pivot point analysis, including the power of multiple time frames or what isknow as confluence of various target levels. This book will highlight thosetechniques, as well as explain how to incorporate the pivot point as a moving average trading system and how to filter out and narrow the field of therespective support and resistance numbers, and will divulge various formulas that are popular today.
MATHEMATICAL CALCULATIONSPivot point is a mathematical formula designed to determine the potentialrange expansion based on a previous time period’s data, which include thehigh, the low, and the close or settlement price. One reason why I believein using these variables from a given time period’s range is that they reflectall market participants’ collective perception of value for that time period.In the beginning of the book, I quoted Jesse Livermore: “The patterns thetraders and technicians observe are simply the reflections of human emotional behavior” [Richard Suitten, Trade Like Jesse Livermore (Wiley, 2005,p. 70)]. The range, which is the high and the low of a given time period, accurately reflects all market participants’ exuberant bullishness and pessimistic bearishness for that trading session. The high and the low of agiven period are certainly important as they mirror human emotional behavior. Also, the high is a reference point for those who bought out ofgreed, thinking they were missing an opportunity; they certainly won’t forget how much they lost and how the market reacted as it declined from thatlevel. The opposite is true for those who sold the low of a given session outof fear that they would lose more by staying in a long trade; they certainlywill respect that price point the next time the market trades back at thatlevel. So the high and the low are important reference points of interest.With that said, pivot point analysis incorporates the three most importantelements—the high, the low, and the close—of a given trading session.
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THE LEADING INDICATORThe definition of the pivot point is the average of the high, the low, and theclosing price. Pivot point analysis is mainly used as support and resistancelevels. The pivot point is the heartbeat of the analysis; without it, projectedranges and market condition cannot be determined. It does act as a supportor resistance level as well. Pivot point analysis helps as a leading price indicator for traders because it gives traders advanced indication of potentialhighs or lows or, in some cases, both in a given time period, unlike Fibonaccistudies, where there is no predicted time period in which a projected pricecorrection or projection will occur. I want to step up the concept so that youcan develop a trading system on some powerful setups and on what triggersa trade. As I disclosed, professional stock, forex, and futures tradershave had significant success in utilizing these “hidden lines”; and I thinkthat with a more thorough understanding of the concept, so will you.As a quick review, one of the main benefits for using pivot point calculations is that they help determine when to enter and when to exit positions. As a trader, you already know you can only book a profit when youexit; and if you don’t exit a losing trade quickly, it is hard to maintain, orkeep, what you have already made. Pivot points are used to project supportand resistance or actual highs and lows of trading sessions. These numbersare derived from a mathematical formula; there are several versions that,for your benefit, I will go into; but keep in mind that I still use the most common method to derive my analysis. Here are the most common formulas:• Pivot Point—the pivot point (P) is the sum of the high (H), the low (L),and the close (C) divided by three.P = (H + L + C)/3• Resistance Level 2—R-2 is the pivot point number plus the high andminus the low.R-2 = P + H – L• Resistance Level 1—R-1 is the pivot point number times two minusthe low.R-1 = (P × 2) – L• Support Level 1—S-1 is the pivot point number times two minusthe high.S-1 = (P × 2) – H
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• Support Level 2—S-2 is the pivot point number minus the high plusthe low.S-2 = P – H + LSome analysts are adding a third level to their pivot calculationsto help target extreme price swings on what has occurred on such occasions as a price shock news-event-driven market reaction. It seemsthat I have noticed that the spot forex currency markets tend to experience a double dose of price shocks beause they are exposed to foreigneconomic developments and U.S. economic developments that pertain to a specific country’s currency. This tends to make wide tradingranges. Therefore, a third level of projected support and resistance werecalculatedResistance Level 3—R-3 = H + 2 × (Pivot – Low) or (P – S-1) + R-2Support Level 3—S-3 = L – 2 × (High – Pivot) or P – (R-2 – S-1)There are other variations that include adding the opening range, inwhich case you would simply find the sum of the open, the high, thelow, and the close; and then divide it by four to derive the actual pivotpoint.P = (O + H + L + C) /4One more variation of that concept—to factor in gaps from adverseprice moves from one day to the next—is to take the previous session’shigh, low, and close, add in the new trading session’s open, and thenadd in those variables and divide by four. In using both open prices,you still calculate the extreme support and resistance levels with the sameformulas.P = (new O + old H + old L + old C) /4Let’s go over what these numbers mean and how price action reactswith these projected target levels. But first, let me state that I personally donot use the R-3 or S-3 levels because I believe in looking at the progressivelyhigher time period’s price support or resistance projections. For example,from the daily numbers, I would look at the weekly numbers, and then fromthe weekly numbers I would look at the monthly numbers. The longer thetime frame, the more important or significant the data. Also, it is rare thatthe daily numbers will trade beyond the extreme R-2 or S-2 numbers; andwhen the market does, it is generally in a strong trending condition, in
