Option Investor
Trader's Corner

Pivot Points, Current Sentiment and a Weekly Index Chart view

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A few weeks back I received a note from one of our Option Investor Subscribers that included the following quiry... "(I'm) curious as to your thoughts on the use of pivot points in trading."

I answered back on in this space on 9/13 (06) that:

'Pivot points as a topic is just not a defined or well-defined topic in technical analysis. If you go searching through the books on the subject, there is no definition of the term. This is not to say that it's a meaningless term. I've heard of a 'pivot point' trading method or system but don't have the details. Anyone who has any references on the subject, send them to me. I'm interested. (The term 'pivot' point can be pretty subjective. I use the term 'pivotal' support or resistance to mean a price point that if pierced, would be significant for the trend; e.g., suggesting a possible reversal of the trend or acceleration of the existing trend.)'

My request for more information led to an answer (at the end of last week, 9/29) from another OI Subscriber as follows (although I did make a few edits):

"Pivot points are daily, weekly and monthly price points that act as price targets for any underlying instrument (indices, stock etc.). Pivot points are employed by day traders and floor traders too to help them calculate entry and exit points. They have use as predictive support and resistance levels and can help confirm other technical methods. Some of the numbers have confluence with Fibonacci levels.

The numbers are based on the 4 numbers that all of us have at our disposal: the open, close, high and low. Daily numbers are updated on the close of each day, weekly numbers on the close of the week and monthly on the close of the month. For each day, there's a middle pivot point (the fulcrum of daily action), a resistance 1 and resistance 2 numbers (the expected highs for the day) and support 1 and support 2 numbers (the expected lows for the day). You only have to watch these numbers to see how often they act as daily targets or turning points.

With regard to swing trading, monthly and weekly pivot points are excellent swing areas. Price momentum has to be very high to break through these levels significantly. When you get confluence of both, the probability of a swing is even higher. The recent swing in the oil stocks happened at last month's weekly and monthly confluence.

One person with a pivot point 'system' is John Person. Myself and other traders here have been using pivot points with much success over the past months since we learned about them (on stocks, indices and currencies). While I respect your point and figure charts (I don't use P&F but do bare the targets in mind), I find pivot points more accurate and excellent for locking in profits along the way.

(MY NOTE: I'm not a big user of Point & Figure Charts myself, but gave a primer on their use in response to a Subscriber request to do so.)

I use multiple contracts to ensure that some of the options I trade are exited at maximum profits (last month's BA puts were another good example of ensuring exiting at the top, or in that case, the bottom). I have a spreadsheet that updates daily pivot points. I update the weekly and monthly numbers by hand. Charting software like eSignal will update them automatically.

(He offered to send me the formulas, which I did ask for, so I can put them into my TradeStation software.)

I have included a screen shot of JOYG with the weekly pivot point that was close enough to this week's low for me to exit the position. In addition, I have included some numbers below that I used this month to help exit profitably:

JOYG Weekly Support S1 level - 32.37
CAT was even more accurate, with a monthly Support 1 level - 62.71 (CAT closed last week with a low of 62.78)"

End of Subscriber comments and BACK TO ME FOLKS:
The chart I was sent by our Subscriber didn't come through, but to make a reference to the Weekly Chart of CAT, here it is with what I show to be a low of 62.76. Maybe the charts down under don't read the same lows due to the closeness to the South Pole:- KIDDING!


SO YOU GET AN IDEA OF A GREAT INDICATOR, WHAT DO YOU DO?
Test it out and look at before you commit money to it!

I will get the particular pivot point 'formula' in question here (John Person's) in order to start looking at it and testing it, in order to have a more definitive look at it next in my Wednesday's Trader's Corner column. By the way, the kind of formula that divides the High, Low and Close and divides by 3 as the first step in helping determine current support/resistance levels is well known by me and has been used for many years. I used to use this kind of method at UBS (formerly PaineWebber), to compute the daily-expected price range of the stock indexes.

DEFINITION:
A pivot point is a computed number based on the high, low and close of the previous price bar, whether the time period is a day, a week or a month. Using that pivot point number, traders calculate support and resistance levels, which are considered to be price brackets for the current time period.

CURRENT MARKET 'SENTIMENT':
In my most recent Index Trader post on the Option Investor.com web site, I was speculating somewhat on a possible near term top or pause in market advance (WRONG!), while at the same time showing that the weekly charts suggested plenty of 'room' on the upside, which I'll get to in a moment. First: Sentiment.

In the early and many times the most powerful phase of bull market moves, bullish sentiment DOES NOT get to the extremes that are seen later when the powerful move in question has made believers of the majority of traders. When it's a LEG (a move that is well beyond an 'average' up or down price swing), it's often accompanied by DISBELIEF.

Psychologically, traders and investors take some time to adapt to a new phase of the market. When the move is very strong and traders were not in on it early, they tend to hold back waiting for the usual REACTION; e.g., a pullback. When the market just keeps powering up, it leaves a lot of people sitting on the sidelines, NOT buying calls and or taking out puts for a hoped for profit on the reaction that doesn't come.

CASE IN POINT:


MY METHOD OF COMPUTING 'SENTIMENT':
The way my particular 'sentiment' indicator is calculated is simplicity itself. So that it reads the way most 'overbought/oversold' indicators do, with oversold on the low end of the scale and overbought on the high end, I divide total daily call volume BY daily put volume. Calls into puts, for a CALL to PUT ratio, NOT the put-call ratio that is usually a fractional number.

The other important aspect is that I take OUT the INDEX options volumes to take OUT the effects of portfolio hedging and to try to get a clearer view of trader bullishness or bearishness by the ratio of EQUITIES (only) call to put options daily volume. I have to keep this number by hand, or rather by a calculator, once I get the daily CBOE daily market summary e-mail, which anyone can sign up for.

How many trades like the those suggested by a nearness to a high-potential bottom, as suggested by the dip of this indicator [ABOVE] into the 'oversold/extreme bearishness' column would have made your year in terms of options profits? And made it worthwhile for you to keep a running account of this ratio? I leave it to your imagination!

S&P/DOW/NASDAQ WEEKLY CHARTS (AND THEIR TREND CHANNELS):

The S&P 500 (SPX) is the market leading Index right now, so it's of course the one to pay close attention to. Only lately has the Dow 30 (INDU) come on like gangbusters as the Institutions pile into the market. And, SPX has a quite well-defined uptrend channel and tend to do the same ol thing over and over as it trades back and forth WITHIN its weekly uptrend channel. Quite predictable, easy to forget, overlook or disbelieve! By this measure (trend channel trading parameters), there is not significance SPX resistance until around 1360.

The first parallel line to the lower up trendline is constructed by touching the more recent highs, or the bulk of those highs if they form a trendline. The next broader trend channel is constructed by going back to the highest high for the 2-year period shown and creating a parallel upper trend channel line that touches that/those highs. By this measure of the broader Dow 30 (INDU) weekly uptrend channel, the first significant technical resistance INDU will reach is up around 12,050 currently.

The Nasdaq Composite, my last (weekly) chart shown below, is trying to get back ABOVE its previously broken up trendline and therefore (if pierced) back INTO the uptrend channel it had going until mid-2006. This construction of suggests that the first critical (dare I say 'pivotal'!) resistance in COMP comes in at, and just over, 2300.


GOOD TRADING SUCCESS!
... and, keep those cards and letters (ah, e-mails) coming!


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