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Pivots

Pivots

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03/18/2014

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Stocks & Commodities V. 18:2 (16-22): Pivot Points by Jayanthi GopalakrishnanCopyright (c) Technical Analysis Inc.
CLASSIC TECHNIQUES
Pivot Points
Classic techniques still work on charts at all timelevels, and the most basic charting technique is theidentification and development of pivot points. Takea look.ut your losses, ride your profits!
Thatadage should befamiliar to all traders,and it may buzzthrough their minds assomething taken forgranted but not easyto implement. Thepivot point techniquecan help you do both.Floor traders use pivot points to determine critical price andsupport/resistance levels. It is a relatively simple calculationthat can be jotted on the back of a trading card for easyreference. Off-floor traders who have the luxury of lookingat monitors with real-time datafeeds can adopt this techniqueas well.
C
ALCULATION
A pivot point is the price at which the direction of pricemovement changes. It is calculated using data from theprevious trading day. By looking at the high, low, and close,you can calculate the next day’s pivot point as well as supportand resistance levels.Many variations exist for calculating the pivot point and itsrelated support and resistance levels. Here are a few:
Traditional method 
Pivot point = (H + L + C)/3First support = (2 * Pivot) – HFirst resistance = (2 * Pivot) – LSecond support = Pivot – (H – L)Second resistance = Pivot + (H – L)
Variation 1
One variation involves adding the trading day’s open andcalculating the average of the four values. This takes intoaccount any opening gaps and also accounts for overnight orextended-hours trading. The formula changes to:Pivot point = (H
yesterday
+ L
yesterday
+ C
yesterday
+ O
today
)/4
1308.001305.501289.501287.50
   T   R   A   D   I   T   I   O   N   A   L   M   E   T   H   O   D   V   A   R   I   A   T   I   O   N   1   V   A   R   I   A   T   I   O   N   2
= Resistance 2
= Resistance 1
= Pivot Point
= Support 1
= Support 2
Today
Open
(1327)
Yesterday
FIGURE 1: PIVOT POINT CALCULATIONS.
Different methods are used to calculate thepivot point. Here, you see the results of the traditional method and two variations of it.
TRADITIONAL METHOD
Resistance 2 =1320.83Resistance 1=1313.17Pivot point=1300.33Support 1 =1292.67Support 2=1279.83
VARIATION 1
Resistance 2 =1327.50Resistance 1 =1326.50Pivot point=1307.00Support 1 =1306.00Support 2 =1286.50
VARIATION 2
Resistance 2 =1328Resistance 1 =1327.50Pivot point =1307.50Support 1 =1307Support 2 =1287
 by Jayanthi Gopalakrishnan
The support and resistance calculations remain the same.
Variation 2
Another variation of the calculation is to substituteyesterday’s close with today’s open. This also accommodatesopening gaps and extended-hours trading. The calculationchanges to:Pivot point = (H
yesterday
+ L
yesterday
+ O
today
)/3The calculations for the support and resistance levels remainthe same.Figure 1 shows the difference in results of the threevariations. I prefer using the traditional method to calculatethe pivot and support/resistance levels for the next day’strading. However, if the open is either a gap-up or gap-down day, I have found that the second variation may bemore effective.
I
N
 
THEORY
The pivot point should be the first place you look at to entera trade. Only when prices reach this point will you be able todetermine whether to go long or short and set your profitobjectives and stops accordingly. Generally, if prices areabove the pivot it’s considered bullish, and if they are below,it’s considered bearish.Suppose the price is below the pivot at the open and youdecide to go short at that point. The first price you will look at to cover is the first support level. Of course, you wouldrather hold onto the short position if there were an indicationthat prices will fall further. If traders are reluctant to lower
C
 
Stocks & Commodities V. 18:2 (16-22): Pivot Points by Jayanthi GopalakrishnanCopyright (c) Technical Analysis Inc.
CARL PRESCOTT
prices, you should cover your shortposition at the first support level.However, if you see prices continueto fall below the first support level,then you should place a stop-lossorder just above the first supportlevel and watch carefully.If prices fall further still, youwill have to use a trailing stop-loss and keep moving it lower totake advantage of higher profitmargins. Typically, the secondsupport level will be the expectedlowest point of the trading dayand should be your ultimate profitobjective. When prices reach thislevel, the last thing you want todo is go long. So cover your shortposition and stay out of themarket! You should opt to golong in your strategy only whenthe price retraces back to the pivotand penetrates it to go up towardthe first resistance level.The converse applies to anuptrend. If prices were above thepivot, you would enter a longposition and use the first andsecond resistance levels as yourprofit objectives.
A
PPLYING
 
