Pivots and Trends

In the first article about pivot, I wrote down my understanding about pivots and how one can test trading ideas around pivots and price. In this blog, I am going to touch upon the basic ideas of how to identify trends using pivots. 

So, I bet most of readers have once in a while encountered the below scenario in the market.

This is what we call overnight sentiment reversal in price. Suddenly bullish sentiment reverses to the most bearish and vice-versa. There may be overnight news or any other important events or development around the world that may cause this reversal in the price. But as a data-driven trader is there an edge in this reversal setup that we can benefit from? 

Well I think there might be a shining edge because as legendary trader Larry Williams said, most of the times the market reverses when it breaks important support/resistance levels that are most visible and easy to spot on the chart. Because most of the people are waiting for this opportunity to go with the trend, but what they don’t realize is they are too late to join and move has already occurred.

Testing the Hypothesis

To test the above hypothesis, we need to quantify two things first -how will we identify trends and point out where it will most likely to reverse. Let’s fix the intraday time-frame for simplicity.

We know that if the price for the day closes below BC level then there is weakness in the price for that particular day at least. But if it closes below BC level for two consecutive days then definitely the trend is down currently. Vice-versa for close above TC suggest good up-trend in the price. So, I think we can quantify existence trends using this concept.

Now, as said in the previous post, pivots levels are an equilibrium of price. Meaning pivots can be used to see the balance point of the price. We have already established our view that price is uptrend or downtrend so in other words where is the initial balance?

Now, let’s say the price is close below BC for the last two consecutive days, so the trend is down but what if next day it opens above the Pivot level? It will make a good probability of reversal, right?

The Backtest

This test is done on the Bank Nifty spot price year 2011-2020.

In simple terms, rules are as follows:

• Last two day if the price closed above TC and next day if it opens above pivot then go long at open and close the position at market close.
• Last two day if the price closed below BC and next day if it opens below pivot then go Short at open and close the position at market close.

Here are the points captured by the above plane vanilla set-up:

See, shining edge following this type of simple set-up. Yet this is just ideas on how one can go about testing concepts around pivots. This is not a trading strategy. But I am sure tweaking maybe some parameters or introducing risk management techniques one can optimize this setup into a full-proof trading system. 

Until then, Happy trading!