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which case we have methods to follow the market’s flow, which we willcover in the next few chapters. By focusing in on just a few select numbersand learning how to filter out excess information, I eliminate the analysisparalysis from information overload. Do yourself a favor and keep readingbecause this does get exciting. The following list shows how the numberswould break down by order, what typically occurs, and how the market behaves. Keep in mind that this is a general description. You will learn whatto look for at these price points in order to spot reversals so you can become more profitable from trading in the markets.• Resistance Level 3—Extreme bullish market condition generally created by news-driven price shock. This is where a market is at an overbought condition and may offer a day trader a quick reversal scalptrade.• Resistance Level 2—Bullish market price objective or target high number for a trading session. It generally establishes the high of a giventime period. The market often sees significant resistance at this pricelevel and will provide an exit target for long positions.• Resistance Level 1—Mild bullish to bearish projected high target number. In low volume or light volatility sessions or in consolidating trading periods, this often acts as the high of a given session. In a bearishmarket condition, prices will try to come close to this level but mosttimes fail.• Pivot Point—This is the focal price level or the mean that is derivedfrom the collective market data from the prior session’s high, low, andclose. It is the strongest of the support and resistance numbers. Pricesnormally trade above or below this area before breaking in one direction or the other. As a general guideline, if the market opens above theprimary pivot, be a buyer on dips. If the market opens below this level,look to sell rallies.• Support Level 1—Mild bearish to bullish projected low target numberin light volume or low volatility sessions or in consolidating trading periods. Prices tend to reverse at or near this level in bullish market conditions but most times fall short of hitting this number.• Support Level 2—Bearish market price objective or targeted lownumber. The market often sees significant support at or near thislevel in a bearish market condition and is a likely target level to covershorts.• Support Level 3—Extreme bearish market condition generally createdby a news-driven price shock. This level will act as the projected targetlow or support area. This is where a market is at an oversold conditionand may offer a day trader a quick reversal scalp trade.
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Most of the research and books written on technical analysis cover thetopic of trade entry and how to use indicators, oscillators, and moving average studies. Few go over how to target exits. Longer-term traders haveread the works done on volume analysis to help determine the strength orthe weakness of a trend. There is further information on consensus studies,such as the Commitment of Traders (COT) reports; the VIX, which is avolatility index, is based on calculations using options on the Standard &Poor’s (S&P) 500 Stock Index. Plus, the put-to-call ratio helps give investorsan idea if a trend is ready to change. None of these studies actually helps atrader with targeting a potential trading range in a given time period. Thatinformation will help a trader with setups and triggers on entering a position and, most important, exiting a position. This is where pivot pointanalysis will help you.Think for a moment: If most technical tools are lagging indicators andif most traders follow and use these trading indicators to make trading decisions, then it would make sense that most traders get trading signals andexecute entering into a position on a lagging basis or well after a move hasbeen established. Then, if the same indicator gives the exit signal too late,perhaps that is what perpetuates habit or the consistency of losing moneyin the markets, from entering or exiting later, based on lagging indicators.Then, in order to adjust getting in too late, traders anticipate a marketturn; and more times than not, that turns out to be a bad trading decision.Or traders may decide to just “hang in there” a while longer, thinking thatthe market may just return and give them back the sweet profits that werejust accumulated in the trade. That is a syndrome that many traders tell methey fell victim to. By using pivot point support and resistance levels, youcan speed up the analytical process on entries; and by employing certaintrade management techniques that we will go over in a later chapter, youcan effectively help improve your exits. After all, that is one of the most important aspects of trading. A profit is just a paper asset until a position isoffset. The offset relies on an exit strategy. Ask yourself this question: Howmany times have I been in a trade and thought I was doing the correct thingby letting my winners ride, by holding on to the position only to see mypaper profits erode and then perhaps turn into a loss? The flip side to thisis: How many times have I taken a quick profit, banked the money, and nomore than a few moments later watched the market explode dramaticallyfurther in the direction of my original position? Just when you say the market can’t move any further, that’s when it usually does. You need disciplineand patience to stay with a trade. These situations will likely happen; but byutilizing pivot points and by watching the market’s behavior at or nearthese levels, you will be better prepared to make better trading decisions,especially on exits.
