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Using Pivot Points to make Better Trades Pivot Points have been used by floor traders at the major equities and futures exchanges for a long time. Traders found that the price tended to hover near the pivot level and trade in between the pivot and support and resistance levels generated by a simple calculation based on the previous day’s high low and close. One advantage of using Pivots is they are a predictive indicator as opposed to lagging. Predictive Vs Lagging Indicators The majority of technical indicators most traders use such as moving averages and RSI are lagging. Meaning they are telling us what has already happened, or at best, what is happening in real time. Few indicators are predictive; one type of predictive indicator is Pivot Point study. Pivot Points use old data to predict future price movement, and, since technical analysis is based on the idea that many people looking at the same thing will draw similar conclusions, we can use pivot points in a variety of ways to improve our trading. Pivots have been used by floor traders for many years, traders found that daily price action seemed to fluctuate more intensely around certain levels based on the previous day’s high, low and close. Traders also found that by using the pivot point and the previous day’s range, high and low, they could set support and resistance levels that price respected. There are several methods of calculation for these pivots we will explore the classic calculation method in this article in detail but we will also discuss the alternative methods. Classic Pivot Points To calculate the pivot point, take the previous day or session’s high(H), low(L) and close©, add them together and divide by 3 [(H+L+C/3 = Pivot Point (PP)] Now we can calculate the support and resistance levels based off of the pivot, Support 1 is (PP x 2)-H , Resistance 1 is (PP x 2) – L =, S2 is (PP-Range), S3 is(PP-Range) x 2 and S4 is (PP-Range) x 3. R2 is (PP+Range), R3 is (PP+Range x 2) and R4 is (PP+Range x 3). Range is High-Low. E-mini S&P500 Chart: For this example we will use the E-mini S&P 500 futures. The previous session high was 1124.25, the low was 1110.25 and the close was 1122.25 Using these values we can calculate the pivot point, which is 1118.92, Support1= 1113.57, Resistance1=1127.58, S2=1104.94, S3=1090.92 and S4=10796.92. R2=1132.92, R3=1146.92 and R4=1160.92. Looking at this chart, we see that when price fell, it fell exactly to the first level of support and bounced higher. We used the exchange hours to set our session and ignored the Globex/overnight session when calculcating our pivot points. The reason we did this is because much more volume is traded during the exchange session and the institutions that really move the price are trading during these hours. Most institutions do not trade the low liquidity overnight session unless there is a news event. So when the market opened the next day it immediately fell and found support exactly at S1. The difference between R1 and S1 was about 14 points, which is a pretty large range for this contract. In other words, it would take a major event to push the price to the next level of support or resistance (S2, R2). By using S1 as the buy entry and our pivot point as a take profit level we can use S2 as the Stop Loss level, the difference between S1 and the PP was 5.34 (5.25 rounded down, which is 21 ticks on this contract), so that was our profit potential on this setup. Conversely, we could have set a buy stop slightly higher than R1 and a sell stop right below S1, this would be more of a breakout strategy where we look for the price to move through either level with momentum and continue down to S2 or move higher to R2. Alternate Calculation Methods There are several methods to calculate pivot points, 2 alternate methods are Woodie’s and Fibonacci. For Woodie’s method instead of using the previous session’s closing price, we use the current session’s open price. The formula to calculate the pivot point is PP=(H+L+(Today’s Openx2)/4. Our Support and Resistance levels are calculated the same way as the classic method. Another method is Fibonacci, this method uses the Classic calculation to find the Pivot Point (H+L+C)/3 but uses the major fibonacci levels to calculate support and resistance levels. S1=PP-0.382 x (H-L), S2=PP-0.618 x (H-L) and S3=PP-1.0 x (H-L). R1=PP+0.382 x (H-L), R2=PP+0.618 x (H-L) and R3=PP+1.0 x (H-L) Here is a table using the same Open, High , Low and Close data to compare the different calculation methods: Combining Pivots with other tools. Pivot Points are a valuable tool for any trader, however, no single tool tells the whole story, we are looking for multiple indicators to align and confirm a move. Meaning, if the price is nearing R1, our RSI is above 90 and we have an important Fibonnacci level at or around the same price, that validates our prediction that we will encounter resistance more than relying on any 1 indicator. It is important to look at different indicators that tell a different story. For example if you are using a moving average crossover for entry confirmed by a MACD, you are basically looking at the same thing in two different ways, a MACD measures the difference between 2 moving averages so of course the signal will be confirmed! But if we mix the inidcators up by using a momentum indicator such as RSI or Stochastics, now we are looking at 2 different instruments that are giving a similar reading. Combine these indicators with support and resistance tools such as pivots and Fibonnacci, now you have 3 totally different indicators for confirmation, that means you have a much better chance of making a good trade. You may find yourself taking less trades, however this is about quality, not quanitity. In the end, trading is all about probablilty, and if you put the probability in your favor over and over again, you will increase your chances of coming out on top. Risk Disclosure: There is a substantial risk of loss in trading futures and foreign exchange. Please carefully review all risk disclosure documents before opening an account as these financial instruments are not appropriate for all investors. Jesse Richards is a Series 3 registered Commodities Futures Broker and a Principal of Fast Trading Services LLC
