Significant Pivot Points Determine Trend

01/05/10 09:01:07 AM

by Alan R. Northam

Alan Hall Andrews became famous for the Andrews pitchfork, but he also developed many other trading techniques. One such technique is his unique way of using pivot points. This article discusses how Andrews would have identified and used significant pivot points to determine when the upward trend of the Standard & Poor's 500 should reverse to the downside.

Security: !SPX
Position: N/A

During one of his seminars, Alan Andrews stated that the first thing he looked for when studying a price chart was the number of significant pivot points he could identify. Andrews knew that a trend would often reverse directions after five significant pivot points. A pivot point is either a high price point or a low price point.

To help us in identifying the significant pivot points on the S&P 500 chart in Figure 1, I have added a trendline that does not cut through any of the price action. By using this trendline, we can identify the significant pivot points as those that come closest to the trendline. Andrews labeled these six pivot points as P0, P1, P2, P3, P4, and P5. I show P5 in gray to denote that this last pivot has not yet occurred. Andrews denoted the smaller high and low price points on the chart as minor pivot points that occurred in between the significant pivot points and used these minor pivot points in some of his other trading techniques. As a note, Andrews did not say that he used the trendline as I did in helping to identify significant pivot points; as far as I know, this is my own invention.

FIGURE 1: S&P 500, DAILY. This chart shows the significant pivot points. Andrews noted that after five significant pivot points developed, there was a high probability for the trend to reverse directions. The chart also shows the relative strength index (RSI) help locate these significant pivot points.

Graphic provided by: AmiBroker.com.

Another way of identifying the significant pivot points is to look for a negative divergence between price and a momentum indicator. I have added the relative strength index (RSI) to show how this is done. Note that just before P1, price continued to make higher peaks as did the RSI. However, when price made a higher high at the point labeled P1, note that the RSI made a lower peak; this is called a negative divergence. Negative divergences normally occur, if they occur at all, at significant market turning points. These significant market turning points is what we are looking for as significant pivot points. Therefore, by looking for negative divergences between price and a momentum indicator, we can identify the significant pivot points. In addition, the final market high is also usually identified by a negative divergence. When you think of it, this makes perfect sense. Looking at Figure 1, I have identified three negative divergences. Negative divergence ND1 helps to identify significant pivot point P1. Negative divergence ND2 helps to identify significant pivot point P3. I have shown negative divergence ND3 as a dotted line to separate it from negative divergence ND2. Negative divergence ND3 helps to identify significant pivot point P5.

The first thing Alan Andrews did when looking at a price chart was to identify how many significant pivot points have already developed. He would use this information to determine how much further a trend had to go before reversing directions. Once he made this determination he would use these other trading techniques to help him identify areas on the price chart where he would enter or exit a trade. Through the use of identifying the significant pivot points, we now know that the upward trend for the S&P 500 is almost complete and significant a pivot point as P5 is almost fully developed.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.