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POSSIBLE OUTCOMES WHEN PRICES ARENEAR PIVOT AREAYou need to stay in the “now,” to focus on the current market condition orenvironment. Keep telling yourself that what happened in the past or perhaps even your last trade is of no concern to the current trade you are in.Remember that each trade will have a different outcome. The patterns wesee and the way a market behaves at or near a pivot point support or resistance level will be different. Therefore, the velocity and the magnitude of aprice move will vary every time. For example, as shown in Figure 5.1, pricescould come close to but not exactly hit the pivot level. That does not meanprices will do that every time. As Figure 5.2 shows, prices can exceed resistance by a small margin; this may invite you to buy a breakout of the resistance level and trap you into buying the high. Then, as Figure 5.3illustrates, prices can hit the pivot support number exactly, which doeshappen frequently. But if you program yourself to anticipate, that will bethe outcome every time; you will be in for a rude awakening due to the potential that Figure 5.4 represents the occurrence that sometimes prices justcome close and consolidate or congest near the pivot point support or resistance levels for a period of time before reacting off those levels. Onceagain, the market’s past performance is not indicative of future results; sowe need more information in the thought process to initiate a trade and toexit a trade. The pivot point levels will allow you to set up a particulargame plan; therefore, when you apply more layers of analysis, such as candle patterns and a moving average approach of the pivot point, that iswhere you will improve on your trading decisions, from both your entriesand your exits.
FIGURE 5.1
Prices could comeclose but not exact.
FIGURE 5.2resistance.
Prices exceed
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FIGURE 5.3
Prices can hitexactly at the pivot level.
FIGURE 5.4
Prices congest near
support.
DETERMINE THE RANGEData should be used for the all session trading markets with the close ofbusiness as the settlement price. In the futures markets, I do not use justthe U.S. markets’ open outcry trading session. Here is why: The night sessions of most markets include the Asian and the European markets; andthose participants do trade in U.S. financial markets. If an event took placethat caused a market to move and a trade price was recorded, then it is avalid price point and will be put in the history books as a trade occurring.Therefore, I consider that information as accurate from a valid trading session. Most U.S. retail or individual speculators may not be up at 3 A.M. (CT)trading off a market move; but potentially, professional traders are, andtherefore the information is considered valid. Gosh, even the exchangesseem to believe it’s valid since money moves into and out of an account ifa trade is made; so the high or low of that period should be considered.
