CHIEF TECHNICAL ANALYST
Q. Dear Sandy, what are market phases and how do I recognise them?
A. As you might remember, we have discussed how traders can be on the “right side of the market”. If we could trade by being correct all the time, then life would be so much easier. However, trying to get it right is one part of a major hurdle for many traders. So in order to simplify this process, let’s consider this. We know that markets go up, down and sideways, but the problem is that we know this after the market has made its move. So how do we determine which way the market is likely to move in order to catch a significant portion of a trend and hopefully some profits too? Well markets often, but not always, provide a clue. And once a market has tested a price level, it will either accept or reject it, which opens up the prospect of further moves either higher or lower. This creates what is known as a pivot. Once a pivot has been created, the market may then either trade sideways, or it could start to stair step higher or lower.
Q. Dear Sandy, how do I recognise a pivot?
A. Let’s use this as an example: assume that today the market made a low at 100 and a high at 150. Yesterday, the market made a low at 120 and a high at 170. We can now say that today the market made a lower low and a lower high. Assume that tomorrow the market makes a low at 110 and a high at 160. Now we have a higher low and a higher high. It is the combination of these three price bars that creates the pivot. Now as long as the market does not break below the 100 level, which is the price rejection level, then the market should continue higher. If it breaks the 100 level then we need to start the whole process again until the market creates another pivot setup.
Q. Dear Sandy, where do I place my stop loss to protect my position?
A. This is simple. Once a market has created a pivot, we should “anticipate” a move away from it. Think about it for a moment. If the market should move away – or make a break – then ideally it should not come back to touch this level. Unfortunately, like everything in the markets, there is no guarantee that this will be the case. However, the pivot level is a good place to put a stop-loss order. So to conclude we would like to enter a position on a break above the third bar high, with a stop at the pivot low for a long position. You would reverse the process for a short position if you anticipate a move lower. As you can see in the Dow Jones Industrial Average chart below, there have been some significant tradable moves after pivot highs and lows of late.
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