2003 and their expectations for a decline in real estateprices? By July 2006 we had started to see prices go back down but notto the severity as was predicted and certainly not at the time that wasexpected by economists. I can go on and on with examples when prognostications were correct, but timing was really wrong, resulting in a financial loss.
Time and PriceAs I stated earlier, pivot point analysis relies on both time and pricespecifics in its calculations to project future support and resistance levels.By incorporating price data for various time frames, such as daily, weekly,and monthly, the more price areas that coincide with the different time periods, the greater is the likelihood that these price clusters will repel themarket’s advance in an uptrend or cause prices to reverse in a downtrend.This clustering, or confluence, from more than one time period that convergences with another is an awesome event and can translate into a verylucrative setup. The time frames of numbers that target a specific pricelevel is termed confluence; in other words, the more corroborating numbersthat target a general area, the greater is the significance of that specific targeted price level. Pivot calculations work to pinpoint almost exact timesand prices for trades in various markets and can be used to validate otheranalysis. Remember this phrase: “There is always strength in numbers!”The more pivot numbers that line up, the greater is the potential for a reaction off those levels. This knowledge, combined with identifying the shift inmomentum by identifying and acting on strong triggers, increases the probability of a successful trade.As an example, Figure 5.14 shows the daily, weekly, and monthly pivotpoint numbers drawn across the chart; this gives a trader a heads up thatthe market may reach an unsustainable extreme or oversold market condition. Just by looking at the graph, you can see that the market has been ina prolonged downtrend. Generally, the market may stop its descent at a
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FIGURE 5.14
confluence support zone; then you would want to wait for a shift in momentum to trade a potential price reversal. When the market starts to giveclues as to a bottom, you can determine a low-risk entry, as a bottom hasbeen defined. What would not be known is how high the market’s reactionwill be off this target level of support. This is where the candle chart sectionwill play an important role in helping to determine the strength of thetrend’s reversal.In Figure 5.15, we have a weekly stock chart on Alcoa. Here we see aconfluence of two higher-degree time periods, such as the weekly andmonthly support numbers. What is uncanny is that the weekly pivot S-1 target low number was 22.33, with the actual low coming in at 22.28, just pennies below the pivot support number. The monthly number lined up a littlehigher than that at 22.99, which is a slightly wider margin of error. Remember, when I am trading, I am not looking to catch a falling knife by anticipating a bottom, even though in this example you could have placed a buyorder at the weekly number; and as the price moved through your buyorder, you may have been filled—and that was a great buy. However, thebetter course of action, and the more reliable method to trade off this confluence area, was to wait for a confirmed buy signal, such as the high closedoji signal (we go over that in Chapter 7). Notice the moving averagecrossover and that prices confirm a conditional change in the market byclosing above the open and closing above both moving average components. The true buy signal was generated at 24.20, and the risk would beusing a stop below the low at 22.28.
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FIGURE 5.15RealTick graphics used with permission of Townsend Analytics, LTD.
Volatility Is GoodAs long as there is trading volume—liquidity so you can enter and exit positions and price movement, otherwise known as volatility—pivot pointanalysis will work in any market for position traders and short-term daytraders. No matter what your choice is for a trading investment vehicle, itmakes no sense that you would not want to incorporate this methodologyinto your trading style. Let’s examine the chart in Figure 5.16, which is adaily look at a spot forex euro currency versus the U.S. dollar. The monthlyS-2 target low was 116.90, the weekly S-1 lined up in close proximity at116.58, and the actual low was 116.41. Looking at the market’s reactionthree days after the low, we see a bullish engulfing pattern. The confluenceof pivot support numbers gave one of the best and only predictive supporttargets. Therefore, it should be noted that the longer-term numbers shouldbe watched carefully for clues not only for trading opportunities to enterpositions but also as a warning that the current trend could be exhaustedand potentially reverse. At the very least, you may not have wanted to es-
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 5.16RealTick graphics used with permission of Townsend Analytics, LTD.
