Happy Easter!
This time of year, I can’t help but think about bunny rabbits and their mating habits.
What can I say? I’m a Fibonacci Nerd.
Those “Fibonacci Extensions” you see on my charts and read about when we talk about trade setups?
The Fibonacci Sequence was originally used to model the growth of a rabbit population.
Rabbits and their rate of reproduction helps us become better traders.
And we’re moving on Microstrategy (MSTR) because of the information they give us about risk and reward…
Uncharted Territory
MSTR is trading at all-time highs:
New all-time highs are prices that have never been seen before.
When a stock is in uncharted territory, traditional levels of support and resistance are non-existent.
It’s particularly true in the case of Microstrategy – or “Strategy,” as co-founder and executive chairman Michael Saylor wants to call the company now.
There’s no price history for MSTR at these levels.
So that’s where the Fibonacci Extension levels come into play. Those are the five gray lines on the chart.
The way to calculate these risk levels is by using the Fibonacci Sequence.
Here’s how it works.
When you take any number in the sequence and divide it by the prior number, the answer is always 1.618.
The further to the right you get in the sequence – in other words, the further away from the beginning – the closer the ratio gets to exactly 1.618, or 161.8%.
Here’s where things get interesting.
If you divide any number in the sequence by the number two places to the left of the sequence, the answer you get is 2.618, or 261.8%.
If you divide any number by the number three spaces to the left, then you arrive at 4.236, or 423.6%.
When you divide by the number four spaces to the left, you arrive at 6.854, or 685.4%.
This sequence extends to infinity.
In the absence of price history, these levels define support and resistance. Those are the lines I’ve highlighted in the MSTR chart – scroll up to take a look.
We’ll continue to talk about these key levels.
In this case, these are specifically extensions based on the prior-cycle highs down to the bear market lows.
For MSTR, that’s the late 2022 bottom.
We’re looking to buy on a breakout above 322.
From there, upside is… 513.
A Magical Sequence
Our story starts in the 13th century, when Leonardo Fibonacci posed a simple question.
“How many pairs of rabbits placed in an enclosed area can be produced in a single year from one pair of rabbits if each pair gives birth to a new pair each month starting with the second month?”
The answer is 144. But the answer is not “the magic.”
As investors – as technicians – we’re more interested in how the problem is solved.
The magic is in the sequence.
The sequence assumes a rabbit population starts with one pair of newborns, matures after a month, and produces a new pair each subsequent month.
It starts with 1 and it takes that pair of rabbits one month to mature before going into reproduction. Each subsequent number is the sum of the two preceding numbers.
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
The sequence is what helps us every day in the market.
I’m sure you’ve noticed these lines on a lot of my charts.
I’ve been doing this for over 20 years. I can tell you from experience that these Fibonacci levels come into play over and over and over again.
Stay tuned for more on how we’ll continue to use them to help you manage risk and maximize reward.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs