Trading Pivot Points Part 1

I've been studying reaction of price to pivot points for the EUR/USD and USD/JPY for a couple of weeks now but have yet to come up with a viable way of trading pivot points.  I've been exploring pivot points in an effort to create yet another system that uses price as its main indicator and not a lagging indicator.  There is a lot out there on the web that explain how to trade pivot points but nothing that has really got my attention.  Many of the systems use the pivot point level as the main support or resistance level that is targeted for a possible breakout or fade trade.  

One way of trading pivot points that I've been exploring is by incorporating the divergence of the MACD.  MACD is obviously a lagging indicator but divergence can take some of that lag out when certain patterns are recognized.  Let me show you an example.  It's easier with a video but I'm just brainstorming here so I'm just going to attach a graphic.

The question I'm asking myself is, as the price is approaching the pivot point level marked on the chart, how do I know whether to trade a break or a fade.  Looking at just price, the only indicator is the previous day and the fact that the pair was bullish.  I think that only having this information is not enough to make anything but a total guess trade.  Let's now bring our attention to the MACD histogram and the bullish hidden divergence that was evident even before the price touched down on the pivot point level.  You could see this divergence forming during the first few candles of this day and maybe even before that.  We can use this as a confirming indicator to tell us what direction we should be looking to trade.  In the above case, we would be looking to go long at a pullback to the pivot point.  We get the pullback and target the R1 level as our profit level where you can see the price consolidated.  

Like I said earlier, I'm just brainstorming and have not seen this exact method anywhere (you may have.)  I am not trading this method either.

I started a new site last week, http://www.allpivotpoints.com that has the latest pivot points for FOREX and 50,000 other securities.   These FOREX pivot points are not derived from any particular market maker, but from 250+ contributors from the interbank market.

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Rob Booker Divergence System

Though I don't consider Rob Booker my full-time mentor, I still do follow a little of what he's been up to.  I did pay for it after all so I might as well utilize it. 

Anyway, I've heard him talking more about his divergence system, so I decided to shoot him off an email to find out a little more.  What peaked my interest was that he mentioned in one of his videos that it works well during the Asian session.  I had altogether given up trading the Asian session months ago.  His response regarding his divergence system was "that system works really well in the asian session, even on short term charts like the 5 and 15 min."  I'm sure a lot of you know what divergence is but I put together a nice little reference PDF with graphs and examples of the 4 types of divergences.  You can download it here:

 Forex Divergence 25/08/2006,14:53 90.84 Kb

If you're interested, start looking for divergences on your charts between price and especially an indicator like MACD.  You could also use RSI, CCI, or another indicator of your choosing.  This requires some work but it may be worth it.  When I find the time to look into it more, I'll be sure to post more about it. 

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Divergence Chart

As most of you are aware, divergence can be a good predictor of future price.  I posted a couple of weeks ago the differences between the following types of divergences:

1. Classic Bullish Divergence
2. Classic Bearish Divergence
3. Bearish Hidden Divergence
4. Bullish Hidden Divergence  

For someone that hasn't been doing this for years and years, it isn't always easy for me to look at a chart and immediately see that a certain type of divergence is evident.  These 4 types of divergences have 4 totally different characteristics and I've been known to make a mistake identifying them.  Therefore, I have created a divergence identification chart PDF complete with charts.  It's only 2 pages and printed in landscape can really help a lot with spotting divergences.  Check it out. 

 Forex divergence 25/08/2006,14:53 90.84 Kb

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Regular vs. Hidden Divergence

I realized today that unbeknownst to me, regular divergence and hidden divergence are absolutely and totally different beasts.  In fact, I'm not even sure if I knew about hidden divergence.  What this means is that I may have been classifying regular divergence as hidden divergence and vice versa.  This is my mistake, one in which I don't want you to make too.  So I am going to reference some material to give an overview of both types.

Divergence happens when price makes one pattern and a corresponding indicator makes the opposite pattern.   You can use any indicator but the most commonly used are RSI, MACD, CCI, or Momentum.  I'm going to go through the process of identifying 4 types of divergence.

The first type is Regular Bullish Divergence.

Characteristics:  

• Occurs in a downtrend
• Possibly signals the end of a downtrend
• Possible bullish correction
• Lower lows in price
• High lows in indicator

#1

 

 

 

 

 

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The second type is Regular Bearish Divergence.

Characteristics:

• Occurs in an uptrend
• Possibly signals the end of an uptrend
• Possible bearish correction
• Higher highs in price
• Lower highs in indicator

#2

 

 

 

 

 
 

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The third type is Bullish Hidden Divergence.  

I would have simply called this next type of divergence regular bearish divergence in the past and I would have also expected it to have the regular bearish divergence characteristics above.  Let's first look at a chart of Bullish Hidden Divergence.

#3

 

 

 

 

 

As you can see, the price continues its ascent because Bullish Hidden Divergence is a continuation pattern.  You have to look closely but look at the MACD in the chart #3 above as opposed to the MACD in chart #2.  In chart #3, the price is making higher highs and the indicator is making lower lows and the MACD in chart #3 IS ALREADY IN OVERSOLD TERRITORY.  This is quite different than chart #2 as MACD is still in positive territory.   

Characteristics:

• Trend continuation
• Higher highs in price
• Lower lows in indicator

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The fourth type is Bearish Hidden Divergence.

This too is a continuation pattern as the bearish trend is expected to continue.

#4

 

 

 

 

 

You also have to look closely at the MACD in chart #4 above.  The MACD is already in overbought territory and the indicator is making higher highs.

Characteristics:

• Trend continuation
• Lower highs in price
• Higher highs in indicator

This isn't the easiest thing to explain.  Just look closely at the four charts above and the four different types of divergences shouldn't be hard to see.

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