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Pivot Points, a Critique
By Donald L. Jones©
August 14, 2005
There is no 'trading university'. A potential trader typically looks for
training and educational courses on the internet or through a brokerage
firm. Most of these sources have a goal, brokerages to get the new person
trading as soon as possible; purveyors of courses to get the newbie to
take their course. Neither route seems to be very successful, since it is
reported that some 90 to 95 percent of new traders fail within their first
year.
The courses often teach a goodly amount of worthwhile information; a
respect for leverage, a reasonable approach to risk management and so
forth. Most courses fail where the rubber meets the road, at the
trading model level. Most analysis schemes rely on some sort of smoothing,
e.g. moving averages and oscillators. Some use an elegant display method
called 'Japanese Candlesticks'. Possibly the most egregious model of all
is 'Pivot Points'. If the vast majority of new traders lose, it is fair
to concede that none of the methods promoted by trainers work. The fault
of pivot points is their innate simplicity and their story, that pivot
points are used by members on the floor.
Pivot Points Defined
We use a day timeperiod for illustration, but any other consistent timeframe
will suffice.
At the end of a day we have the Open, High, Low and Close: O, H, L, C.
Let P = (H + L + C)/3. This is a sort of center of gravity for the day.
The second resistance: R2 = P + H - L. This is the 'far' resistance.
The first resistance: R1 = 2P - L. This is the 'near' resistance.
The center is P.
The first support: S1 = 2P - H. This is the 'near' support.
The second support: S2 = P - H + L. This is the 'far' support.
For example, take the case where H = 110, L = 90 and C = 91:
P = (110 + 90 + 91)/3 = 97
R2 = 97 + 110 - 90 = 117
R1 = 194 - 90 = 104
S1 = 194 - 110 = 84
S2 = 97 - 110 + 90 = 77
The formula computes, but what does it mean? Roughly it says that if tomorrow
trades exactly like today then 104 is an upside breakout point and 117 is
a confirmation of the breakout. The same is true on the downside at 84 and
77. Think for a moment; if tomorrow's market is the same as todays, a price
of 104 is not a breakout, because the high will be 110. For the downside,
however, a price of 84 is a breakout and really would be a breakout compared
to today's prices (the actual point is 90, price below that is a breakout).
The formula does not give symmetrical results, but you
would expect it to do so. It turns out that the close, in this case, pulls the
calculation down. But in a balanced market, the only place where a support and
resistance pair can be correctly found, the close rotates within the balance
and hence is of minimal importance. You can read about the Meta-Profile which
discusses the relative importance of highs, lows and closes in an ongoing market.