We've all heard it before: there are no guarantees in trading.
That seems like it's true. No, it's definitely true.
Wait, is it true?
I was first introduced to pivot points many years ago by my friend Rob Booker. Pivot points, I've come to learn, are a powerful representation of "fair value" (and you know how I love fair value).
To create a pivot point, all you have to add up the high + low + close of a financial instrument and divide by three. Pretty easy. And when you do that, you get a fair indicator of what that instrument is worth right now.
For example, we could take any stock and use this formula to determine what our stock is worth today.
Looking at the formula, we could first examine yesterday's high. That's relevant, but, whatever it was, that's not really what our stock is worth. That's what was happening when the market was super excited about our company for some reason.
Okay, what was yesterday's low? That's relevant, but, whatever the low was, our stock isn't worth that either. The market was too pessimistic at that moment.
How about the closing price? After the market got too happy and too sad during trading, what did our stock end the day at? That's closer to a fair value but not quite.
But using all of the components gives us a powerful number. By adding all those emotions up (happy, sad, and satisfied) and dividing by three, we have a value that takes the craziness out and gives us a great idea of what our stock is really worth.
It makes sense but does it work? You bet!
Pivot points are almost always hit on the day they're created. If we do our calculations before the market opens and put a pivot point on our chart, chances are extremely high that the pivot point will be hit on the day we plotted it.
If we believe in the universal law that all things settle back to equilibrium, then it makes perfect sense that the pivot point will be hit on the day it's created.
But is there anything that will make price not hit the pivot point? Yes!
If fear or greed suddenly grips the market, price will speed off violently in one direction, leaving the pivot point far behind. In those rare cases, the pivot point level would not be touched, and that's a phenomenon Rob calls a "missed pivot." In other words, price moved so fast that it missed its equilibrium point that day.
When that happens, a trading opportunity is born.
If we know (and understand why) prices always hit their pivots, then we now have a level to trade to when things get nutty. If price rockets away and leaves a pivot point missed (untouched at any time), then we can set up a trade back toward that missed pivot.
While emotion kept price from reaching equilibrium today, when things calm down, we can strongly assume that it will get back to that level when cooler heads prevail.
That seems logical.
But do we have any examples of this?
I've done a lot of work on missed pivots over the years and this past week I did a little more. Here's what I found.
[note: Keep in mind that pivot points can be used on a daily, weekly, or monthly basis. I like weekly pivots the best. Using weekly pivots diminishes a lot of noise and it's less work than recalculating pivots every day. And monthly pivots don't offer enough trading opportunities for me. But both daily and monthly pivots are still okay to use.]
First, I looked at stocks. I wanted an individual stock that has been trading a long time so we had lots of data. I picked Home Depot because it's been around for a while (and also because I drove by one the other day).
Looking at Home Depot (HD), I wanted to see how many missed weekly pivots have occurred and if there are any missed pivots still out there.
Guess what? There are none. All of the pivots have been hit. Every single weekly pivot since June, 1990 has been touched. If we had made a bet twenty-seven years ago that all weekly pivots would hit, we would have won all our bets.
That's pretty amazing. And, of course, there's a couple small caveats.
- The weekly pivots don't all get hit right away. In periods of insanity like 2000 or 2008, price can drop a long way for a long time, leaving a trail of missed pivots. While it's true that all of those missed weekly pivots eventually got hit, it can take weeks or months for price to get back to the pivot level. This means that a trader would need to be patient and have a plan for what to do if it takes a long time.
- My research was only for missed weekly pivots in the LONG direction. I ignored all missed pivots that would make us trade Short. This means I don't care about taking Short trades back down to missed level. I only care about taking Long trades back up to missed levels.
Why do I only look for Long missed pivots? Simple. The stock market has an upward bias. The stock markets rise over time. It's like the saying: if it doesn't kill you, it makes you stronger. In the stock market, if a stock doesn't go to $0, then it probably goes up. That's the guarantee of an upward bias. Check out a chart of the Dow Jones Index going back to 1925 and you'll see what I mean.
Want another example? Guess how many (Long only) missed pivots are still out there on Apple (AAPL)? None. They've all been hit. How about Netflix (NFLX)? Zero. How about SPY (the S&P 500 ETF)? Zilch.
In other words, if we had placed bets on any of those stocks when price had fallen rapidly and left missed pivots up above, we would have won 100% of the time.
That kind of sounds like a guarantee.
Again, it's important to stress that even something that looks like guarantee is not necessarily easy to trade. To buy something that's fallen and have it stay down for many weeks is difficult.
And, remember, if a stock goes to zero, it's not going to hit its missed weekly pivot. There are some retail stocks that have dropped and may not ever come back to those missed pivot levels.
But if we're sure a stock isn't going bankrupt, then a Long missed pivot level is about as close to sure thing that's out there.
And, oh, by the way, Amazon (AMZN) stock just dropped and missed a weekly pivot level. AMZN is currently trading at $987.58 (8/7/17) and there is a missed pivot up at $1,034.78. I'm not saying, I'm just saying.
So, does the missed weekly pivot phenomenon only work on stocks? Nope. It works on other things, too.
And we'll talk about that tomorrow in this week's Thursday 2 pm EST webinar.
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