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Filtering the Numbers Forex Analysis
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• Take the R-1 and the S-1 initially from all time frames for your analysis, especially in low-volume consolidating trading sessions.

• The pivot point can be used as an actual trading number in determining the high or the low of a given time period, especially in strong bull or bear market conditions.

• In a bearish market, the highs should be lower and the lows should be lower. In this case I use the actual pivot point up to the R-1 for resis tance and the S-2 for support targets.

• In a bullish market, the highs should be higher and the lows may be higher than those for the preceding time period. I use S-1 up to the pivot point and the R-2 for targeting the potential trading range.

If in a given trading day the market goes through my daily target num bers, the importance of the weekly and even monthly numbers is what gives me an indicator for the next major target levels of support and resistance. I use the actual pivot point for many things; for example, it is important to understand that it can be used as an actual trading number in determining the high or the low of a given time period, especially in strong bull or bear market conditions. In an extremely bullish market condition, the pivot point can become the target low for the trading session. This number rep resents the true value of a prior session. In an uptrending market, if the market gaps higher above the pivot point, then a retracement back to the pivot will attract buyers. Until that pivot point is broken by prices trading below that level, traders will step in and buy the pullback. The opposite is true in an extremely bearish market condition; the pivot point will act as the target high for the session.

If a news-driven event causes the market to gap lower after traders take time interpreting the information and the news, generally prices come back up to test the pivot point. If the market fails to break that level and trade higher, sellers will take action and start pressing the market lower again. Technically speaking, in a bearish market, the highs should be lower and the lows should be lower than in the preceding time frame. If they are, then to help me filter out unnecessary information or excessive support and resistance numbers on my charts, I use the actual pivot point up to the R-1 number for resistance; and then I target the S-2 for the potential low or for that time period's trading range.

As you can see in Figure 2.4, if I determine that the market is bearish and if I understand the relationship of the geometric distance of the resis tance and support targets, I can eliminate the R-2 number, since in a bear ish environment we should see a lower high. If I am looking for a lower low, then I can eliminate the S-1 support number as well; and now I have re duced the field to just three numbers. If I apply the same methodology on a daily, a weekly, and a monthly chart now, instead of 39 numbers, I am now working with just 9 numbers. Once again, I am not using the numbers to place orders ahead of time (even though you could); I use the numbers as a guide.

These numbers work very well and often act as a self-fulfilling prophecy because so many institutions and professional traders use them. Many have different-size positions on; and some traders may not wait for the exact number to hit and may start scaling out of positions (as I do), and as you should also. With this method, you can use these numbers as exit areas on your trades. As Figure 2.5 depicts, in a bullish market environ ment, by definition, you may agree that the highs should be higher and the lows should be higher than those of the preceding time period. When I have determined that we are in a bullish trend, I target the S-1 up to the pivot point for the low of the session and the R-2 for targeting the high; and that will give me an idea of what the potential trading range will be.

When the market goes through the projected daily target numbers, I then use the next time periods to give me the next reliable price objective. That is where the significance of the weekly and monthly numbers comes into play.

There are several methods to use to help determine whether a market is bullish, bearish, or neutral. One method is an open/close indicator. If after a prolonged uptrend prices close below the open (black candles: C < O) after at least two or three consecutive sessions, and there is a close below prior lows, then you will know the market internals have switched from bullish to bearish or from uptrend to a consolidation phase. Therefore, you could choose the R-1 to the pivot point to target the high of the next session down to the S-2 number.

Another method, which is more in line with my moving average meth odology, is if on a daily, weekly, or monthly time period, the close is below the prior time period's close and if the current close is below the open and closes below the pivot point, then the next time period should be consid ered as a bearish trading session. In Figure 2.6, the square boxes represent the value of that time period's pivot points.

If the market closes below the session's open, below the prior session's close, and below the pivot point, then the next time period would be considered a bearish trading session. In this case, I would consider the next time period's pivot point up to the R-1 for a targeted high and the S-2 for a targeted low.

The opposite would be true for a bullish consideration. In Figure 2.7, if the market closed above the open, above the prior session's close, and above the pivot point, then I would target the next trading session range from the S-1 up to the pivot point to the R-2 resistance target level.

