Ask a Broker

ISSUE 607 | JULY 2007

Q: How Can I Use Technical Analysis as a Money Management Tool?

This month, Lind Plus Senior Market Strategist Jeffrey Friedman answers:

A: Of course there are many technical tools you can use to help manage your risk, but I think pivot points are a good place to start. Pivots are a basic technique for determining support and resistance, one of the cores of technical analysis. You can use a variety of data to get this formula, in different time periods.

The basic pivot technique involves trading with support and resistance levels derived from the previous day's or week's (what ever time period you want to use) high, low, and close price data with volatility, which shows momentum. The idea is to sell when the market's price violates these levels on a break and buy when the price pushes through them on the upside. You can also use the opening and closing prices of the day or week and the previous day's highs and lows as support and resistance levels. Remember, once broken, old resistance typically becomes new support, and old support becomes new resistance.

I use pivots to determine entry and exit points, as a momentum indicator, and also for money management. First and foremost when you trade, you need to establish discipline, and tools like pivots can help. Before you even place your trade, determine where you are getting in, where you are getting out, and stick to your game plan. Pivot trading can help you establish those parameters.

I calculate daily and weekly pivots for a number of markets for my clients. Here is an example of my pivot point analysis on July 18, 2007, for the COMEX August gold futures contract, the NYMEX September crude oil futures contract, and the NYMEX RBOB August gasoline contract.

You can see how these pivots look when overlaid on a daily price chart for the RBOB contract.

Playing the Pivot

What these numbers mean, and how do you use them to trade? As mentioned, pivots can help you find specific support and resistance points to guide your trading, and apply to any market. Support occurs when increased demand for commodities futures builds a floor under prices. A support level or zone appears when buyers miss purchasing a commodity future and vow to buy it should prices decline to the same, or nearly the same, level. Resistance occurs when selling pressure stops a price rise. A resistance level is similar in that traders buy the commodity just before it tumbles, and they vow to sell if prices reach their purchase price. How many times have you heard novice traders say, "as soon as I get my money back, I'm selling?"

"Pivot points" sound like they could be critical junctures in the market, and for some active traders looking at intra day charts, they are. A pivot point is a computed number, and from it, support and resistance levels are calculated that act as brackets for the next bar's price action. Active traders treat them like support and resistance levels, acting as potential boundaries for the next bar's price range. Or, if prices do break through your calculated first support (S1) or first resistance (R1), a stop might catch a move to the next target, the second support (S2) or second resistance (R2) line. The support and resistance lines may turn back prices, because that's as far as market strength or weakness can take them, or because enough traders expect that to happen. But remember, these lines aren't walls. What may be more important is how prices react as they approach or break through these lines. When prices are attacking the R1 and R2 resistance lines consistently, the up trend is well-entrenched; when prices back away from the R1 and R2 lines, the up trend is weakening. Like many things about price charts, pivot-point analysis isn't perfect. It helps if the pivot point lines coincide with prior highs or lows, chart patterns, candlestick analysis or other corroborating evidence. Pivot points can be another effective trading tool, and if you contact me, I'd be happy to tell you how to apply them to specific markets as you trade.

Good luck and good trading!

Jeffrey Friedman is a Senior Market Strategist with Lind Plus, Lind-Waldock's broker-assisted division. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com if you have questions on this topic or to discuss specific trading strategies for your unique situation in this or other markets.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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