Pivots also help in the management of risk. In the example in Figure 3, the stop-loss order is placed under the previous pivot low. Confirmation of the trend reversal from down to up is seen when price makes another higher pivot high and low. If price cannot make a higher high, then a trend reversal has not occurred, and the trader will exit the trade. If price does make a higher high and higher low, then the stop-loss is moved to the next higher pivot low, and the stop is trailed under subsequent pivots as the trend progresses.
An uptrend reverses to the downside with the opposite pivot sequence. An uptrend will have a series of higher lows and higher highs, and an up trendline is drawn on the pivot lows. Once there is a lower low and lower high, there is presumptive evidence of a trend reversal to the downside (Figure 4). Again, the strength of the signal is increased when the lower pivot high forms below the uptrend line. Traders can enter at the closing price on the same day the higher low completes the pivot formation. An initial stop is placed at the previous pivot high and trailed in accordance with the trend.
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| Source: Telecharts, Worden Brothers Inc. |
| Figure 4: Uptrend reversal in Goldman Sachs. The lower pivot high/low triggers a reversal. |
Pivots frame out price, allowing us to see when the trend enters a period of change. Price normally cycles between trend and range conditions. When pivots form a series of variable highs and lows, price enters range consolidation, or a sideways trend. In a range, the pivots are not moving consistently up or down. Price moves back and forth between support and resistance, testing for levels of buying and selling pressure. During these periods of price consolidation, trendlines can be drawn on the boundaries of the pivot highs (resistance line) and lows (support line) to show price patterns.
Using Patterns as Confirmation
A rectangle, or channel pattern, appears when both support and resistance lines are horizontal (Figure 3 and Figure 5). A triangle pattern is seen when one or both of the lines are slanted (Figure 4 and Figure 5). Small penetrations of these lines can be faded in the opposite direction. The lines also help identify when range conditions change back into trend. A new pivot high with price that remains above the resistance line suggests a breakout into an uptrend. A new pivot low with price that remains below the support line suggests a breakout into a downtrend.
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| Source: TDAmeritrade Strategy Desk |
| Figure 5: Chart patterns |
One of the major benefits of using pivots for trade signals is that they are objective price points and can make trading less emotional. Either price has reversed or not, based on the structure of the price bars. Stops are placed according to specific pivot points. There is no need to guess where to put a stop or make predictions on the future direction of price. Pivots show us what is really happening as opposed to what we hope will happen. Traders who understand pivot structure will no longer have to wonder what price is doing: they will know.