The Advantage of Confluence

Time is an essential element in trading. Many times, traders are correct in their predictions for a top or a bottom in a market; but their timing is off, which results in a loss. Many analysts were calling for a top or for the bubble to burst in the stock market in 1999. In that situation, not demonstrat ing patience would have resulted in dramatic loss of profit potential or, worse, actual losses due to selling short tech stocks too early. How about economists' predictions of a housing bubble back in 2004 and their expec tations for a decline in real estate prices? As of February 2006, that has not happened. I can go on and on about examples when prognostications were correct but timing was wrong, resulting in a financial loss. As I stated ear lier, pivot point analysis relies on both time and price specifics in its calculations to project future support and resistance levels.

By incorporating various time frames, such as daily, weekly, and monthly price data, the trader can take advantage of price areas that coin cide with the different time periods. These price clusters will repel the mar ket's advance in an uptrend or act as support by causing prices to reverse in a downtrend. This clustering or confluence of more than one time period is an awesome event and can translate into a very lucrative setup. The more confluences or corroborating numbers there are that target a general area, the more significance there is for that specific targeted price level. Pivot calculations work to pinpoint almost exact times and prices for trades in various markets and can be used to validate other analyses. Remember this phrase: “There is always strength in numbers!” When several pivot numbers line up, there is a great potential for a reaction from these levels. This knowledge, combined with identification of the shift in momentum by recognizing and acting on strong triggers, increases the probability of a successful trade. One reason for using various time periods (day, week, month) for your pivot point analysis is that it incorporates and reflects three different groups of traders: short-term day traders, intermediate-term swing traders, and long-term position traders, who are generally higher capitalized, trend-following hedge funds.

Figure 2.8 shows the daily, weekly, and monthly pivot point numbers drawn across the chart; this gives a trader the heads-up that the market may reach an unsustainable extreme or oversold market condition. Just by looking at the graph, one can see that the market has been in a prolonged downtrend. Generally, the market may stop its descent at a confluence support zone, and then you would want to wait for a shift in momentum to trade a potential price reversal. As the market starts to give clues that a bottom is near, you can determine a low-risk entry since a bottom has been defined. What would not be known is how high the market's reaction will be from this target level of support. This is where the section on candle charts will play an important role in helping to determine the strength of the trend reversal.

Let's examine the chart in Figure 2.9, which is a 60-minute chart from July 19, 2006 , on the spot forex euro currency versus the U.S. dollar. The monthly S-1 target low was 125.16, the weekly S-2 lined up in close prox imity at 125.01, and the daily S-1 was 124.63.

The actual low was 124.55! Looking at the market's reaction, we see a strong value area in which the market embarked on a stellar rally. The confluence of pivot support numbers gave one of the best and only predic tive support targets. Therefore, it should be noted that the longer-term numbers should be watched carefully for clues not only for trading oppor tunities to enter positions, but also as a warning that the current trend could be exhausted and potentially reverse. At the very least, even though you may not have established a long position, you certainly would have been alerted not to sell short at the lows or at this confluence of pivot sup port target numbers.

I want to dissect this trade a bit further and switch to a daily chart to show you when, at times, you can implement these confluences with can dle chart patterns and milk what might turn out to be a simple day trade into a nice swing trade. Figure 2.10 zooms in on the low that occurs on that Wednesday, July 19, 2006 , when the daily chart shows the euro took off in a three-day run. July 21, 2006, was a Friday; so as a trader, if you can learn to spot these high-probability value areas or confluence of pivot point support targets, more times than not, when you have a secondary confirming element (such as the three-candle pattern like the morning star formation), you can milk a trade for more than you think by letting the trade mature and following along with the position. Trailing your stop-loss or stop-profit or ders and setting either a profit target or a time target (such as exiting the trade before Friday's close so as not to leave yourself exposed to surprise risks through the weekend), will get you ahead of the game as these lineups occur. If you bought to go long on the close on July 19 or on the open, which would be considered 5:05 P . M . (EST) on Thursday, and then by hold ing that trade until Friday's close, which is approximately 5:00 P . M . (EST). By identifying longer-term time period pivot support targets that are in play, you can determine that there could be more room for prices to appreciate. By monitoring the positions and managing the trade with trailing stop tech niques, you can let these trades “breathe” or allow to mature into big trend plays, which is where you really can rack up some juicy profits.