tablish a long position; you certainly would have been alerted not to sellshort at the low.Let’s examine the 15-minute candle chart in the 30-year Treasury bonds(T-bonds) shown in Figure 5.17. Once again, the market price scrapesagainst the lows, and a hammer pattern forms the exact bottom. But noticethat the weekly pivot S-1 support target is 11214⁄32, which coincides with thedaily S-1 support target of 11220⁄32. The actual low was 11415⁄32! Notice that themarket broke the daily support but did not make much of a decline and certainly did not remain below the support for a long period of time. Thatleads me to this point: There are those who believe that once a supportlevel is violated, you should go with that breakdown momentum and sellshort. That may work occasionally, but it needs to be defined in more detail, with a list of special rules and certain criteria in order for that to be anautomatic trading rule for me to initiate a trade. I believe that you shouldlook for buy signals at support and for sell signals at or near resistance, especially when there is a confluence of pivot point price targets. It is morefruitful in buying the projected support, as this example shows.In Figure 5.17, we see a trigger to go long after the high close doji trig-
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FIGURE 5.17Used with permission of esignal.com.
ger is made at 11218⁄32 (notice that the low was also formed by a hammer). Asthe market goes into trend mode and rallies nearly a full basis point higher,the signal to liquidate occurs once we see prices change conditions. As thecandles indicate, prices are closing below each period’s open; a lower closing low from a doji top occurs and the moving averages cross; and, finally,the market price closes below both moving averages. That triggers the exitat 11314⁄32. This was a 28-point (each thirty-second is 31.25 per point) gain for$875.00 profit per position on a day trade.
CONFLUENCES WORK AT TOPSWe have all heard in the field of technical analysis that what works forsome patterns or signals is not applicable for all situations. However, thepower of pivot point confluences does work at market tops as well as working to indicate bottom reversals, as we just went over. In Figure 5.18, onceagain the three main time periods that we use are the monthly, the weekly,and the daily. When a congestion of pivot numbers line up, or cluster, near
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FIGURE 5.18
a specific price zone, this heightens your awareness for possible reversals.It is important to note that if a market has been in a long uptrend, say formore than two months, and if the end of the quarter is near, the market isripe for a profit-taking correction. Generally speaking, professional tradingmanaged funds receive payment by a performance fee (profits) at the endof a quarter. Since many of these large trading entities use pivot analysis orare aware that others use them, when a confluence of resistance develops,especially near the end of a quarter, look out below. It not only marks aprime price level but also indicates a specific reason why a profit-takingcorrection can occur at that time period. The same holds true for bottoms.After a long price decline, if the numbers line up and if it is near the end ofa quarter, a profit-taking reversal could be in the works. That does not meanto say that the original trend won’t resume, but you could take a great countertrend reversal trade. Generally speaking, market sell-offs have more velocity; therefore, spotting resistance confluences can result in verylucrative opportunities, under the right circumstances.Earlier, I explained the saying “There is always strength in numbers.”The concept can be explained further in that there is a strong analyticalvalue found in the number three, not just in trading and technical analysisbut also in our universe. As you may be aware, the number three is a Fibonacci number; and when I look at confluences in the three different timeperiods, “three” represents the three different groups of traders. The dailynumbers are used by day traders, the weekly numbers are used by swingtraders, and the monthly numbers are used by longer-term position tradersand institutions. Even in the Commodity Futures Trading Commision
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TABLE 5.1
Japanese Yen Spot Forex
Prior Period
High
Low
Close
Monthly—NovemberWeekly—12/02/2005Daily—12/02/2005
119.95121.24121.24
116.37118.33120.19
119.80120.59120.59
(CFTC) COT report, there are three classifications of traders: reportable,commercials, and non-reportable. The number three is a highly correlatednumber in market analysis. The coincidental factor in pivot pont analysesderives from the fact that one set of numbers from one time frame generally has nothing to do with another. If you look at the data for the Japaneseyen spot forex data in Table 5.1, you will see that the high and the close ofthe week coincided with the daily high and close, as that was on a Friday.Let’s look at Figure 5.19 and see how the numbers in the spot forexJapanese yen line up. The market made a tremendous price move from the
FIGURE 5.19RealTick graphics used with permission of Townsend Analytics, LTD.
