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The pivots help to keep a trader groundedHERE'S EXACTLY HOW I SET THEM UP ON MY CHARTS I'm going to go through the process of htiw I update the pivots on my charts each day. ['m doing this on Saturday, March 19, 2005, and 1 want to calculate the updated pivot levels for when the market reopens again on Monday. To calculate the daily pivot numbers, 1 use the following data to generate my high, low, and close numbers: YM: Start Thursday at 8:15 p.m. ET; end 5:00 p.m. on Friday ES: Stan Thursday at 4:30 p.m. ET; end 4:15 p.m. on Friday NQ: Start Thursday at 4:30 p.m. ET; end 4:J5 p.m. on Friday ER: Start Thursday at 4:30 p.m. ET; end 4:15 p.m. on Friday This range of data gives me all the price action for when these markets are trading, allowing for both pre- and postmarket price action to be factored into the next trading day's numbers. The times are slightly different on the above contracts because of the times they were traded on the exchange. The settlement price is the key. If traders are ever unsure about the settlement price, they can check it on the YM at www.cbot.com and go to market data, then settlement prices. For the ES, NQ, and ER, a trader can go to www.cme.com and go to trade CME products, market data, historical data, view more, settlement prices, equity index. Il*s kind of a maze to get there on the CME website. The direct link is http://www.cme.com/ tradi n g/dta/h ist/dai ly_sett le_prices. html ?iy pe=idx. The easiest way to gel an accurate high/low/close is to just set up a daily chart with the timeframes listed for each contract. In TradeStation this is very easy to do. Just enter the continuous symbol, such as @YM or @ES, and set it on a daily chart. The data will default to the ^regular session*' which refers to the limes listed above. With many other charting programs a trader has to go in and set this up manually, as many of them default to the regular stock market session from 9:30 a.m. to 4;00 p.m. Eastern, Once the chart is setup, just wait until after 4:15 p.m. Eastern on the ES. NQr and ER and wait until after 5:00 p.m. Eastern on the YM. After these times, just take the high/low/close reading on the daily bar generated for that trading day to gel the correct numbers. This closing price will almost always match the settlement price, though I like to check to make sure. For Monday, then, I want the high/low/close for Friday. Let's take a look (see Fig. 7.1): On Friday, March 18, 2005, we have a daily baron the YM that started at 8:15 p.m. ET on Thursday, March 17, and ended at 5:00 p.m. ET on Friday, March 18. This range gives us the following numbers: High: 10679 Low: 10579 Close: 10635 By changing the chart to a weekly time frame, I can also lake the high/low/close of the completed weekly bar and get the numbers I will use for the weekly pivots. On Monday the daily and weekly close will be identical, since they are both based on Friday's close. In this instance the lows are also identical because the lows on Friday were also the lows of the week The process can be repeated with the monthly levels, but I won't need new monthly inputs until the first trading day in April. Now that I have my key levels, I want to figure out the key pivot points that I'll be using for Monday, March 21,2005. The first thing I do is take these high/low/close figures and plug them into the formula. To Figure out the daily pivot, I take the high + low + close and divide by 3. 10679 + 10579 + 10635 = 31,893/3 = 10631. We now have our pivot point for the day. To figure out Rl, which is the next level above the pivot, 1 multiply the pivot by 2, and then subtract the low. So we take 10631 X 2 = 21,262 - the low at 10579 = 10683. We complete this process until we are done, and we come up with the following levels: R3: 10783 R2: 10731 Rl: 10683 Pivot: 10631 SI: 10583 S2: 10531 S3: 10483 Once I have these levels, I place them on my chart. I also like to note the midpoints between the daily pivot levels. These are calculated very simply as they are literally the midpoint. The pivot is 10631, and Rl is 10683, 52 points away. Half of 52 is 26.1 add that to the pivot, and 1 get a midpoint of 10657. These are all formulas that can be set up in Excel, making this a very quick and easy process. I don't calculate the midpoints for the weekly and monthly levels. With the chart created and the appropriate pivot levels added, the first thing I will note is where the daily pivot is in relation to where the market closed. The daily pivot is at 10631, and the market closed at 10635. The second thing I will be watching for is where the markets are trading at 9:30 a,m. Eastern on Monday. How far away are they from the daily pivot? This will work in relation to the gap play. The markets test their daily pivot level 90 percent of the time at some point during the day. 1 will always fade the first move to the daily pivot. For example, if the markets are trading above the central daily pivot, and they sell off to this level, 1 will fade the move by buying it when it reaches the pivot. I will talk about specific entry methods in a moment. By setting up these formulas in an Excel template, I can quickly obtain all the key levels for the YM, ES, NQ, and ER. I did that, and all I do today is just enter the high, low, and close. Once this is done, the spreadsheet fills in the rest of the numbers for me automatically. It takes me just a few minutes to look up, and then plug the high, low, close into this spreadsheet I then instantly have my levels for the next trading day. Of course, I have to update the weekly pivots only once a week, and the monthly pivots once a month. The spreadsheet for the chart we are working on is shown. I also like to note where the extreme levels are, because it is very rare when the stock indexes hit their R3 or S3 levels. This is important to know because if the markets rally to R2 or a sell off to S2, that usually ends up being the dead high or the dead low of the day. This knowledge will help temper a trader's emotions. When a market is going up, it is easy to think that it will go up forever. On this same note, when the market is heading down quickly, it is easy to assume it's the end of the world. The emotion of greed is, of course, a disaster to anyone who succumbs to it because of the surge of adrenaline that runs through the body. By understanding the odds of a move above and beyond these outer levels, a trader