Friday, January 12, 2007

How I Trade: Handicapping the Odds of Hitting Pivot Points

Pivot points are prices that have been used to identify potential spots of support and resistance. Can we use information generated during the day to help us identify when we're likely to hit pivot points? For this study, I calculated the market pivot as simply the average of the previous day's high, low, and close. The first resistance level (R1) was (Pivot x 2) - Yesterday's Low. The second resistance level (R2) was Pivot + (Yesterday's High - Yesterday's Low). The support levels were the reverse: first support (S1) at (Pivot x 2) - Yesterday's High; second support (S2) at Pivot - (Yesterday's High - Yesterday's Low).

Since 2004 (N = 762 trading days), we've had 387 occasions in which today's market hit R1 and 339 occasions of hitting S1. We hit R2 151 times and hit S2 156 times. Now let's look at whether today's NYSE TICK is greater than the average TICK level for the previous 20 trading sessions. This is the Adjusted TICK measure reported daily in the Weblog.

When the TICK has been greater than its 20-day MA (N = 385), we have hit R1 on 271 of those occasions: a bit over 70% of the time. We have also hit R2 on 131 of those occasions: around a third of the time. At those times, we've hit S1 on only 89 of the days (less than 25% of the time), and we've hit S2 on only 20 occasions (less than 6%).

When the TICK has been less than its 20-day MA (N = 377), we have hit R1 on 116 occasions--a little less than a third of the time. We've hit R2 only 20 times. On those occasions, however, we've hit S1 250 times (about 70% of the time) and hit S2 136 times (a little over a third of the time).

When the Adjusted TICK was in the top quarter of its values (i.e., very much stronger than the 20 day average), we hit R1 on 159 out of 190 days. We hit S1 on only 24 of those days.

When the Adjusted TICK was in the bottom quarter of its values (i.e., very much weaker than the 20 day average), we hit R1 on only 49 out of 190 days, but we hit S1 on 153 occasions.

When TICK was very strong (weak), we hit R2 (S2) a little over half the time.

Now imagine that we add volume at the market bid and volume at the offer as a handicapping tool (a la Market Delta) and imagine that we use the pivots as price targets for exits, leaving a piece of a position on when we have signs of extreme buying or selling. Imagine using historical market patterns to identify likelihood of heavy buying or selling.

That, folks, is pretty much a summary of how I trade.