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
low of 108.76 on September 5, 2005, until the high was made on December5, 2005, at 121.40.Let’s review before we go further. If you recall in Chapter 1, I statedthat forex traders can borrow information from the futures industry. Onesuch piece of data is the CFTC Commitment of Traders report. In essence,this report reveals whose hands “control” the market. Except for the yen, allcurrencies are quoted as the currency versus the U.S. dollar. The yen futures are quoted as the opposite—as the spot forex markets. So spot forexwould quote the yen as 117.35; the futures quote would be .8572. What thismeans is that when the CFTC report shows a net short position, traders arein a long position in the spot yen forex markets against the dollar. As theCFTC report showed at the end of the trading session as of 11/29/2005, thefunds, or the “non-commercials,” were long 22,626 contracts and short86,626. That is a net short position of 64,000 contracts. Each contract is1,250,000 worth of yen! The “commercials” were long 154,396 contracts andshort 85,604 positions. The small speculators were long 29,368 contractsand short 34,160 positions. This means the banks, or “smart money,” established a protective hedge position in the futures, betting that the spot yenwould fall in value against the dollar. Keep in mind that the non-commercials are considered professional speculators; they, too, are considered thesmart money. The difference is that they are speculating and will not generally take delivery of a futures contract, which is 1,250,000 worth of Japanese yen.If we examine Figure 5.19 closely, we notice that after a substantialprice appreciation in a relatively short period of time, prices hit just past themonthly R-1 of 121.04. Remember that the low on September 5, just threemonths earlier, was 108.76. So the market made a huge up move, and thebanks and institutions or commercials were betting prices would fall. Theends of the year and of the quarter were closing in, and we were hitting upagainst a confluence of pivot point resistance. The weekly R-1 was 121.77;and on the day the actual price high occurred at 121.40, the daily pivot R-1was 121.16. When we combine the pivot point resistance levels with a fewbearish candle patterns, such as the rickshaw doji that formed the day before the high or the trigger to initiate a sell that occurred on the third dayafter the target high was made you have a high chance to see a negativemarket reaction on price reversal. Market tops that align with a cluster, orconfluence, of various pivot points can result in tremendous market reversals, as this example shows, especially as they coincide with a major consensus reading toward the end of the quarter.The power of a sell-off does not necessarily have to occur near the endof a quarter. In equities, end-of-year tax-loss selling prevails; and at thefirst of the new year, as pension funds are buying stock, others are lookingto cash out their profits for tax deferment purposes. As the Chicago Board
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FIGURE 5.20RealTick graphics used with permission of Townsend Analytics, LTD.
of Trade (CBOT) mini-Dow chart in Figure 5.20 shows, the monthly targetresistance R-2 was 11105, the weekly R-1 was 11101, and the daily pivottarget number was 11076 on 1/11/2006. The exact high was 11086! That topmarked a 413-point decline, as the low was 10673 just six trading dayslater. The power of pivot point confluence from the prevailing three timeperiods demonstrated that there was significant resistance; and the actions of the three groups of traders may have joined together in identifyingthat area as a spot to sell. In Table 5.2, we see that the data collected to determine the pivot point resistance levels from the three time frames wereall noncorrelated to some degree. The closing, or settlement, prices allhad different values, as did the highs and lows of each time frame. The purpose for identifying a confluence zone is to heighten your awareness thata potentially substantial move may be on the horizon and that a bigger reversal reaction may occur, giving a trading opportunity longer than a daytrade. Once you identify an opportunity, you can apply a strategy. In thiscase, you might have been able to make a choice among selling Dow futures, buying put options on the futures, or selling the exchange tradedfund (ETF) diamonds.