MULTIPLE TIME FRAME ANALYSISDaily, weekly, and monthly time frames can and should be utilized as well.To understand how price moves within the pivots, begin by breaking downthe time frames from longer-term to shorter-term. So start with a monthlytime frame, for which, as you know, there is a price range, or an establishedhigh and low for that given period; so we should be watching these predictive price points as well. Think of this: There are approximately 22 businessdays, or about four weeks, in every month; and each month, there will be anestablished range—a high and a low. In a week, there are typically five trading days. Now consider that on one day of one week in one month, a highand a low will be made. It is likely that the high and the low may be made
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in a minute or within one hour of a given day of a given week of a givenmonth. That is why longer-term time frames, such as monthly or weeklyanalysis, should be included in your market analysis. It is also the reasonwhy I do not use the R-3 or the S-3 targets. I rely more on the longer-termtime frames targeted support and resistance levels. Pivot point analysis relies on data from specific time frames in order to determine support and resistance levels for the next particular trading session. It is prodictive andboth time- and price-sensitive information.The analysis or calculations for the prior day, week, or month may notbe applicable two or three sessions later. At the end of each time period,data will need to be recalculated. The exception to this rule is that if thereis a time period after a wide-range session that is a smaller range, then Iwould keep the data from the session with the wider range in mind for another one or two trading periods. For example, using a daily analysis, ifTuesday had a wide trading range and then Wednesday had a small range,I would keep the targeted support and resistance numbers derived fromTuesday in mind for Thursday’s session. The same principle applies to aweek or a month.In the world of 24-hour trading, the most popular question I get fromthose studying and using pivot points is, “What are the times that you derivethe high-low-close information from?” There are many different peopletelling many different stories. Here is what I do and what seems to workbest. For starters, just keep things simple and apply some good old-fashioned common sense. If the exchanges and the banking system use a specific time to settle a market, then that is the time that you should considera close. The exchanges and banks should know—their rules make themoney move. I want to follow the money flow.• Stock traders use the settlement price from the close of business at 4P.M. (ET).• Forex traders should use the 5 P.M. (ET) New York bank settlementclose.• Futures traders, in the e-mini–S&P, Nasdaq, and Russell contracts, usethe close of 3:15 P.M. (CT). For the Chicago Board of Trade (CBOT)mini-Dow contract, I take the close at 4 P.M. (CT).• For the weekly calculations, take the open from Sunday night’s session, and use the close on Friday.• For the monthly calculations, take the open from the first day of themonth, and use the close of the last day of the month.We have established the reasons why we use all sessions for extractingthe range, or high and low, and what time periods constitute the closes. Weknow where and how and when. Now, let me show you what pivot point
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FIGURE 5.5
projected supports and resistance line up to look like. In Figure 5.5, wehave a good representation of how the R-3 down to the S-3 levels would lineup based on a previous session’s high, low, and close data. The hash marksbetween each level are the midpoint numbers. As you can see, this presents13 price points to monitor. To most traders, including myself, this is simplyinformation overload. If you include using these 13 levels for each day,week. and month, that would put 39 trading support and resistance numbers on your chart for each trading day. That could cause a trader to possibly go blind or, at the very least, could create analysis paralysis. Granted,you may be right in stating that you picked the top or the bottom of eachtrading session, but it is impractical or highly unlikely that you can trade offthat information. I am not saying that at times it may help having the midpoints or R-3 or S-3 target levels in front of you; I just believe in keepingthings simple, and less is better.
FILTER OUT INFORMATION OVERLOADI have developed a method to filter out the pivot numbers; this is just onefacet that I explain to attendees of my trading seminars and to students.
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Keep in mind that this methodology applies to all markets, including stocks,futures, and especially spot foreign currency markets, or forex. Thismethod can work for a short-term application for identifying a potentialrange for a day, a week, or a month. By having a good idea, well in advance,of what the high or the low for a given time period might be, you are able touse this information to apply the right trading vehicle or strategy, such aswhether it is simply selecting an entry level or getting in or selecting a profitobjective or getting out of a trade. You could also determine whether toapply an option strategy or when to use an exchange traded fund, as wediscussed in Chapter 1.
Predicting Highs and Lows Using theCalculationsWhat I do to determine the potential range for a given session is to take theR-1 and the S-1 initially for my analysis, especially in low-volume consolidating trading sessions.I use the actual pivot point for many things; one that is useful is understanding that it can be used as an actual trading number in determining thehigh or the low of a given time period, especially in strong bull or bear market conditions. In an extremely bullish market condition, the pivot pointcan become the target low for the trading session. This number representsthe true value of a prior session. In an up-trending market, if the marketgaps higher above the pivot point, then a retracement back to the pivot willattract buyers. Until that pivot point is broken by prices trading below thatlevel, traders will step in and buy the pullback. The opposite is true in an extremely bearish market condition; the pivot point will act as the target highfor the session. If a news-driven event causes the market to gap lower, oncetraders access the news and discover it is not as bearish as thought, pricesmay trade back up to test the pivot point; if the market fails to break outabove that price level and trades higher, sellers will enter the market andtake action, pressing the market lower again.
