Tuesday, October 30, 2007

Pivot Level Support and Resistance: How Often Do We Hit Those Price Targets?

In recent posts, I have examined the odds of hitting high and low prices from the previous trading day and the odds of closing opening price gaps and hitting average trading prices from the prior day. This post will conclude a survey of intraday price behavior by examining how often we hit pivot-derived support and resistance points.

For the purposes of calculation, the pivot price is defined as the average of the previous day's High, Low, and Closing price. As with the earlier posts I am using the S&P 500 Index (SPY) going back to 2004 (N = 963 trading days) for my calculations.

The R1 resistance level is defined as (Pivot Price *2) minus the prior day's low price. The S1 support level is defined as (Pivot Price *2) minus the previous day's high price.

Thus, let's say that SPY closes at 150. Its high price is 151 and its low price is 149. The Pivot Level would be (151+149 +150)/3 = 150. The S1 level for the next day would be (150 * 2) - 151 = 149. The R1 level for the following day would be (150 *2) - 149 = 151.

Going back to 2004 (N = 963 trading days), we find that SPY hits either the S1 or R1 levels on 779 occasions, or a little over 80% of the time. We hit R1 on 490 occasions (a little over half the time), we hit S1 on 425 occasions (about 45% of the time), and we hit both levels on 135 occasions (about 15% of the time).

Thus, we tend to hit one of the pivot-derived levels during a given trading day, but which one we hit--on the basis of price alone--is pretty much a crap shoot. We'll want to look for indicators that help us effectively handicap the odds of hitting these levels.

Finally, let's look at the frequency with which we *close* above or below R1 and S1. Of the 490 occasions in which we hit R1, we close above R1 on 244 occasions, or about half the time. Of the 425 instances in which we hit S1, we close below S1 on 212 occasions, again about half the time.

Clearly, then, it is more common to trade above the R1 resistance and S1 support levels than to close above them. If we think of R1 and S1 forming a trading range, it will be helpful to have indicators that help us handicap the odds of closing outside that range vs. returning to that range.

In all, going back to 2004 (N = 963 trading days), a total of 455 days closed outside R1 or S1, a bit less than 50%. So about half of the time, we will close within the range defined by R1 and S1.

In my upcoming posts in this series, we'll begin the search for indicators that help us handicap the odds of hitting and closing above these benchmark prices:

* Previous Day's High
* Previous Day's Low
* Previous Day's Pivot Level
* Opening Gap (Previous Day's Close)
* R1 Resistance Level
* S1 Support Level

If we can find measures that assist us in handicapping those odds, we'll be able to trade more like a card counter, placing bets when probabilities are favorable and standing aside when they're not.


Handicapping Odds in Trading