150TABLE 5.2
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
Pivot Point Confluences for Dow
Prior Period
High
Low
Close
Monthly—December
11007
10728
10744
Weekly—1/06/2006
11014
10720
10998
Daily—1/10/2006
11058
10990
11052
In fact, let’s look at the actual chart pattern on that day to see what occurred. In Figure 5.21, the date and time are stamped at the bottom of thegraph; and you will see we have a 15-minute candle chart showing that thehigh was made at the end of the day, formed by a pair of shooting stars followed by a doji.These candle formations are very ominous signs indicating a bearishtone; but, due to the end of the trading day, it hardly makes for a trading opportunity for a day trader to take a short position. However, the data didgive a trader a great opportunity to look at a profit objective from an earlierlong position, as the confluence of pivot point resistance levels and the
FIGURE 5.21Used with permission of esignal.com.
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FIGURE 5.22RealTick graphics used with permission of Townsend Analytics, LTD.
candle patterns confirmed that the bullish momentum was fading. In addition, once the market confirmed a top pattern, the day trader would be ableto shift his or her trading plan from buying breaks to taking selling opportunities as the trend conditions changed and there was overhead pivotpoint resistance.Looking at Figure 5.22, we see how the pivot points from the threetime frames (daily, weekly, and monthly) target the high near the 1300level. The actual high was 1301.In Table 5.3, you can see that the three sets of data (high, low, and
TABLE 5.3
Pivot Point Confluences for S&P
Prior Period
High
Low
Close
Monthly—December
1285.00
1251.25
1254.75
Weekly—1/06/2006
1293.00
1251.50
1291.75
Daily—1/10/2006
1296.75
1289.25
1296.00
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
close) from three different time periods are different values. So the coincidental factor really highlights the importance of pivot point confluences.In Figure 5.23, the confluence of pivot points in the CBOT 30-yearbonds shows a setup similar in resistance levels to both the S&P and theDow in the examples in Figures 5.20 and 5.22 from the daily chart perspective. In fact, in this case, the bonds peaked nearly at the same time as the equity markets. This is a great point to bring up now; we will see periods inthe market where intercommodity or intermarket relationships change.Stock and bond prices go in phases of parallel price moves, and then thereare periods in time where they decouple. Generally speaking, when interestrates decline, bonds and stocks move higher. Then there are times whenstocks move sharply lower and bond prices move higher because they offersecurity, which is known as a “flight to quality.” And then there was 2005,when interest rates were rising and stocks and bonds moved in sync. Knowing when these changes in market relationships occur is helpful; however,it is best at times to trade the markets independently of each other. This iswhere identifying pivot point confluences based on two or three time
FIGURE 5.23RealTick graphics used with permission of Townsend Analytics, LTD.
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Pivot Points
TABLE 5.4
Pivot Point Confluences for Bonds
Prior Period
High
Low
Close
Monthly—December
115
11183⁄ 2
11463⁄ 2
Weekly—1/13/2006
114243⁄ 2
11333⁄ 2
114223⁄ 2
Daily—1/17/2006
114303⁄ 2
114113⁄ 2
114283⁄ 2
frames will help you as a trader because you have predetermined price targets figured out in advance.As Figure 5.23 shows, the daily and weekly numbers were more accurate in determining the top. The monthly number was slightly higher by 10⁄32,a small margin of error. The important element to remember here is that weare not looking to pick an exact top; rather, we are looking for a reason andan area that offers a high degree of accuracy in helping to pinpoint a top ora bottom and then looking for a secondary signal to trigger, or initiate, atrade. The importance and coincidental factor in the theory of confluencesis once again that the numbers derived from the various time frames aregenerally noncorrelated. Table 5.4 shows that the high in December wasfrom a different time period and had an assigned value different from theweekly or daily number; and the same holds true for the low and the closing values.The relationship that exists between geopolitical issues and economicconditions (such as inflation, interest rates, foreign currencies, and gold)from a historic perspective has been easy to track. In general terms, attimes when the dollar goes up in value, gold prices decline. When interestrates climb, lease rates are more expensive, therefore putting downwardpressure on gold. Gold prices also move higher as investors buy gold as asafe haven investment, as it acts as cash as well in times when doubt exists over the stability of a country’s economic condition or when currencyvalues change, as happened in the middle of 2005 when dissention amongeuro zone countries existed and riots due to political instability in Francedeveloped.By late 2005, the dollar rallied as interest rates climbed, widening theinterest rate differentials between the United States and foreign countries.Gold rallied sharply higher on these events, from the low on February 8,2005, at 410 per ounce. By the end of 2005, gold had made a high of 540 perounce. By January 20, 2006, gold continued its ascent by making a high at568.50 in the February futures contract.The market had made a sharp rally, but the confluence of resistancenumbers held the market back, as shown in the 15-minute chart in Figure5.24. In this chart, you will see the bearish engulfing pattern form as the
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 5.24Used with permission of esignal.com.