IT
The technique
sounds
simple,and it seems as though it shouldbe easy to use. Unfortunately, itdoes not work all the time. Therewill be many occasions whenyou find that prices do not toucheither support or resistancelevels. It is best to use thistechnique for securities with awide price range and highliquidity. You must be veryselective and create a strategythat you intend to follow strictly.In Figures 2 and 3, the pivotpoints and support and resistancelevels using the traditionalmethod are plotted on the pricechart to determine thistechnique’s effectiveness. TheDecember 1999 Euro contractsrepresent a market in a tradingrange, and the Nasdaq 100 futuresrepresent a trending market. Theuse of pivot points does not seem
 
Stocks & Commodities V. 18:2 (16-22): Pivot Points by Jayanthi GopalakrishnanCopyright (c) Technical Analysis Inc.to reveal any significant differences between trending andbracketing markets, but this could be because you are onlylooking at the data for one day. What is important here is thatmarkets have different patterns, and it is best to analyze themprior to applying pivot points.Since this technique is useful for short-term trading, it maybe worth your while to determine the short-term trend.Analyst Neil Weintraub introduced a methodology to helpdetermine both the daily and short-term trends using pivotpoints. Besides looking at just the pivot points, he also usestheir average. The period you use for calculating the averagedepends on what works best for you.After experimenting with various periods, I found thethree-day average of the pivots to be the most useful withwhich to determine the daily trend. I update the three-dayaverage on a daily basis and compare it to the pivot point. If 
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1030010400110001050010600107001080010900
DATE
      P      R      I      C      E
= Resistance 2
= Resistance 1
= Pivot Point
= Support 1
= Support 2
December 1999Euro contracts
DATE
      P      R      I      C      E
250026002700280029002400230022003000
December 1999NASDAQ 100 futures
   9   /   2   7   /   9   9   9   /   2   8   /   9   9   9   /   2   9   /   9   9   9   /   3   0   /   9   9   1   0   /   1   /   9   9   1   0   /   4   /   9   9   1   0   /   5   /   9   9   1   0   /   6   /   9   9   1   0   /   7   /   9   9   1   0   /   8   /   9   9   1   0   /   1   1   /   9   9   1   0   /   1   2   /   9   9   1   0   /   1   3   /   9   9   1   0   /   1   4   /   9   9   1   0   /   1   5   /   9   9   1   0   /   1   8   /   9   9   1   0   /   1   9   /   9   9   1   0   /   2   0   /   9   9   1   0   /   2   1   /   9   9   1   0   /   2   2   /   9   9   1   0   /   2   5   /   9   9   1   0   /   2   6   /   9   9   1   0   /   2   7   /   9   9   1   0   /   2   8   /   9   9   1   0   /   2   9   /   9   9   1   1   /   1   /   9   9   1   1   /   2   /   9   9   1   1   /   3   /   9   9   1   1   /   4   /   9   9   1   1   /   5   /   9   9   1   1   /   8   /   9   9   1   1   /   9   /   9   9   1   1   /   1   0   /   9   9   1   1   /   1   1   /   9   9
= Resistance 2
= Resistance 1
= Pivot Point
= Support 1
= Support 2
AB
the daily pivot is higher than the three-day average, it isindicative of a positive trend. If, on the other hand, it is lower,that indicates a negative trend.Next, I look at the five-day moving average to determinethe weekly trend. If the pivot is above the average, abullish trend is indicated. If it is below, that is a bearishsign (Figure 4).If both the daily and weekly trend shows bullish strength,I consider going long. Conversely, if both show a bearishtrend, I consider shorting. If there are conflicting signals, Istay out of the market. This method helps to get a broaderpicture of the market.
S
TRATEGY
When using pivot points to determine entry and exit points forthe following day’s trading, I use the following strategy:
= Pivot Point5-day MABULLISH BEARISHEntershortpositionsEnterlongpositions
FIGURE 2: PIVOT POINTS, SUPPORT AND RESISTANCE LEVELS FOR DECEMBER 1999EURO CONTRACTS.
 
The second support level is touched or penetrated more frequentlyduring a downtrend, and the second resistance level is penetrated or touched morefrequently during an uptrend.
FIGURE 3: PIVOT POINTS, SUPPORT AND RESISTANCE LEVELS FOR DECEMBERNASDAQ 100 CONTRACTS.
 
Here as well, prices touch or go below the second support levelmore frequently during a downtrend, whereas the second resistance level is penetrated ortouched more frequently when prices trend up.
FIGURE 4: PIVOT AND THE AVERAGE.
In looking at the five-day moving averageto determine the weekly trend, if the pivot is above the average, a bullish trend isindicated, but if it is below, that is bearish.
FIGURE 5: PIVOT STRATEGY.
When using pivot points to determine entries andexits, here’s a strategy to use.

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