Last week I mentioned that a close below 2,901 in the E-mini S&P 500 at the end of last week would confirm a weekly sell pivot.
Prices did end up closing below there, so a weekly sell pivot is in place on the charts.
‘So what?’ I hear you ask. Good question.
Today I want to describe what buy and sell pivots are and why they matter.
They aren’t the holy grail of trading. They are simply a logical necessity when markets change direction. They aren’t dependant on a lot of past data, so they aren’t lagging in nature as so many other indicators are.
If prices are going to change direction in whatever time frame you are using, a buy or sell pivot is the first thing that must occur. But just because they happen doesn’t mean a long-term trend is about to start in the other direction.
The simplest way I can describe them to you is to describe a very simple market where prices are continually marching higher day after day. The low of each day is higher than the low of the previous day. Also, the high and close of each day is higher than the last.
If prices ended up falling over and returning all the way to the lowest price, what must occur? The very first thing that must happen is that we see a closing price below the low of the highest price candle.
Let me show you a picture of what I am talking about.
Buy and sell pivots
Source: Port Phillip Publishing
The green bars in the picture mean that the price on that day closed at the highest price, whereas the red candles mean that prices closed that day on the lowest price. I am making this chart as simple as possible to describe the concept of buy and sell pivots for you.
Hopefully you are starting to see that prices can’t go very far in the opposite direction without creating a buy or sell pivot.
If you go to a bird’s-eye-view of prices by looking at a monthly, quarterly or even semi-annual chart, you will see that buy or sell pivots occur far less frequently than they do on the shorter-term charts. That makes them far more powerful.
If you were to look at buy and sell pivots alone without any other indicator, I’m certain they would be completely useless. As I have been saying, my edge is derived from analysing what happens after buy and sell pivots occur within the key zones where I expect to see a reversal in prices.
If we were to look at the current price action in the E-mini S&P 500 for example, the fact that we have a weekly sell pivot in place is not the signal for me to start shorting the market aggressively. Instead I will enter at a price where short-term traders are being shaken out of their positions, after the weekly sell pivot has been confirmed.
That calculation will be based on the things I have been discussing over the past few weeks. The widening distribution and buy and sell zones of waves and ranges.
When I write to you about opportunities that I am seeing in the markets I will always be discussing the same thing. I will be describing what the current trending situation is across different time scales and I will be looking for key areas where prices often change direction and searching for buy or sell pivots in those zones.
There will always be a fundamental basis for my views and I will describe those, but at the end of the day the opportunity will be based on the technical set up.
If you haven’t put the work in by reading a few of my articles on the theory behind my approach you won’t understand much of what I write about in future. Once I have written a few of these explanatory articles I want to dive into live analysis and see if I can add some real value to your day by pointing you towards some great trading opportunities you can further research yourself (I will NOT be making recommendations, obviously).
But we aren’t there yet. I still need to teach you a bit more about the trading model and show you a few examples to help you understand why I trade the way I do.
Let’s look at the model of the widening distribution again:
Model of widening distribution
Source: Port Phillip Publishing
If the trend is up and you wanted to buy this stock and understood how these distributions formed where would you want to buy the stock? How would you work out where you would be proven wrong quickly?
We know that the area 61.8% below the range (the thick black ‘reaction’ line above) usually provides strong support if the range is going to continue and a return to the point of control is on the cards.
With the long-term trend up, we are interested in buying after a false break of the low of the range. If prices are bouncing from the level 61.8% below the range, then we are extremely interested.
So if we do see a bounce from that zone (a buy pivot in a daily or weekly chart for example) and it looks like prices will re-enter the range we could buy with a stop loss somewhere below the most recent low. That is a very small stop loss in the scheme of things.
Let’s have a look at what I am saying in a diagram:
Model of Potential Trade Opportunity
Source: Port Phillip Publishing
You can see in the diagram that I have placed an initial target at the point of control. Taking part profit at a point that we know has a high probability of happening makes sense. Who knows what will happen once prices return to the point of control (POC)? If we are wrong about the uptrend continuing, prices will find resistance at the point of control and we could see prices turn and plummet from there.
So we want to be free carried once prices reach the POC and in reality the whole trade could be that leg alone. What’s wrong with taking the meat in the sandwich and leaving the unknowns to take care of themselves?
If prices fail to reach the point of control and turn back down and fall through the recent low by a good margin, we can feel comfortable that we were wrong, and the distribution is at risk of completely failing. Look at the chart and notice how small the distance is between the entry point and the stop loss in relation to the overall volatility. We are proven wrong very quickly with this trade.
The entry point is based on waiting until a series of stop losses have gone off once the current low of the structure is breached. Traders usually place their stop losses just below recent lows, so the market is great at setting them off and then turning back up.
Waiting for a buy pivot on a daily or weekly chart before entering the trade means that you will avoid blindly catching a falling knife. It confirms that there is some real momentum building in the opposite direction.
I think that’s enough for today. Hopefully I haven’t scared you off from reading my weekly offerings and if you want to learn more just go here to view my weekly videos. I can explain so much more when I show you my charts in a video, so I’d highly recommend that you view a few of those videos if you are interested in my approach.
Editor, Alpha Wave Trader