Filtering the NumbersTechnically speaking, in a bearish market, the highs should be lower andthe lows should be lower than those of the preceding time frame. If theyare, then I use that information to help me filter out unnecessary data or excessive support and resistance numbers on my charts. I use the actual pivotpoint up to the R-1 number for resistance, and then I target the S-2 for thepotential low or for that time period’s trading range.As you can see in Figure 5.6, if I determine the market is bearish and if
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FIGURE 5.6
I understand the relationship of the geometric distance of the resistanceand support targets, I can eliminate the R-2 number, since in a bearish environment we should see a lower high. If I am looking for a lower low, thenI can eliminate the S-1 support number as well; and now I have reduced thefield to just three numbers. If I apply the same methodology on daily,weekly, and monthly charts, instead of 39 numbers, I am now working withjust 9 numbers. Once again, I am not using the numbers to place ordersahead of time (even though you could); I use the numbers as a guide. Thesenumbers work so well and often act as a self-fulfilling prophecy because somany institutions and professional traders do use them. Many have different size positions on. Some traders may not wait for the exact number tohit and may start scaling out of positions (as I do); and so should you. Withthis method, you can use these numbers as exit areas on your trades. AsFigure 5.7 depicts, in a bullish market environment, by definition you mayagree that the highs should be higher and the lows should be higher thanthose of the preceding time period. When I have determined that we are ina bullish trend, I target the S-1 up to the pivot point for the low of the session and the R-2 for targeting the high; and that will give me an idea of whatthe potential trading range will be.
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FIGURE 5.7
Lining Up the NumbersWhen the market goes through the projected daily target numbers, I thenuse the next time periods for a better gauge or reliability as to the next priceobjective. That is where the significance of the weekly and the monthlynumbers comes into play.Back in the late 1990s when I owned a brokerage firm, I developed amethod to help me line up the pivot point levels as shown in Figure 5.8; Ihad all my brokers use these numbers, and many still do to this day. Thetable of information was for the trading session of 1/18/2006.My method categorizes the pivot point levels to the various market conditions, such as neutral (Target Key) bullish, and bearish. I like to knowwhat the prior time period’s range and close were for fast access, so I included that in as well. Since the pivot point is important, I include that onthe sheet, as shown in the last column on the right. The third column fromthe right states Market Direction. That is a moving average of the actualpivot point.If the pivot point and the close or settlement price are below the market direction number, then the market condition is deemed to be in a bearish mode; and it helps me to line up the R-1 and S-1 numbers as theprojected target range for that next session. If you look down the far-left
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FIGURE 5.8Used with permission of www.nationalfutures.com.
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column to where you see “Bonds,” you will see that the market directionnumber classified the market condition as bullish due to the location of theprevious settlement and that the pivot point was above the pivot point moving average.The numbers targeted the high in bonds to be 11510⁄32 (R-2) and the lowto be 11416⁄32 (S-1). The pivot point was 11423⁄32.Since the market closed at 11428⁄32, there was a strong chance to see10115 ⁄32, as well as a low of 11416⁄32. Figure 5.9 shows the exact trading sessionactivity on a 15-minute candle chart. If you are a candle chart aficionado,you will have spotted that the high was formed by a shooting star patternand that the low was made by a bullish engulfing pattern. While the marketbroke out above the targeted resistance, it certainly did not stay there long.Notice how the price penetrated the low but reversed off the projected lowas well. We will use this chart later in the book as we share statistical information on which candle patterns have high frequency of forming topsand bottoms. At this point, just heighten your awareness that there was adoji after the star at top and a doji near the bottom.This chart also has another component—a moving average methodthat we will discuss a variation of as well. By using the true value of the
FIGURE 5.9
Bonds trade the predicted pivot range.Used with permission of esignal.com.
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market, which I refer to as the pivot point, we can help determine the market condition and the projected price ranges as well as potential turningpoints as market conditions change from bullish (uptrend) to bearish(downtrend).
