PIVOT POINT ANALYSIS

This section will describe in full detail the principles behind the Mathematical calculations, the rationale behind the psychological impact that drives traders to make decisions around these levels. I will break it into separate sections to explain how it can be applied for short and long term Stock trading, how it applies to the Spot FOREX markets. Each investment vehicle has its own nuances, such as trading session hours, time periods in which volume flows change, contract sizes and decimal point placement so that you know how to correctly calculate the Pivot Point levels. First, you need to know the foundation of the methodology

of Pivot Point analysis: this will then allow you to apply i, ,0 the specific markets of interest that you are trading.

The power in using Pivot Analysis is that the strategy works in ali markets that have established ranges, based on significant volume or a large group of collective participants. After all, the current market price equals the collective action of buyers and sellers. Pivot Point analysis is a robust, time tested and best of all, testifiable form of market analysis. This means that you can back test to see the accuracy of this trader’s tool’s predictive analysis. The really unbelievable aspect of Pivots is who uses them. In fact, many traders feel compelled not to learn about them because they seem complicated. I will dispel that myth.

Pivot Point Analysis is the best “right side” of the chart indicator as I like to call it due to its predictive accuracy. It is a mathematical formula, originally developed by Henry Wheeler Chase in the 1930’s. Chester W. Kellner used part of the formula to develop the Kellner Bands as described In his book, How make money in Commodities, which was released back in the 1960’s.

However, it was really Larry Williams who was credited with re-popularizing the analysis in his book, How I made a million Dollars Trading Commodities last Year, released in 1979. Don Lambert, the creator of the Commodity Channel Indicator, the CCI as it is known, uses the Pivot Point formula that makes CCI work.

In my first book, The Complete Guide to Technical Trading Tactics, I illustrated many trading methods that one can apply using Pivot Point Analysis with Candlesticks Patterns, including the power of multiple time frames, or what is know as confluence of various target levels. This course will highlight those techniques as well as explain how to incorporate the Pivot Point as a moving average trading system, how to filter out and narrow the field of the respective support and resistance numbers and divulge various formulas that are popular today.

Pivot Point is a mathematical formula designed to determine the potential range expansion based on a previous time period’s data, which includes the high, the low and the close or settlement price. One reason why I believe in using these variables from a given time period’s range is that it reflects all market participants’ collective perception of value for that time period. In the beginning of the course I quoted Jesse Livermore as stating, “The patterns the traders and technicians observe are simply the reflections of human emotional behavior”. The range, which is the high and low of a given time period, accurately reflects all market participants’ exuberant bullishness and pessimistic bearishness for that trading session.

The high and low of a given period is certainly important, as it mirrors human emotional behavior. Also, the high is a reference Point for those who bought out of greed thinking they are missing an opportunity. They certainly won’t forget how much they lost and how the market reacted as it declined from that level. The opposite is true for those who sold the low of a given session out of fear they would lose more by staying in a long trade; they certainly will respect that price point the next time the market trades back at that level too. So the high and low are important reference Points of interest. With that said, Pivot Point analysis incorporates the three most important elements, the high, the low and of course the close of a given trading session.

The most common formula is:

Some analysts are adding a third level to their Pivot calculations to help target extreme price swings that have occurred occasionally, such as a price shock resulting from a news event. It seems that I have noticed that the spot FOREX Currency markets tend to experience a double dose of price shocks as they are exposed to foreign economic developments and US economic developments that pertain to a specific country’s currency. This tends to make wide trading ranges. Therefore a third level of projected support and resistance was calculated.

There are other variations which include adding the opening range, which in this case, would involved simply taking the Open, High, Low and Close and divide by four to derive the actual Pivot Point. Since there is no formal opening range, one can use the close of 5 PM (ET) and assign the next day’s US session open as 8 AM (ET). This method works best in markets that have official close and open sessions such as Futures and equity markets. However I wanted to show you various methods of how others are using Pivot analysis.

Let’s go over together and see what these numbers mean and how price action reacts with these projected target levels. Here is how the numbers would break down by order, what typically occurs and how the market behaves. Keep in mind, this is a general description and we will learn what to look for at these price Points to spot reversals in order to make money. First, let me state that I personally do not use the R-3 or S-3 levels.

