Sunday, November 22, 2009
Monday, November 2, 2009
Pivot Points Trading
Using pivot points as a trading strategy has been around for a long time and was originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.
The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels.
Every day the market you are following has an open, high, low and a close for the day. This information basically contains all the data you need to use pivot points.The reason pivot points are so popular is that they are predictive as opposed to lagging.
Because so many traders follow pivot points you will often find that the market reacts at these levels. This give you an opportunity to trade.
If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.
The three most important pivot points are R1, S1 and the actual pivot point.
The general idea behind trading pivot points are to look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.
A perfect set would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.
If, after starting the day above the Pivot, the Price crosses back through the Pivot, the Pivot will act as a Resistance area. Pivot Points and Support and Resistance levels behave exactly like any historical Support and Resistance level.
Unfortunately life is not that simple and we have to deal with each trading day the best way we can. Combine these with simple channeling, retracement levels, past critical supports & resistances, SAR will enhance the success rate.
Pivot Points - Trading Methodology:
To make the discussion a bit less abstract, let's take a most superficial look at some simple trading methodology employing Pivot Points.
Step 1
"In general, if the day's Price Action starts above the Pivot, it will tend to stay above the Pivot.
This simple observation provides the basic rules for two of the simplest Pivot trading systems.
System 1:
Open is above Pivot: Buy
Open is below Pivot: Sell
System 2:
Place Buy and Sell stops bracketing the Pivot. Whichever is not filled acts as safety stop for the other.
These "systems" are very much too raw for my tastes. Too much chance of getting whipsawed. Let's take it one step deeper. Let's refine these simple systems just a bit more:
Step 2
First Fundamental Of Pivot Trading After the opening range (first 15-30 min. to one hour), if price is above/below the Pivot, Price Action will strongly tend to remain above/below the Pivot for the session.
Although this rule bids us to wait out the Opening Range and thus avoid much of the wildness and whipsawing, overlooking the next Fundamental Of Pivot Trading could be disastrous:
Step 3
If the market opens, or later trades at the extremes (R2, R3 or S2, S3), it will exhibit a tendency to trade back toward the Pivot. Thus, the general rule, 'Avoid buying the High or selling the Low', becomes increasingly more stringent as price moves farther from the Pivot.
I have picked 5 days of last week and what follows are some ideas on how you could have traded those days using pivot points.
The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels.
Every day the market you are following has an open, high, low and a close for the day. This information basically contains all the data you need to use pivot points.The reason pivot points are so popular is that they are predictive as opposed to lagging.
Because so many traders follow pivot points you will often find that the market reacts at these levels. This give you an opportunity to trade.
If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.
The three most important pivot points are R1, S1 and the actual pivot point.
The general idea behind trading pivot points are to look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.
A perfect set would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.
If, after starting the day above the Pivot, the Price crosses back through the Pivot, the Pivot will act as a Resistance area. Pivot Points and Support and Resistance levels behave exactly like any historical Support and Resistance level.
Unfortunately life is not that simple and we have to deal with each trading day the best way we can. Combine these with simple channeling, retracement levels, past critical supports & resistances, SAR will enhance the success rate.
Pivot Points - Trading Methodology:
To make the discussion a bit less abstract, let's take a most superficial look at some simple trading methodology employing Pivot Points.
Step 1
"In general, if the day's Price Action starts above the Pivot, it will tend to stay above the Pivot.
This simple observation provides the basic rules for two of the simplest Pivot trading systems.
System 1:
Open is above Pivot: Buy
Open is below Pivot: Sell
System 2:
Place Buy and Sell stops bracketing the Pivot. Whichever is not filled acts as safety stop for the other.
These "systems" are very much too raw for my tastes. Too much chance of getting whipsawed. Let's take it one step deeper. Let's refine these simple systems just a bit more:
Step 2
First Fundamental Of Pivot Trading After the opening range (first 15-30 min. to one hour), if price is above/below the Pivot, Price Action will strongly tend to remain above/below the Pivot for the session.
Although this rule bids us to wait out the Opening Range and thus avoid much of the wildness and whipsawing, overlooking the next Fundamental Of Pivot Trading could be disastrous:
Step 3
If the market opens, or later trades at the extremes (R2, R3 or S2, S3), it will exhibit a tendency to trade back toward the Pivot. Thus, the general rule, 'Avoid buying the High or selling the Low', becomes increasingly more stringent as price moves farther from the Pivot.
I have picked 5 days of last week and what follows are some ideas on how you could have traded those days using pivot points.
Divergence Trade
When divergences between price and momentum indicators (roc, rsi & macd)arise, it can lead to some very profitable, high probability trades.
These set-ups are counter trend tactics, and as such, one must employ a hard stop in the event that the trend reasserts itself and you are on the wrong side. Contrast this tactic with the principle: “Trends have a higher probability of continuation than reversal.”
When you play for a momentum divergence trade, you are always playing for a target closer to the price the divergences commenced and playing for a possible shift in buying/selling pressure. Before attempting any such trade, I suggest researching further on this potentially profitable topic.
Some of the most popular Oscillators/indicators for uncovering price divergences include the MACD, stochastic, RSI, Ultimate Oscillator, rate of change, etc. You have to discover which indicator works best for you. Indicators are used as ‘training wheels’ until you can develop an intuitive sense of determining where the buying and selling pressure (momentum of the move) are diverging with the price action. This process takes time, yet indicators can help highlight these conditions. There is no perfect indicator to do this. I am using a fast MACD oscillator in my chart example. You can also spot divergences in other momentum oscillators.
