Measuring breakouts with “ROC”:

Many believe it is important to view the market from as many different angles as possible. The market's day-to-day price action is the result of the perpetual battle between the buying and selling forces which enter the marketplace every day, driven by their own reasons or motivations. Because the human decision to buy or sell any given market is guided by emotional factors, mathematically it may be difficult at times to logically dissect the trading activity into a straight forward formula. For this reason, we must do our best to look at the same picture from as many different angles as possible.

The (ROC) Rate of Change indicator is a very straight forward momentum oscillator which measures the percent change in price, from one period to the next. With the center line set at either 0 or 100, the ROC can be used to identify range bound conditions as the market continues to move to a lesser degree each time it revisits a narrowing support and resistance line. However, when the market breaks out of its own respective trading range, the ROC will reflect this change in sentiment as it may break out of its own respective consolidation pattern. This reminds us of a crucial point: it is not only important to identify those times when the market trades at a new high or low price, but also to measure this move in respect to the market's “normal” trading habits.

For example, we can see the following (2) charts show a very common trade setup or situation; the market in both cases formed a common triangle consolidation pattern as its support and resistance lines continue to trend towards one another. This may take the form of a consolidation triangle pattern on a number of different time frames. Throughout the course of a trading day, there may be many times when traders will buy a new high or sell a new low in anticipation of a breakout in either direction. But we can see the true breakout did not occur until the ROC broke out of its own respective trading range. Logically we can see that when a breakout occurs, the market has a tendency to move to a greater degree than it did during the previous period(s) of time. As we can see from the chart above, the ROC plots this phenomenon in an easy to understand format. Additionally, we can continue to anticipate the market's trading range will persist until a new high/low occurs not only on the physical price chart, but also when reflected in our ROC.

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Pivot Point Trading

The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels.
The pivot level and levels calculated from that are collectively known as pivot levels.
Every day the market you are following has an open, high, low and a close for the day (some markets like forex are 24 hours but generally use 5pm EST as the open and close). This information basically contains all the data you need to calculate the pivot levels.

The reason pivot point trading is so popular is that pivot points are predictive as opposed to lagging. You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).
Because so many traders follow pivot points you will often find that the market reacts at these levels. This give you an opportunity to trade.

If you would rather work the pivot points out by yourself, the formula I use is below:

Resistance 3 = High + 2*(Pivot - Low)

Resistance 2 = Pivot + (R1 - S1)

Resistance 1 = 2 * Pivot - Low

Pivot Point = ( High + Close + Low )/3

Support 1 = 2 * Pivot - High

Support 2 = Pivot - (R1 - S1)

Support 3 = Low - 2*(High - Pivot)

As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 7 points, 3 resistance levels, 3 support levels and the actual pivot point.

If the market opens above the pivot point then the bias for the day is for long trades as long as price remains above the pivot point. If the market opens below the pivot point then the bias for the day is for short trades as long as the market remains below the pivot point.

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

A perfect set up would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.
This all looks pretty straight forward.

Unfortunately life is not that simple and we have to deal with each trading day the best way we can. I have picked a day at random from last week and what follows are some ideas on how you could have traded that day using pivot points.

On the 12th August 04 the Euro/Dollar (EUR/USD) had the following:High - 1.2297Low - 1.2213Close - 1.2249
This gave us:

Resistance 3 = 1.2377

Resistance 2 = 1.2337

Resistance 1 = 1.2293

Pivot Point = 1.2253

Support 1 = 1.2209

Support 2 = 1.2169

Support 3 = 1.2125

Have a look at the 5 minute chart below

The green line is the pivot point. The blue lines are resistance levels R1,R2 and R3. The red lines are support levels S1,S2 and S3.

There are loads of ways to trade this day using pivot points but I shall walk you through a few of them and discuss why some are good in certain situations and why some are bad.

The Breakout Trade

At the beginning of the day we were below the pivot point, so our bias is for short trades. A channel formed so you would be looking for a break out of the channel, preferably to the downside. In this type of trade you would have your sell entry order just below the lower channel line with a stop order just above the upper channel line and a target of S1. The problem on this day was that, S1 was very close to the breakout level and there was just not enough meat in the trade (13 pips). This cab be a good entry technique for you. Just because it was not suitable this day, does not mean it will not be suitable the next day.

The Pullback Trade

This is one of my favorite set ups. The market passes through S1 and then pulls back. An entry order is placed below support, which in this case was the most recent low before the pullback. A stop is then placed above the pullback (the most recent high - peak) and a target set for S2. The problem again, on this day was that the target of S2 was to close, and the market never took out the previous support, which tells us that the market sentiment is beginning to change.

Advanced

As I mentioned earlier, there are lots of ways to trade with pivot points. A more advanced method is to use the cross of two moving averages as a confirmation of a breakout. You can even use combinations of indicators to help you make a decision. It might be the cross of two averages and also MACD must be in buy mode.

In the example below the market passed through S1 and then retraced to the S1 line again. It then formed a channel. At around this time we had a cross of the averages, MACD signaled buy and there was a breakout of the channel line. This gave a great signal to go long with a target of the original pivot line.

Mess around with a few of your favorite indicators to help determine an entry around a pivot level but remember the signal is a break of a level and the indicators are just confirmation.

We haven't even got into patterns around pivot levels or failures but that is not the point of this lesson. I just want to introduce another possible way for you to trade.

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