A common question traders have is, what are some good tools for finding support and resistance levels? Nowadays, even the most basic retail charting platforms come loaded with tools used to find these key areas. Unfortunately, many traders are not sure how to use these tools correctly and more importantly; how to implement and combine these powerful tools. Using these tools on their own will help you identify areas of support and resistance. Using these tools together drastically increases the probability of a confirmed breakout and a big move. We will look at 2 of these tools in this article, Gann Fans, and Fibonacci retracements. We will also look at volume as a confirming factor. Gann Fans William Delbert Gann was born outside of Lufkin, Texas in 1878. Gann was a financial genius, he started trading at the age of 24 and accumulated a fortune worth over $50 million. Gann developed many trading philosophies using a variety of methodologies. His works have been published for nearly 100 years and are still very much relevant. Gann’s most well known contribution to the trading world is the Gann Fan. The Gann fan is made of a series of angles drawn from a pivot high or a pivot low. The most important of these angles is the 1x1 angle. The 1x1 angle is a 45 degree angle in an uptrend and 315 degrees in a down trend. Below is an example of a Gann Fans. As you can see, the price trends up to the 1x1 angle very closely and when it breaks the trend line we have a nice move. The other angles of the fan are important however the key angle is the 45 degree 1x1 angle. Using a Gann fan is a good way to find support, however using only a Gann fan can lead to false breakouts and head fakes. Gann fans should be used in conjunction with other drawing tools to find the areas with the highest probability of predictable price movement. Fibonacci Retracements Leonardo Fibonacci was an Italian mathematician who is most famous for his work with number sequences. The Fibonacci sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55… The sequence adds the two previous numbers together to get the next number and so on and so on. By dividing the last two numbers of the sequence, i.e. 34/55=61.8 we get the 61.8% ratio. Often referred to as the “golden” ratio, many prominent scientists and mathematicians have spent decades examining the ratio and how it applies to nearly everything from the swirls on a Conch shell to the distance between stars. As the numbers in the Fibonacci sequence increase, dividing the last two numbers in the sequence gets closer and closer to 61.8%. The other ratios are found by dividing alternative numbers of the ratio, i.e 21/55=38.2. This is a very popular tool for finding key support and resistance. Drawn from a swing high to a swing low, the Fibonacci ratios give 2 key areas of support and resistance; the 61.8% retracement and the 32.8% however most Fibonacci tools will have the 50% ratio as well even though it is not derived from the Fibonacci sequence. Below is an example of Fibonacci and Gann used together to spot key areas of support and resistance. These areas are used to confirm breakouts and also should be used to place stop loss and take profit levels. Volume Another important tool for identifying meaningful breakouts is volume. Volume is important because many times a move on weak volume will appear to be a breakout, and not follow through. Using any of these tools alone will give you some idea of where moves will happen. Using these tools together will give a much higher probability of confirmed breakouts and meaningful gains. On this chart there is a head fake move up on light volume, followed by the breakout down on rising volume. As you can see, using any one tool on its own may have lead to taking the trade too early and getting stopped out. But when we put all three of these tools together we have a much higher probability of finding good breakouts and more importantly avoiding head fakes. In the above example, there are many things going on. The first move is the 50% retracement that also coincides with the 1x1 Gann line for an area of strong resistance. As the price begins to retest the first retracement it breaks the 1x1 Gann line on declining volume. The result is a failure to break through the 38.2% retracement. As the price falls on rising volume it breaks through the original support but the 1x1 Gann line serves as new support and the price does not break it. Summary Traders should be aware of these key levels for several reasons. The theory of technical analysis is based on the idea that many people looking at the same information will come to similar conclusions, basically the only reason it works is because enough people believe it does. Using these technical levels can give you a better chance of spotting the meaningful breakouts that lead to nice gains. These tools are not limited to any one financial market and can be applied to futures, forex, equities etc… There are many more tools for finding support and resistance however these are two of the more popular ones and therefore should be understood and considered. Volume is also very important to confirm the Gann and Fibonacci levels because light volume moves tend to reverse quickly stopping traders out before the big move. Using these tools together will help you identify the areas for big moves and help to set yourself up for success. Jesse Richards
Market Profile is a powerful statistical analysis tool developed by J. Peter Steidlmayer and the CBOT during the 1980s. This article introduces traders to the Market profile tool and goes over the basic uses and functions. Introduction: Market profile is a technical analysis tool developed by J. Peter Steidlmayer in conjunction with the Chicago Board of Trade in the mid 1980s. Market Profile is a statistical analysis of time and price to create a graphical representation of a trading session or multiple trading sessions. Price is plotted on the vertical axis, and time is plotted on the horizontal axis. Market Profile essentially puts a daily bar or candle under a microscope. By looking at a bar with the naked eye, all we know is where the bar opened, where the high and low were and where the bar closed. A Market Profile of that bar will let you know when the bar made the low, when it made the high and, more importantly, where the price action or Time Price Opportunities (TPO) for that bar took place. Market Profile Construction: A standard Market Profile assigns a letter to each 30 minute period of a session. Typically, a Market Profile will start with letter A and end with letter X. It is not required for each letter to represent a 30 minute time, this is just the default setting and most used time frame, I would not recommend using