Secrets of the Floor Traders Pivot Points: The Self fulfilling Prophecy?
By Jim Harrison, CTA and Founder of eMiniMaster.com
"True Trading Mastery derives from understanding the relatively small role technical analytical factors play in the overall trading process and the inestimatably important role that correct market attitudes and beliefs exert in facilitating a consistently profitable result." â€¦â€¦â€¦â€¦ Bob Koppel
Contrary to popular belief, most consistent traders do not spend their days attempting to predict price action by â€œpicking topsâ€ or â€œpicking bottomsâ€. They spend their days executing a well drafted simple to follow trading plan.
You see, it is in the nuance of price behavior where the market's true intent can be recognized. The first step in understanding that behavior lies in creating a structure in which to analyze the day's activity.
Letâ€˜s explore the fabled Floor Traders Pivot Points. First, we define Support and resistance as those price zones where the forces of supply and demand are most likely to meet. It is at these key junctures where bulls (representing demand) and the bears (representing supply) are most likely to do battle, with the victor determining the market's next directional move. Notice, we DO NOT define support or resistance as an area where price WILL change direction.
Floor Traders Pivot Points are defined as a form of Static Support and Resistance. That means that they are not dynamic like a moving average which is more responsive to the tick by tick action, and therefore are â€œfixedâ€ or â€œstaticâ€ throughout the trading session. They have a gravitational pull, and they work because the large majority of participants believe they work, and therefore the self fulfilling prophecy exists.
Floor traders and other professionals who do the actual buying and selling of futures contracts in the trading pits of the exchanges, generally employ very similar systems for valuing the price of such contracts in the absence of significant outside influences. These systems employ a method of calculating relative value based on the price activity of the prior day. A price equilibrium point is determined as well as support and resistance levels in relation to that equilibrium point. This method is called the Floor Trader Pivot System.
Pivot System price levels act as potential support and resistance zones throughout the day. They serve as focal points for floor professionals as they adjust their bids and offers, especially when trading activity is slow. The use of these values, along with tape reading skills and candlestick pattern recognition* can help in determining appropriate areas for trade entry, stop placement, and exits.
The principle reference level under this system is the Daily Pivot, or the Pivot Point (DPP). Generally, as we enter each trading day, we regard this level as our balance point between bullish and bearish forces. A demonstration of significant price activity above the Daily Pivot is considered to have bullish implications, while significant activity below this level is bearish. Although actual trading activity is initiated by a variety of other market indications, we look at price behavior relative to the Daily Pivot level as an aid in determining the market's general directional bias.
Pivot System Support and Resistance Levels
The day's trading activity can generally be thought of as revolving around and gravitating towards the Daily Pivot level. As price moves away from this zone and approaches either the first level of resistance (R1) or the first level of support (S1), market behavior becomes increasingly critical. Any rejection of these newly attained levels increases the likelihood of a return to the DP. On the other hand, a breach of either of these levels is regarded as market acceptance and a perceived change in the valuation of the instrument being traded.
Additionally, should the market extend its move even further from the Daily Pivot, penetration through each successive level of support or resistance is generally regarded as having drawn in a greater degree of participation from off-floor interests. An increase in off-floor interests represents a greater likelihood that longer-term positions are being established, resulting in greater potential for the market to trend even further. Each consecutively greater level of Pivot System support or resistance breached is generally regarded as having stirred the interest of successively longer term participants.
Once the market has made a convincing break of a particular support or resistance level, that level is considered to have reversed its support/resistance role, and, subsequently, becomes a test point for further market activity. For example, if the first level of support (S1) is penetrated to the downside, any return to that level is considered a test of that level's integrity. The rejection of any price advance back towards the level of S1 is considered to be a successful test of that breach, and adds to that level's credibility as a renewed valuation point. Furthermore, any additional move away from that level has the potential to force the market through the next level of support or resistance, drawing players of even a longer time-frame into the market, and so on, continually expanding the market's range of activity.
The longer time frame traders will â€œwake upâ€ or become active as we expand price to and or beyond the inner levels of the Pivot System. As price breaks through the levels of R2 or S2 they will most likely resolve the price action in one of two ways. First, we will see an acceptance of the new found value resulting in what we refer to as trend days where price seems to move only in one direction with force. Alternatively, if the new found value is not generally accepted by the longer time frame traders, price will attempt to find its way back to the Daily Pivot Point.
The traditional formula for calculating Floor Trader Pivot System Support and Resistance Levels are as follows:
Pivot(P) =(H + L + C)/3
Resistance level 1 (R1) =(2*P) - L
Support level 1 (S1) =(2*P) - H
Resistance level 2 (R2) =(P - S1) + R1
Support level 2 (S2) = P - (R1 - S1)
Resistance Level 3 (R3) =(P - S1) + R2
Support Level 3 (S3) = P - (R2 - S1)
This formula generally uses what we refer to as 24 hour data, including a high and or a low that may have occurred outside Regular Trading Hours. Alternatively, one could use just the High, Low and Close price information from the Regular Trading Hours to calculate the Pivot Point. Certain traders also have modified the formula in a number of different ways to including opening â€œgapsâ€ and or mid day recalculations in price which is not the scope of this article.
Pivot levels of support and resistance can also be applied to the weekly and monthly time frames.
Daily and Weekly Floor Trader Pivot Level Confluence
Those areas in which multiple levels exist in proximity can be considered to have a greater likelihood of providing stronger support or resistance. The same process can be applied to the monthly time frame to add even more potential for confluence.
An important point to remember about these Floor Trader Pivot Numbers is that they act as potential support and resistance zones throughout the trading day. The "context" in which they occur often determines their significance. Your use of tape reading skills combined with an ability to properly interpret candlestick formations can lead to a very simple, yet powerful trading set up and play a critical role in the appropriate use of Floor Trader Levels as a profit tool.
SIDEBAR: Traders may download a FREE Floor Traders Pivot Point Calculator and Price Projector @ http://www.eminimaster.com/signup.html
Jim Harrison is the founder of eMini-Master.com. An active trader since 1996, M. J. Harrison, III & Associates, LLC ("MJH3") is a registered Commodities Trading Advisor (CTA) with the National Futures Association. As principal and President of MJH3, Jim brings intensity and passion for the markets to all his endeavors.