will be able to stay more objective and take the money away from the people who are panicking. The pivots help to keep a trader grounded. Instead of getting overexcited and hoping for a market crash, the pivot trader knows there is a 90 percent chance that the markets will not close above R2 or below S2 on any given day. A move to that level signals a time for the trader to take profits instead of pyramiding into a bigger position that will lead to disaster-Let's take a look at the pivot levels that we calculated for Monday, March 21, 2005, on a Five-minute chart (see Fig. 73): This chart looks very busy with the daily pivot levels labeled on the left, the midpoints of the daily levels in the middle, and the weekly pivot levels on the right. For sake of space, I left the monthly levels off. I like to take a look at this wide view first in order to see where the extreme levels are located for Monday's trading- Once Ive done that, I will then reduce the chart to a more manageable level. In this chart I've zoomed jn so that I can see where the key close levels are for Monday's trading, THE PSYCHOLOGY BEHIND THE PIVOTS WHO IS GETTING BURNED Before I jump into the rules and specific setups that I use to trade the pivots, I want to cover briefly why they work. The first, and most obvious, is that a lot of traders watch these daily levels, so there is a self-fulfilling prophecy involved. The same can be said for Fibonacci Levels, but they do not hold nearly as well as the pivots. Why? I elaborate on this in the next two points. On the floor, it is generally a trader's goal to grab smaller moves, typically two points in the S&P 500, which is about 20 points in the Dow, or smaller depending on what is going on in the pit. The floor traders all operate in a big circle, with the brokers standing on the first step that surrounds the pit. This gives them the best view of all the locals so they can get the best price for their customers. Since it is easier to trade with someone right in front of you, the prime space for locals to stand is just inside the top rail that separates the top step brokers from the locals. Experience, politics (who you know), and the ability to take orders of all sizes (not just I lots) can get a local a prime position near the top step brokers. Usually this space is determined by how long the local has held the spot and his ability to continue to make markets. New traders musi Find space where available. This is usually the farthest point from the brokers, which is the center of the pit. Because of this layout, there are several different scenarios being trading at one time. The locals on one side of the pit are making markets based on order flow coming from the brokers on their side of the pit. If a broker in one corner was selling size (a very large position) while a broker on the other side of the pit was buying, the two brokers don't always hear each other or even know what the other side is doing. It would be very easy for them to do their trade together if they knew that they could meet each other's needs. Instead, locals near the broker who is buying start racing the broker by buying from other nearby brokers and then turning around and selling their contracts to him. This causes many price fluctuations throughout the day and often results in the public getting stopped out before the action settles down again. In its purest form, the traders on the outside will get in on a trade, lefs say it's a long, and then sell their position to the guys on the inside of the circle who can*t really see what is happening way out on the top steps. What happens is that the traders on the inside, by the time they see the market moving, are the last ones in the pit to get in on the move. If they are lucky, they will then be able to turn around and sell it to the public. As the guys on the inside are selling to the public and closing positions, the guys on the outside are also selling to the public but they are opening new short positions, essentially fading a public that is chasing the up move. And the cycle renews itself like this throughout the day. This causes a specific dynamic in the markets, generating specific cycles of speed and rest on an intraday basis. They focus on the pivot levels to base their entries and to also gauge market action. The pivots play on this in that they are spaced out to catch these patches of momentum. A Dow pivot is usually 30-50 points apart, and this is the type of movement that perpetuates the cycle I just described. The floor traders in the center of the circle are catching half this move, dumping it. and waiting for the next level to be hit. The key is to get in when the market is quiet and get positioned for the next round of activity. One of the main reasons these pivots work has to do with the vast majority of inexperienced traders out there. The floor traders start a trade, and the inexperience of most traders causes the momentum that finishes a trade. How? Because average traders rely on a lot of different 'indicators, They are getting in and out of their positions far too late, which causes Losing trades and a specific cycle of market movement as their stop placement slowly and steadily increases the velocity of market movement in the direction of their stops. Indicators are just that, an indication. This is like your significant other slapping you across the face, and you taking it as an 'indication that this person might be angry with you. If it takes a slap across the face to realize this, then you are following the wrong indicators. By the way, all market indicators are the wrong indicators, because they are all lagging. Price action is pure. This overreliance on indicators by the majority of traders is what helps this system to work. By the time the average trader gets a buy signal, the pivot play is almost over and users of this system will be selling their position to the indicator-based trader. Then the subsequent reversal that takes place is because of all the stop losses sitting out there, like trout sunning themselves on top of a lake easy targets for the hawks who come swooping down from overhead. The market pauses, drifts down, and picks up steam and rips through all the stop losses, pausing when the run is over. This pause generally happens at a pivot level. It's where the floor traders are beginning to accumulate their next position for the next cycle of play. |
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