If you have been trading long enough one of the most difficult parts of investing is knowing when to take your losses and move on. Another equally challenging aspect of investing is also knowing when to take profits. You’ve probably have gone through the bitter disappointments of closing your trade at break-even or worse, at a loss after you missed your take-profit target because of greed or indecision.
For many investors closing a trade is far more important than opening one. When you think about it, even a poorly timed executed trade can sometimes lead to a profitable outcome if you manage to exit the position at the optimal time. So, the question then becomes – I am now involved in a trade or an investment, but when and at what price should I take profit?
How much easier would life be if you can trade with better precision and have more confidence when buying and most important selling a position. However, one of the greatest hurdles 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 projection. This concept is similar to the more popular and widely practiced Fibonacci retracement strategy, which seeks to determine how far the prices will correct before the resumption of its underlying trend. The major difference is that Fibonacci projection utilize the 100%, 138.2%, 161.8%, 200%%, 238.2%, and 261.8% levels as compared to the traditional Fibonacci retracements levels of 38.2%, 50%, 61.8% and 100%.
The premise behind all of the Fibonacci studies remains the concept of the golden ratio. 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 is derived from the Fibonacci sequence named after the famous Italian mathematician, Leonardo Fibonacci. There exists a special relationship between the golden ratio and 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). These number converges to a single number that equals to approximately 1.618. Hence the significance of the 61.8% Fibonacci retracement as a pivotal support zone when securities are in a correction and the importance of the 161.8% and 261.8% Fibonacci projections when securities are in well-defined primary bull trends.
The Fibonacci retracements and projections can greatly help traders and investors better identify potential reversal levels and upside 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, technical patterns, moving averages, etc).
Enclosed below are charts of key US indexes including S&P 500 (Index), Dow Jones Industrial Average (INDU), NYSE Composite Index (NYA), and NASDAQ Composite Index (COMPQ). Included are the 161.8% Fibonacci projections as well as the impending or confirmed V-pattern breakout targets. It is interesting to point out that one key US indexes are fast approaching these technical levels (i.e., COMPQ), while the others are far from achieving the projected technical targets (i.e., INDU and NYA).