember to protect yourself!
Above is a current daily chart of Baidu that shows the stock has just met the 1.272 extension of the prior major swing. It's possible the stock will also meet the next target, at the 1.618 extension -- but since Baidu is currently technically extended, I recommend ratcheting up stops on any long positions in this one, as well.
Note that Gilead (GILD) is also in a place where it would be a good idea to protect profits.
The stock, after all, has met the 1.272 of the prior major daily swing. Actually, many of the biotech stocks are in this same position!
With that in mind, our last example is a daily chart of Alexion Pharmaceuticals (ALXN).
Notice that this stock saw a $24.58 decline from the high, as illustrated on this chart. That peak was hit just slightly above the 1.272 extension. Alexion is also currently extending on its most recent swing, so this is another position on which I would ratchet up stops.
In summary, it's worth protecting profits on any stock positions when key Fibonacci extensions are met! I hope that the illustrations on these charts helps you understand why we watch them.