Friday, January 16, 2009

Framing Trades With Price Targets

The proprietary SPY target prices that I put out each AM prior to trading days via Twitter (free subscription here) are volatility-adjusted estimates of likely price movement. (See this post for further background). The pivot level is a kind of average price from the prior day's trade. In a range environment, the pivot becomes a price target as price fails to sustain moves outside the prior day's value area. Since 2000, about 75% of all trading days touch this pivot level.

The R1 and S1 levels are initial upside and downside targets for SPY; since 2000, SPY has touched either its R1 or S1 level about 75% of the time. The R2 and S2 levels are further away, with a 55% hit rate since 2000. In a market that opens strong, well above the prior day's pivot, we expect to take out R1 quickly and, if market internals look good (NYSE TICK, advance-decline, Market Delta), we then target R2 on temporary pullbacks.

The 30-minute chart above from today and yesterday marks both the pivot and R1 levels that were operative today (blue horizontal lines). We hit R1 prior to the market open, breaking above yesterday's trading range. Given such strength, we should have made a beeline for R2. Instead, price stalled, the NYSE TICK turned negative, and the leading sector of banking stocks turned down. The trader who recognized this early could see that we were likely to return to the previous day's range, making the pivot a likely price target. That one trade was enough to make your day, if you have the conviction and perspective to size the trade up.

By keeping the price targets and pivots in mind, you can frame promising market hypotheses and then update the odds of those working out by tracking leading sectors and market sentiment (stocks trading on upticks/downticks; volume trading on upticks/downticks).