The reason is simply this, I believe in looking at the progressively higher time period’s price support or resistance projections. For example, from the daily numbers, I would look at the weekly figures and then from the weekly numbers I would look at the monthly numbers. The longer the time frame, the more important or significant the data. Also, it is rare that the daily numbers will trade beyond the extreme R-2 or S-2 numbers and when the market does, it is generally in a strong trending condition. In this case we have methods to follow the market’s flow, and we will cover this in more detail in the next few sections. By focusing on just a few select numbers and learning how to filter out excess information, I eliminate the analysis paralysis from information overload.

Resistance Level 3 – extreme Bullish market condition generally created by news driven price shocks. This is where a market is at an overbought condition and may offer a day trader a quick reversal scalp trade.

Resistance Level 2 – bullish market price objective or target high number for a trading session. It generally establishes the high of a given time period. The market often sees significant resistance at this price level 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 consolidating trading periods, this often acts as the high of a given session. In a bearish market condition, prices will try to come close to this level, but most times will fail.

Pivot Point – This is the focal price level or the mean, which is derived from the collective market data from the prior session’s high low and close. It is the strongest of the support and resistance numbers. Prices normally trade above or below this area before breaking in one direction or the other. As a general guideline, if the market opens above the Primary 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 number in 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 low number. The market often sees significant support at or near this level in a bearish market condition and is a likely target level to cover shorts.

Support Level 3 – In an extremely bearish market condition, this level will act as the projected target low or support area. A price decline to this level is generally created by news driven price shock. This is where a market is at an oversold condition and may offer a day trader a quick reversal scalp trade.

Daily, Weekly and Monthly time frames can and should be utilized as well. To understand how price moves within the Pivots, begin by breaking down the time frames from longer term to shorter term. As traders, we should begin with a monthly timeframe, where there is a price range or an established high or low for a given period and this range, with its price points, is what we as traders should be looking for. Here is how I utilize it in my research. There are approximately 22 business days, or about four weeks. Every month there will be an established range – a high and a low. There are typically five trading days in a week. Now consider that in one day of one week in one month a high and a low will be made. It is likely that this high and low may be made in a minute or within one hour of a given day, of a given week of that month.

That is why longer-term time frames such as monthly or weekly analysis should be included in your market analysis. In the world of 24 hour trading the most popular question I get from those studying and using Pivot Points is, “what are the times that you derive the High Low Close information?”.

There are many different people telling many different stories. Here is what I do and what seems to work the best for me. For starters, just keep things simple and apply some good old fashion common sense. If the Exchanges and the banking system use a specific time to settle a market, then that is the time period that should be considered for a “close”. They should know those are the rules that make money move. I want to follow the money flow.

■      Use the 5 PM ET, New York bank settlement close.

■      For the weekly calculations take the open from Sunday night’s session and use the close on Friday.

■      For the monthly calculations take the opening of the first day of the month to the close of the last day of the month.

PREDICTING HIGHS AND LOWS USING THE CALCULATIONS:

In figure 5, we have a good representation of how the R-3 down to the S-3 levels would line up based on a previous session’s, High, Low and Close data.

The hash marks between each level are the midpoint numbers. As you can see, this presents 13 price points to monitor. For most traders, including myself this is simply information overload. Using these 13 levels for each day, week and month would put 39 trading support and resistance numbers on your chart for each trading day. That may cause one to possibly go blind, or at the very least, create analysis paralysis. Granted, you may be right in stating you picked the top or bottom of each trading session, but it is impractical or highly unlikely that you can trade effectively using that information. What I am saying is that at times, it may help having the midpoints or R-3 or S-3 target levels in front of you, but I believe in keeping things simple and less is better. I use the numbers and the filtering method to help me select either the high the low of a given trading session and sometimes this works to project both the high and the low with amazing accuracy. Therefore it is important not to be burdened with information overload. Remember:

• Pivot Point Calculations help determine when to enter/exit positions.
• They help as a leading price indicator for traders.
• Pivot Points are used to project support & resistance or actual Highs and Lows of trading sessions.
• They help confirm other technical methods.
• Daily, weekly & monthly time frames should and can be used.
• Break down the time frame of a month. There are approximately 22 business days, about four weeks.

In every week there are five trading days. In every month there will be an established range, in other words a high and a low. In one day of one week in one month a High and a Low will be made.

It is likely that the high and the low may be made in a minute or hour of a given day of a given week in that month; that is why longer term time frames such as a monthly or weekly analysis should be used. Pivot Point Analysis relies on specific time frames in determining support and resistance levels for that timing element only, and infers that the analysis or calculations for the prior day will not be applicable in most cases two, three or four days later. The same principle goes for the Weekly and Monthly calculations, so at the end of that time period, new data must be recalculated.