Confluences Work at Tops

We have all heard in the field of technical analysis that what works for some patterns or signals is not applicable for all situations. However, the power of pivot point confluences does work at market tops and also works to indicate bottom reversals, as we just went over. In the illustration in Figure 2.11, once again the three main time periods that we use are the monthly, the weekly, and the daily. When a congestion of pivot point num bers line up or congest at or near a specific price zone, this should heighten your awareness for possible reversals. It is important to note that if a mar ket has been in a long uptrend, say more than two months, and if we are close to the end of the quarter, the market is ripe for a profit-taking correc tion. Generally speaking, portfolio managers trading managed funds re ceive payment by a performance fee (profits) at the end of a quarter. Since many of these large trading entities use pivot analysis or are aware that oth ers use them, when a confluence of resistance develops especially near the end of a quarter, watch out below. It not only marks a prime opportunity for the market to react off that resistance level, but there is also a specific tim ing reason why a profit-taking correction can occur then. The same holds true for bottoms. After a long price decline, if the numbers line up and if it is near the end of a quarter, a profit-taking reversal could be in the works. That does not mean to say the original trend won't resume, but you could take a great countertrend reversal trade. Generally speaking, market sell offs have more velocity than market rallies do. Therefore, spotting resis tance confluences can be very lucrative opportunities, under the right circumstances.

I just explained the phrase “There is always strength in numbers.” The concept can be explained further in that there is a strong analytical value found in the number three, not just in trading and technical analysis but also in our universe.

As you may be aware, the number three is found as a Fibonacci number. (If you are not familiar with Fibonacci analysis, it is fully described in Chapter 6.) When I look at confluences in the three different time periods, it represents the three different groups of traders. The daily numbers are used by day traders, the weekly numbers are used by swing traders, and the monthly numbers are used by longer-term position traders and institutions. The coincidental factor arrives from the fact that one set of numbers from one time frame generally has nothing to do with the others. The range of the past month had different values for the high, the low, and the close than the input values have for the weekly and the daily time frames.

Before I forge ahead and show you how to use the resistance numbers, I want to review one really important and helpful tactic. Recall that in Chap ter 1, I stated that forex traders can borrow information from the futures in dustry. One such piece information is the Commodity Futures Trading Commission (CFTC) Commitments of Traders (COT) report. In essence, this report reveals whose hands “control” the market. If you look at Figure 2.12, you will see that the Commercials had built a sizable net short position of nearly 100,000 contracts, and it was the small speculators or the retail traders who were net long the market at the top!

The CFTC report showed that at the end of the trading session on May 30, 2006 , the funds, or the Non-commercial category, were long 96,864 contracts and short 16,980. That is a net short position of 79,884 contracts. Each futures contract is $125,000.00 worth of euro currency! The Commer cials were long 39,005 contracts and short 138,891 positions. The Nonre portable positions category (small speculators) were long 58,387 contracts and short 38,502 positions. This means that the banks, or smart money, es tablished a protective hedge position in the futures, betting that the spot euro would fall in value against the dollar. The Non-commercial category is considered professional speculators and smart money, too. The difference between these traders and the commercials are that they are speculating and will not generally take delivery of a futures contract. Keep in mind that this data is from the close on May 30, 2006 , which was a Tuesday, and was not released until Friday June 2, 2006 , at 3:30 P . M . (EST), well before the forex close. The next opening would be considered Sunday night. That leaves plenty of time to examine and digest the information. Now turn your attention to the chart in Figure 2.13 and see how the numbers in the spot forex euro currency line up. Keep in mind that the euro market made a tremendous upward price move from the low of 118.23 on February 27, 2006 , until the high was made on June 4, 2006 , at 129.79

Examine Figure 2.14 closely. You will see that the monthly R-1 was 130.07, the weekly R-1 was 129.92, the daily pivot R-1 was 129.66. The actual high price was 129.79, a very small margin of error as it relates to the prox imity of the predicted pivot resistance level. Here we have a great example of how pivot point analysis pinpointed the exact day of the week in a specific month of the high from which a substantial price break occurred. The euro proceeded to decline further in the month of June to 124.73 on June 23, 2006 .

Combining the pivot point resistance levels with knowledge of a few bearish candle patterns such as the shooting star that formed the high, or if you see the three-candle pattern called the evening star formation and combine it with the CFTC COT report, you certainly have a strong case to enter a short position. Market tops that align with a cluster or confluence of var ious pivot points can result in tremendous market reversals, as this exam ple shows.

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