Pivots Combined with CandlesThe CBOT mini-Dow is one of several great day trading futures products forselecting trades that connect with pivot and candle patterns as Figure 5.10shows. Notice how prices do penetrate briefly above the pivot targeted highby forming the shooting star candle. See the market’s reaction as the pricedeclines over 70 Dow points (each point is $5 on the mini-Dow). That is a$350.00 move in less than 75 minutes per contract. Since most futures firmscarry a $500.00 day trade margin per contract that translates into a healthyreturn. Now that we know how to line up the numbers, we need to wait fora setup or signal to trigger a short position. The shooting star, the movingaverage crossover, and the dark candles all confirmed a technical signalto sell.
FIGURE 5.10Used with permission of esignal.com.
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The graph in Figure 5.11 represents the e-mini–S&P 500 Stock IndexFutures on November 10, 2005; the targeted range was determined to be S1 and R-2, a bullish market condition. The actual low of the day was formedby a hammer candle pattern (keep notes of what candle patterns form neartops and bottoms, as we will be discussing this in detail in later chapters).A buy signal is triggered with the sequence of higher highs and higher lowsbut, more important, higher closing highs, as well. The moving averagecrossover also helps trigger a long buy signal. The market rallies right upwithin a tick or two of the R-2 number. As a day trader, it is great to have apredetermined exit strategy. In this case, pivot point analysis accommodated you in that respect. Other times, you will need to rely on your timingto exit a trade; for example, as a day trader, once the market is near theclose of the business day, you should be offsetting your position. In the example in Figure 5.11, you had a timing and a price element working for youto help target an exit on what was a beautiful trade. The trigger to go longwas after the crossover of the moving average one candle after 11:30, asprices established a higher closing high.This trade would have resulted in a stellar 12.50-point gain from the
FIGURE 5.11
Bonds trade the predicted pivot range.Used with permission of esignal.com.
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entry of 1221.50 up to the exit, which was 1233. The exit was triggered onthe first lower closing low and was confirmed by a close back under themoving averages. On a day trading margin per contract in the e-mini–S&Pof $1,000 (brokerage firms vary on day trading margins), you picked up625.00 per position.The next chart I want to show you in Figure 5.12 is an example of howa market, when targeted to be in a bullish mode, interacts with the series ofpivot support and resistance numbers. If there is a bullish bias, then S-1 upto R-2 will be the potential range. Therefore, we are looking to take buy signals at support and have a profit objective in mind near R-2. This is a 15minute candle chart using the mini–Russell Stock Index futures. Noticethat as the market trades near the pivot support of S-1, prices consolidatefor almost two hours before triggering the buy signal as a higher closinghigh and a crossover of the moving averages confirm the trigger to go longat 657.50.Prices penetrate the R-1 level and come close to the projected S-2 level.As the trading session ends, you still have no reason to exit the position froma technical standpoint except that as a day trader, your time is your exitpoint. This trade was good for nearly a 9.50-point run, or $950 per contract.
FIGURE 5.12Used with permission of esignal.com.
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Let’s look at a spot forex market in Figure 5.13. We are looking at theyen versus the U.S. dollar. The targeted resistance was the R-2; and as youcan see, the top was formed by an evening doji star formation, based on afive-minute candle chart. Combining the knowledge of how to determinethe right pivot level with practicing the discipline to wait for a signal willcertainly help you target and select better trading opportunities. As youcan see in this chart, on a $100,000 lot size, you would have realized over a100-point gain in less than two and a half hours. That translates to $1,000per lot or contract.Special note: Big moves do occur in forex during the U.S. nighttime.This trade signal hit at 20:00 hours, or 7 P.M. (ET). So depending on yourtrading capital and time constraints during regular market hours, the potential opportunities that abound in the spot currency markets may be suitable for you to take advantage of.
FIGURE 5.13Used with permission of esignal.com.
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THE IMPORTANCE OF CONFLUENCETime is an essential element in trading. There are many instances whentraders are correct in their predictions for a top or a bottom in a market;but they are off in their timing, which results in a loss. Many analystswere calling for a top or for the bubble to burst in the stock market in 1999.In that situation, not demonstrating patience to wait would have resultedin dramatic loss of profit potential or worse, actual losses due to sellingshort stock too early. How about economists’ predictions of a housingbubble back in 