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Nasdaq, Pivot Points and Stops

12/20/00 02:43:23 PM
by Dennis D. Peterson

Each day in the market is a contest between bulls and bears. Pivot points, or variations thereof, may play a role.

Security:   $compq
Position:   N/A

Each day buyers (bulls) try to buy at the lowest price, while sellers (bears) try to sell at the highest price. Each day gives us a reading of whether the bulls or bears are in charge. When a bear market takes a sudden jump up, was it because of a change in market sentiment or was it a day when the bulls managed to "catch" the bears? Just the opposite would be true in a bull market.

Pivot points, originally devised by commodity traders, are sometimes useful to gain insight into today's market action. They provide simple formulas for setting the next day's stop-losses based on today's prices. While most amateurs do not use stop-losses, professionals usually do, and professionals deal in bigger trade blocks. Thus, they tend to move the market. Either long or short positions are candidates for stop-losses. When the levels for stop-losses are crossed buying or selling accelerates.

To better understand acceleration and stop-losses, suppose you have bought a stock and it continues to go up. You want to protect your profits and place a stop-loss below the current price. The stock turns down, your stop-loss then creates a market order, and your stock is sold. You sold because the stock was coming down, which just added to the selling. You accelerated the selling. If you are a bear, this is selling short heaven. Conversely, if you short a stock and place a stop-loss above the price you sold short to limit losses, then as soon as the market turns up your stop becomes a market order to buy, buying is increased, and the market goes up even faster. You have accelerated the buying and you are in bull heaven.

Understanding the use of stop-losses and resistance/support is the basis for much of price pattern behavior. This kind of analysis is at the heart of technical analysis. What you understand about daily action has direct analogies to longer periods. You need some sort of daily indicator to get an idea of what has happened.

As I watch the Nasdaq, each day I look to see if today's open is greater or less than yesterday's open and how much the open differs from yesterday's close. The rule of thumb I use is a pivot point value. I want to know if the bulls or bears are winning. If the bears win by far, we are in a bear market and similarly for the bulls. I do not want to go against the trend. What the heavy hitters use I do not know. I doubt if they are sharing that kind of information with very many anyway. I am just trying to put a reasonable test around today's action to see if it represents a longer-term shift in sentiment or just the usual daily profit and loss game.

Calculate pivot values for today as follows:

P=yesterday's (high + low + close)/3,

R1 (first resistance level) = 2*P -yesterday's low,
S1 (first support level) = 2*P - yesterday's high,
R2 (second resistance level) = R1 + (P-S1),
S2 (second support level) = P - (R1-S1).

I assume that stop-losses for longs are at S1 and S2 and stop-losses for shorts are at R1 and R2. For example, R1 is a resistance level and traders expect that prices will stop rising when a resistance level is reached. If you short a stock, then rising prices are a loss. To stop the losses, a stop-loss for a short is placed around a resistance level, and I start with R1. I expect volume to confirm price action when the levels are reached and the move is against the current market trend. For example, in a bear market it would be reasonable to expect that stop-losses for short selling are about at R1 and R2. Long positions in a bear market are not going to be dominant. If the open is above R1 or R2, I expect in a bear market that stop-losses will cause buying and accelerate the market.

Figure 1: Nasdaq and pivot point resistance and support lines. R1 is the dashed green line, R2 is the solid green line, S1 is the dashed red line, and S2 is the solid red line.
Graphic provided by: MetaStock.
Graphic provided by: Data vendor: eSignal<.
Looking at the December 5 Nasdaq numbers, the bulls took on the bears. The Nasdaq is currently in a bear market trend and stop-losses for shorts should be sitting around R1 and R2. December 4 set up R1 to be at 2669 for the 5th. If the December 5 open is above 2669 it should produce accelerated buying from stop-losses on shorts. If it doesn't, then stops are higher and insiders are less sure about market bearishness. December 5 opened at 2694. The result was a strong move in volume and price. On December 5 up plus down volume was 2.4B shares compared to December 4, when up plus down volume was 1.8B -- a healthy increase in volume. It happened again on December 8 with strong volume.

If this were a bull market, the gap up on December 5 would mean a significant support level. In a bear market it's an opportunity to take profits. After the gains on December 5, 8, and 9, profits were taken. The trendlines shown are from earlier Nasdaq values and simply confirm a downward channel. Some might see these upward moves as the result of a Greenspan statement or good economic numbers or the resolution of the presidential election. I don't see any daily price action that says anything except that the bears are in charge.

Dennis D. Peterson

Market index trading on a daily basis.

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Date: / /Rank: 5Comment: 12.20.00 Cogently written; especially for us pilgrims. Most helpful and informative. Keep up the good work!
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