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Trading Lessons: Using Pivot Points for Profit


Calculating arbitrary price levels can work to a trader's advantage.


I will never claim to be a technician, but in reality any active trader has to use charts in some capacity, so I will admit that I do use some technical analysis. Last week, I wrote a short article on stop runs for the Buzz & Banter, and I showed how a stop run was triggered near a pivot point. Thinking back, pivots have rarely been mentioned in Minyanville, so I've decided to bring them to your attention, along with what indicators I use for intraday trading.

First, let me discuss my philosophy towards technical analysis including why technical analysis should work, what makes no sense, and finally what I use on an intraday basis.

Back in the old days, before ETFs, stock futures, or any other derivatives, the logic behind technical analysis was simple. The stock price of a company discounted ALL of the available knowledge of the company's future, both public information and insider information which always has a way of slipping out. And not just takeover type stuff, but the more "we had a really good quarter" type stuff heard on the golf course. From the technical analysis viewpoint, a stock acting well reflected upcoming good news, so hop on board for the good news. Acting poorly, get out or short, bad news is coming.

Moving on to stock indices like the Dow, the S&P 500, etc., technical analysis developed new techniques, some obvious and logical, some less so. Horizontal support and resistance levels are logical, buyers or sellers showed up that those levels previously. Therefore, it would be likely to assume they'll show up again at the same prices. Head and shoulder formations also seem logical. First shoulder up, correct, new high, correct, right shoulder fails to make a new high, the move is over.

Slanted trend lines both up or down finally leads to a discussion of the behavior of traders. A return to a slanted trend line does not reflect a location of previous buyers or sellers. It's an arbitrary point in time and a price that looks pretty. If the stock is not at obvious support or resistance, how do you pick an arbitrary point on the hard right edge (there's a charting service called Hard Right Edge, and it really is a good name) of your chart and decide you want to trade there? Tools were developed to address that issue. Slanted trend lines, Fibonacci retracements, pivots, moving averages, and others were developed to try to help.

None of these charting tools make any logical sense, unless, of course, enough traders believe in them and use them to create a self fulfilling prophecy. This is the premise of my technical analysis viewpoint. Much of technical analysis that works is a result of
traders fading (opposing a move in either direction) assuming that other traders will do the same thing, and reverse the movement at trend lines, resistance or support levels.

On to the subject of pivots. Pivots, originally called floor trader pivots, apparently were developed on the NYSE floor back before there were any electronic calculators. There are five pivots all based on simple equations which include the high (H), low (L) and close (C) of the previous day's prices. The 5 equations are as follows:

  • R2 = P + (H - L) = P + (R1 - S1)
  • R1 = (P x 2) - L
  • P = (H + L + C) / 3
  • S1 = (P x 2) - H
  • S2 = P - (H - L) = P - (R1 - S1)

R stands for resistance and S is support. Back when you had to do long division by hand these were complicated enough.

For any outside observer, to think that these simple equations can predict the next day behavior of stocks or futures is simply crazy. But, they do. I'm a flexible technician. If it works, I'll use it. I firmly believe that arbitrary price levels based on pivots or Fibonacci levels simply reflects a self fulfilling prophecy. If enough traders react to an arbitrary price level because they're all using the same indicator, the trend will reverse.

That's my technical trading philosophy on an intraday time period. If it's working, I use it. If it stops working I try to figure out what other traders are using. Currently I use the floor trader pivots and a simple 200 minute moving average on the e-Mini S&P 500 futures. I use both as support and resistance. I don't trade the futures, but use SSO and SDS. From experience, futures brokers charge per contract, where as you can get a flat rate regardless of size from a discount broker. SSO and SDS work great intraday. Any hold of them over a long term period is portfolio suicide. See Volatility Decay: A New Kind of Risk.

Let's look at today's chart of the e-Mini all the way to 11:00 PM last night.

Click to enlarge

At 1:30 the futures dropped to the pivot at 1:30 AM, bounced, then touched it again at 2:30 AM. Then there was a rally to the next pivot, traded sideways for a while, and then it rallied again to the news at 9:00 AM where it touched the blue pivot and promptly fell back to the red pivot. It rallied from there, went through the blue pivot on the 10:00 AM news, and fell back and touched the red pivot. And so on… The 200 minute moving average didn't come into play this morning.

Since pivots are calculated on the previous day's trading range, a big range on the previous day will result in pivots so far apart that they are impractical for that day, but tomorrow will have new pivots. Pivots also work on SPY or SSO, but the pivots tend to not match as exactly as the e-Mini pivots.

That's the tool I use. Again, pivots make no logical sense, but if they work, try them. Not all brokers offer pivots on their charts, so if they don't, complain or find a broker that does.

Good Luck!

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No positions in stocks mentioned.

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