Momentum precedes price in that a slowing of momentum indicates that a possible change in price is yet to come. Do not get caught in the trap of searching for momentum divergences all over the chart. Examine them at the (possible) end of mature trends for greater probability. Again, we are not seeking the end of a trend move (reversal), but just a retest and a small target. In fact, we are playing for a simple retracement swing against the direction of the prevailing trend. This illustration may help:
We are in a mature uptrend and price is continuing higher. A situation develops where the buyers are becoming less aggressive in their momentum (force of buying pressure) and momentum is declining while price is not.
Of importance to note (and the reason behind the divergence in the oscillator) is also price based. Note the steep rise of the previous swing up (creating heightened oscillator/indicator readings) and then the more gradual rise of the second swing up (creating a lower peak in the mathematical oscillator). This sets up the divergence while the reason for it is declining momentum.
If momentum precedes price, then in this case, a decline in momentum forecasts a decline in price as the most probable swing play. If buyers are less aggressive to raise their offers, then it won’t take much effort for price to fall and those who own the stock will begin to sell.
This chart highlights momentum divergences finally reversing the trend:
Divergences are difficult to quantify for a mechanical system, so this is one area discretionary traders may have an edge over programmers.
I did want to highlight another point through the use of various time-frames. Divergences and momentum concepts are valid across all time frames.
There are a few factors to be aware of when identifying momentum divergence plays:
• Momentum divergences are invalidated (and nonexistent) in range bound, consolidating markets
• Only look for momentum divergences in the context of a mature trend (however short the time-frame)
• Momentum divergences work best after a “three-impulse” pattern in a trend( That is two impulse moves followed with a consolidation/pause/sideays move with a final impulse move)
• Momentum divergences are to be played for a target (price correction) commensurate with the time cycle it is noticed and NOT in the higher time cycle.
• The best divergences resemble “double-top” or “double-bottom” chart patterns.
• Keep a stop in the market close to the last pivot point in the event that the strong trend reasserts itself and causes great losses.
• Exit divergence trades which do not resolve within a time parameter.
. Trading momentum divergences is a complex strategy and should only be attempted after repeated exposure and internalization of the price behavior that sets up the pattern.
These set-ups are counter trend tactics, and as such, one must employ a hard stop in the event that the trend reasserts itself and you are on the wrong side. Contrast this tactic with the principle: “Trends have a higher probability of continuation than reversal.”
When you play for a momentum divergence trade, you are always playing for a target closer to the price the divergences commenced and playing for a possible shift in buying/selling pressure. Before attempting any such trade, I suggest researching further on this potentially profitable topic.
Some of the most popular Oscillators/indicators for uncovering price divergences include the MACD, stochastic, RSI, Ultimate Oscillator, rate of change, etc. You have to discover which indicator works best for you. Indicators are used as ‘training wheels’ until you can develop an intuitive sense of determining where the buying and selling pressure (momentum of the move) are diverging with the price action. This process takes time, yet indicators can help highlight these conditions. There is no perfect indicator to do this. I am using a fast MACD oscillator in my chart example. You can also spot divergences in other momentum oscillators.
Momentum precedes price in that a slowing of momentum indicates that a possible change in price is yet to come. Do not get caught in the trap of searching for momentum divergences all over the chart. Examine them at the (possible) end of mature trends for greater probability. Again, we are not seeking the end of a trend move (reversal), but just a retest and a small target. In fact, we are playing for a simple retracement swing against the direction of the prevailing trend. This illustration may help:
We are in a mature uptrend and price is continuing higher. A situation develops where the buyers are becoming less aggressive in their momentum (force of buying pressure) and momentum is declining while price is not.Of importance to note (and the reason behind the divergence in the oscillator) is also price based. Note the steep rise of the previous swing up (creating heightened oscillator/indicator readings) and then the more gradual rise of the second swing up (creating a lower peak in the mathematical oscillator). This sets up the divergence while the reason for it is declining momentum.
If momentum precedes price, then in this case, a decline in momentum forecasts a decline in price as the most probable swing play. If buyers are less aggressive to raise their offers, then it won’t take much effort for price to fall and those who own the stock will begin to sell.
This chart highlights momentum divergences finally reversing the trend:
Divergences are difficult to quantify for a mechanical system, so this is one area discretionary traders may have an edge over programmers.I did want to highlight another point through the use of various time-frames. Divergences and momentum concepts are valid across all time frames.
There are a few factors to be aware of when identifying momentum divergence plays:
• Momentum divergences are invalidated (and nonexistent) in range bound, consolidating markets
• Only look for momentum divergences in the context of a mature trend (however short the time-frame)
• Momentum divergences work best after a “three-impulse” pattern in a trend( That is two impulse moves followed with a consolidation/pause/sideays move with a final impulse move)
• Momentum divergences are to be played for a target (price correction) commensurate with the time cycle it is noticed and NOT in the higher time cycle.
• The best divergences resemble “double-top” or “double-bottom” chart patterns.
• Keep a stop in the market close to the last pivot point in the event that the strong trend reasserts itself and causes great losses.
• Exit divergence trades which do not resolve within a time parameter.
. Trading momentum divergences is a complex strategy and should only be attempted after repeated exposure and internalization of the price behavior that sets up the pattern.