a time frame less than 15 minutes. For the purpose of this article, all examples are in a 30 minute time frame. Each letter is placed in a column next to the corresponding price. After 30 minutes, the letter changes and if the price has already touched that level, the new letter is drawn in the next column, if the price touches a new level, the letter is placed in the first column. The CBOT uses an uppercase A-X for the midnight to noon period, and a lower case a-x for the noon to midnight period. When Market Profile was first developed, most markets traded on set sessions that had an open and a close, however today many markets are open virtually 24 hours a day. This does not eliminate the usefulness of Market Profile because the same psychological factors are in place, in any market you have short term participants and you have long term participants. The concept of market profile centers around the normal distribution curve, or bell shaped curve used throughout nearly all statistical analysis. Here is a daily candle for the e-mini S&P 500: The open for this candle was 1168.50, the low was 1164.25, the high was 1173.75 and the close was 1169.50 And here is the market profile of the same session: The open was 1168.50 noted by the green arrow, the high was 1173.75 noted by the highest printed letter “o”, and the low was 1164.25 as noted by the lowest printed letter “q”. But our market profile shows how the candle was formed, after the bar opened the opening range was tight, between 1169.25 and 1168.25 a range of just 4 ticks, then during the “q” period we made a low and during the “o” period we made our high. The value area for this session was between 1166.00 and 1171.75 noted by the red line. As the distribution of the day is normal, our support is at 1166.00 and our resistance is at 1171.75. As you can see the day forms a nearly perfect bell shaped curve with the most price action taking place at 1169.50. As we can see when the price went above 1172 (High end of the range) it soon retraced back down and when the price went lower than 1166.25 (low end of the range) it quickly bounced back up, which can be interpreted as when the price was in the 1166.25 area buyers became attracted and when the price rose to 1172 sellers became attracted. The middle part of the curve is our balance area, where we have a relatively equal number of buyers and sellers, when the price moved outside the balance area the market reacted and the price moved back into balance. To get a better idea of how the Market Profile is constructed, let’s look at the first 2 hours of a session. Here are 10 thirty minute bars of the ESM0 contract covering 5 hours of data: And here is the corresponding Market Profile for the same period: The First period is the “L” period, which had a high of 1183.50 and a low of1178.75. If we look at the oldest bar in the chart above we can see the same levels, high of 1183.50 and low of 1178.78. The next letter is “M” and it stayed within the “L” period’s range which matches the chart. The “N” and “O” periods also stayed within the “L” range. During the “P” period we moved past the “L” period’s high and made a new high of 1186.25 before retracing back down to 1185.50 which is where the “Q” period begins, “Q” and “R” stayed within the daily range but the “S” period made a new low of 1178.50. The “T” period made the low of the session at 1173.25 before retracing back up to 1175.00 and the “Q” period stayed within the “T” range. This session is clearly a trending session as the price moved throughout several TPOs without much resistance. We also know that the market stayed in its initial range for the first 4 bars made its high in the middle of the day and the low late in the day. Also, the 1181.50 level could be seen as resistance as we had 5 TPOs at that price. Using Market Profile in Your Trading: Now that we have briefly gone over the concept of Market Profile, how can we apply it to our trading? There are 2 main types of markets in terms of range development, normal or non-trending and trending. In addition to range development, market activity can be broken down into two categories initiative and responsive. If the price moves past the previous day’s value area and holds there, traders are taking the initiative of moving the price into a new value area, if on the other hand the price quickly moves back down market participants are responding to the new price by rejecting it as a value area. The psychology for long term and short term trader differs depending on the range distribution. During a ranging or non-trending days the short term traders are in control. Think about it, when the price stays in a small trading range the only way to profit is to buy at the low end of the range and sell at the high end and vice versa. During a trending day, where the distribution is not normal or bell shaped the longer term traders are in control. During trending days, selling at the high end of the range does not make sense as the price will continue to trend higher, during this type of session, buying early in an uptrend and selling when the trend appears to be ending is the better strategy. Now it should be noted that short term traders and long term traders have different ideas of value. Short term traders typically go for small price movements with larger orders while swing or long term traders typically trade less volume but go for more ticks. Therefore a short term trader may see value at the low end of a ranging day, where as a long term trader may not see the same value there. Identifying the range development for the day and knowing the previous days’ value area can give you an edge over traders that do not have access to this data. Here is an example of a normal day: And here is an example of a trending day: As you can see during the normal day, once the range was established, buying the low end of the range and shorting the high end was a good strategy, during the trending day though if you tried buying at the low end of the range, the market kept moving lower resulting in a loss. Where can I get Market Profile Data? Many software vendors have Market Profile data but it can be costly. Our company has a proprietary trading platform that provides free market profile data. Please contact FastBrokers for more information. This was a brief introduction to Market Profile. There is much more to this powerful tool and if you would like more information please visit the CME website: http://www.cmegroup.com/education/in...marketprofile/ Jesse Richards