market makes a violent reversal. Longer-term prices did recover and movedeven higher as of the writing of this book. The point is that by using pivotpoints combined with candle patterns, you can time your entries and exitsin the market for a better price point. That is an outstanding advantagefrom a risk-reward perspective.In this example, prices did stall over time before continuing higher.However, the weekly and monthly resistance targets kept prices in a consolidating pattern, as you can see from the daily chart in Figure 5.25. It is interesting to note that the exact high was formed by a shooting star pattern.The value in using and identifying these confluence levels is that atrader/analyst/investor is given both elements for successful trading: priceobjectives combined with a specific time period. It is up to the trader tomanage a trade or to identify the magnitude of the reversal. Not all outcomes are the same, but the markets do react off these numbers; so that iswhy we are looking to combine pivot point analysis with another dimensionof market analysis.The second part of the trading equation using pivot points is combiningthe idea of how to filter the numbers to help identify which support or resistance numbers to use to determine market condition. Remember we cov-
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FIGURE 5.25Used with permission of esignal.com.
ered the fact that in a bearish market condition, the actual pivot pointwould act as resistance. Confluence, or the cluster of support or resistancenumbers, also works within a specific time period. For example, when theactual pivot point lines up at or near the market direction number or moving average of the pivot point and a resistance target number, we shouldstudy that specific price zone for signals that indicate a shift in momentum.This is the part where we need to comprehend what the charts and price action are revealing.Candle patterns do just that in a clear visual manner. As you look at Figure 5.26, you will see that the exact high of the trading session on 1/20/2006was formed by a doji. A confluence existed with the lining up of the dailypivot point, the market direction numbers, and the R-1. The market nevereven had the strength to test the resistance levels. By the end of the day, theDow fell another 100-plus points from the last price you see on this chart—the low was 10673 that day. Once the low close doji signal occurred and theshift in momentum occurred by making lower closing lows, a sharp sell-offdeveloped.The September 2004 Active Trade Magazine published an article Iwrote and made it a cover story. It was on the power of pivot point conflu-
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 5.26Used with permission of esignal.com.
ence and how calculating pivot points on more than one time frame canhelp identify certain price levels that are likely to repel prices. The article(p. 68) was titled “Pivot Points and Right Side Chart Analysis.” You mayhave read that article or seen the issue—it was the one with President Bushand Senator Kerry on the cover. The article’s focus was on not only entryprices and risk management, but also profit objectives and how to tradearound the support and resistance numbers. What was most interestingabout that article was the fact that the confluence of daily, weekly, andmonthly numbers lined up near 1160 (see Table 5.5) and the exact high forMarch 5, 2004, was 1163.50.
TABLE 5.5
Confluence
Time Frame
Confluence Number
Monthly R-1Weekly R-2Daily R-2
1161.501162.001159.25
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The average price level derived from the confluence numbers was1161.00. The high for the year took less than 15 minutes to form and wasmade by a doji and a shooting star on a 5-minute chart, as Figure 5.27shows. That high held for 11 months, until after the November elections.The point to this example is that the power of confluence worked to repelprices. The outcome can be different each time, meaning we don’t knowwhat the percentage of retracement of price reversal will be. The generalidea, however, is that as a trader you should respect the notion that themarket will at least pause and more than likely generate a significant trading opportunity.The particular setup that initiated a sell signal was my signature lowclose doji trigger, one of the patterns on which we go into detail in the nextfew chapters! This pattern and the high close doji at or near pivot point support targets are the highest probability trade signals I use.
