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# Fibonacci Extension and Head and Shoulders Bottom Breakout Targets

Knowing when to take losses and profits remains the most challenging aspect of investing/trading. Many have missed exiting a trade/investment because of greed, fear, or indecision.

For traders closing a trade may be more important than opening one. A poorly timed buy can sometimes lead to a profitable outcome if sold on time.

The question is - when and at what price to take a profit or loss?

How much easier would life be to trade with better precision and more confidence, knowing when and what price to buy or sell? The biggest hurdle involves the inability of most traders or investors to set logical or realistic goals and targets.

An often overlooked but potentially powerful technical tool that can help traders and investors with exit strategies is the Fibonacci extension. The concept is similar to the more popular and widely practiced Fibonacci retracement, which seeks to determine how far the prices will correct before resuming their underlying trend. The difference is Fibonacci extension utilizes the 100%, 138.2%, 161.8%, 200%, 238.2%, and 261.8% levels compared to the traditional Fibonacci retracements levels of 38.2%, 50%, 61.8%, 78.6%, and 100%.

The premise behind the Fibonacci studies remains the concept of the golden ratio (1.618). The golden ratio describes the predictable patterns in the universe, including the symmetry in the leaves in a tree and the petals in a flower that grows in well-defined spirals. The ratio derives from the famous Italian mathematician (Leonardo Fibonacci), commonly known as the Fibonacci sequence.

A special relationship exists between the golden ratio and the Fibonacci number or the Fibonacci sequence. Each number is the sum of the two numbers before it (i.e., 0, 1, 1, 2, 3, 5, 8, 13, 21, etc.). The number converges toward a singular number that equals approximately 1.618. Hence, the significance of the 61.8% Fibonacci retracement as a pivotal support zone during corrections and the importance of the 161.8% Fibonacci extension as price objectives during well-defined primary bull trends.

The Fibonacci retracements and extensions help traders and investors better identify reversal levels and upside extension targets. However, as with any technical indicator/discipline, it is most effective when accompanied by additional technical analysis tools (i.e., trendlines, technical breakout targets, pattern recognition, moving averages, etc.).

As mentioned, Fibonacci retracements help identify buy levels during pullbacks. Supports can occur at 38.2%, 50%, 61.8%, and 76.4% retracements. Fibonacci extensions can help to identify sell levels during rallies. The most commonly used Fibonacci extension levels are 138.2% and 161.8%.

The general rules are a successful test of the 50%, 61.8%, or 78.6% retracement will often result in a rally toward the 161.8% Fibonacci extension after confirming a breakout above the pivot high (i.e., SPX 1/4/22 high at 4,818.62). On the other hand, a successful test of the 38.2% retracement will often rally toward the 138.20% Fibonacci extension.

A brief analysis of the SPX Index (SPX) utilizing the Fibonacci retracement and extension strategies suggests the following outcome: If SPX maintains 3,491.58 (10/13/22), this implies the index has successfully tested the 50% retracement (3,505.24) from Mar 2020-Jan 2022 rally). A successful test does not necessarily mean SPX will resume its primary uptrend. It is only after clearing the previous reaction high (4,818.62 - 1/4/22) that this signals the resumption of the prevailing uptrend. A breakout renders an SPX target at 5,325.55 (138.20% Fibonacci extension projection) and 5,638.73 (161.80% Fibonacci extension target).

The Fibonacci extension projection is most useful when combined with other technical disciplines. A potential head and shoulders bottom pattern has quietly developed since May 2022. The left shoulders are 3,810.32/3,636.87 (5/20/22 and 6/17/22 lows). The right shoulders are 3,764.49/3,808.86 (12/22/22 and 3/13/23 lows). The head is 3,491.58 (10/13/22 low), and the neckline is 4,307.66/4,325.28 (5/4/22 and 8/16/22 reaction highs).

A convincing move above the 61.8% retracement (4,311.69) from Jan 2022-Oct 2022 decline and the neckline (4,307.66-4,325.28) solidifies the 10/13/22 low at 3,491.58 as a pivotal bottom and confirms a head/shoulders bottom breakout.

Since the height of the h/s bottom base is 833.70 points, a breakout renders an SPX target at 5,159. Interestingly, the h/s bottom breakout target comes close to the 138.20% Fibonacci extension target (5,325.55). It may be a minimum target since the sharp decline to 3,491.58 (10/13/22 low) successfully rebounded from critical support near the 50% retracement (3,505.24) from Mar 2020-Jan 2022 rally. Based on the Fibonacci retracement rules of maintaining above 50%-78.6% retracements, this would imply a breakout above 4,818.62 also renders a Fibonacci extension toward 168.20% or 5,638.73.

The caveat to this bullish SPX call rests with the ability of SPX to complete its head/shoulders bottom breakout above 4,307.66-4,325.28 and, most important, exceed its all-time high (4,818.62 â€“ 1/4/22). The above also reaffirms the Jan 2022-Oct 2022 selloff as a cyclical bear decline and not the start of a structural bear or trading range trend.

On the downside, SPX must maintain its left and right shoulders at 3,636.86/3,810.32 and 3,764,49/3,808.86. Below this and 3,491.58 (10/13/22 reaction low and head) confirms the continuation of the Jan 2022 cyclical bear, triggering the next SPX selloff to 3,195.28 (61.8% retracement) and below this 2,811.78 (76.4% retracement). Despite the sharp selloff, the Jan 2022 cyclical bear is not necessarily a structural bear/trading range trend if the decline retains the critical 61.8-76.4% retracements (3,195/2,812). However, a selloff of this magnitude requires an extensive basing period to repair the technical damages incurred before the next bull rally.

Source: Chart courtesy of StockCharts.com