FIGURE 5.27Used with permission of esignal.com.
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
SUMMARYRemember that pivot point support and resistance levels are a great gaugeof what a potential turning point or a predicted range in a given time periodwill be. The more time periods or confluence of target numbers that line up,the higher is the probability that a strong market reaction will occur. Therefore, it is important to raise your attention when prices reach these predicted price support and resistance numbers. If you apply proper risk andtrade management techniques, as will be covered in the next few chapters,you should see a tremendous turnaround in your trading performance.
CHAPTER 6
Pivot Point MovingAverage System
he moving average is one of the most widely utilized indicators intechnical analysis because the moving average is easily identifiableand easy to back-test. Many automated trading systems use movingaverages or some derivative of a moving average to generate buy and sellsignals. Moving averages are considered classic indicators and are verypopular with traders today. Most technicians view the moving average as away to signal a change in the direction of the trend, as well as a way tosmooth out the volatility of the market. In Chapter 2, we covered a key component in understanding the concept of trend, which in essence gives youthe ability to understand the concept of momentum. Remember this: “In abullish environment, buying begets buying.” Higher closing highs bringhigher highs as momentum and assigned values (the closes) are justified.The law of physics that states that “a body in motion tends to stay in motionuntil a force or obstacle stops or changes that motion” applies in this scenario because higher assigned values can induce more buying from existingbuyers and can attract new buyers. Once again, the opposite is true of abearish market: Lower closing lows bring lower lows as momentum and assigned values are justified. The lower assigned values induce more sellingby existing sellers and can attract new sellers into the market.When prices have appreciated and all buyers have exhausted their resources to add more long positions in a bull market, prices have reachedwhat is known as absolute value. Prices will more than likely consolidatefor a period of time before they change direction and reverse lower invalue. The opposite is true in a downtrending market. An important com-
T
159
160
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
ponent to remember is that price action typically moves from trend phaseto congestion and can either continue with the original trend or reverse thetrend. Momentum and the psychology of the perception of the value of agiven market in a given time period are what will move prices from a consolidation, or congestion phase, back to a trending condition.
DETERMINING TREND DIRECTIONSimply put, one way to determine the trend is by drawing trend lines. Inan uptrend, we should see a sequence of higher highs and higher lows, sowe would draw a line against the lows and extend it outward to forecast asupport level sometime in the future. In a downtrend, as the sequence ofevents shows lower highs and lower lows, we would draw a line against thetop of the highs and extend it outward to help forecast a resistance point inthe future.Another method used in determining trend line support and resistanceis through the use of moving averages. The most popular method of using amoving average is to average the closing prices (sometimes referred to asthe settlement prices) of a defined number of sessions. The moving averageis a lagging indicator. The purpose of the moving average is to indicate thebeginning and the ending of a trend. Since the moving average follows themarket, the signals it generates occur after the trend has already changed.It is argued that most traders (or about 70 percent) lose their money in themarkets. If the reason is that most traders focus on moving average valuesthat are predetermined by default settings in their charting software packages or if they use the media’s favorite 200-day moving average, it’s no wonder that people lose. The majority are following the same indicator.
BEAT THE STREETAs Yogi said, “If you want to do better than the average bear, then you haveto think better than the average bear!” If you want to beat the Street, thenyou need to think better than the Street—use a different set of values or understand how signals are generated. You do not want to follow and trade offwhat everyone else is looking at; so when it comes to moving averages, youwant to look at a different set of conditions and time periods. Think for aminute: If lots of traders are watching for trade signals on 10, 20, and 50 periods and if the statement holds true that the majority of traders lose, thenwhy do you want to trade based off signals on those moving averages? Itmight serve you well to watch these indicators so you can see where others
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get in or out of trades, but certainly not to