Learn to Calculate a Stock’s Pivot Point

…After receiving a number of questions over the past several weeks, I have decided to update and re-post this former article of mine.

Stocks breakout from properly formed bases everyday but many investors don’t understand how to locate a pivot point or what patterns to study that may contain this very important buy signal. A pivot point can be described as the optimal buy point or the area at the end of a familiar base pattern where the stock breaks out into new high territory. William O’Neil, the founder of Investor’s Business Daily is considered the pioneer of the pivot point in modern times. As Jesse Livermore explains in his book (1941), the pivot point can also be described as the point of least resistance. When a stock breaks the point of least resistance, we are presented with an opportunity where a stock has the greatest chance of moving higher in a short period of time, especially when volume accompanies the breakout.

The pivot point can be calculated as the stock is forming the handle on a cup-with-handle base. The ideal buy price would be $0.10 higher than the highest spot during the handle, also know as the top of the right side of the base. The intraday high can qualify at the highest point and does not have to be the closing price of the stock. If the stock closes at the high for the day, then we will use this number as the high point.

The exact methods used for finding pivot points vary depending on the base pattern that is forming on a daily and/or weekly chart.

When a flat base occurs, an investor should look for a move $0.10 higher than the top point on the left side of the base or the start of the formation.

A saucer-with-handle follows the same rules as the cup-with-handle and is described in detail above.

A double-bottom formation triggers a pivot point that will be $0.10 higher than the middle peak in the “W” shaped pattern.

Many investors will try to cheat the rules and place a position prematurely before the stock breaks out and passes the pivot point. I do not suggest buying until the stock triggers the pivot point on above average volume also known as qualifying volume. The area considered as the least amount of resistance is weighed so heavily because all overhead sellers are gone as we break into new high territory. The pivot point usually comes within 5% to 15% of the stock’s old high 52-week high.

Don’t chase a stock that is 5% or more above the proper pivot point. This does not mean that you can’t buy on normal corrections and pullbacks to support or moving averages, especially if the stock remains in an uptrend. This rule only applies to the pivot point area as the stock becomes extended. If you buy with the pivot point and sell when a stock falls 7-10% from the pivot point, I guarantee that your yearly performance will increase dramatically.
Piranha

Words of Wisdom

...I would like to share some words of wisdom from Steven A. Cohen, the founder and famous hedge fund manager for S.A.C. Capital Advisors. Mr. Cohen was profiled in the book Stock Market Wizards by Jack Schwager, released in 2001. Last year, his salary topped $450 million as he remained in the top 10 highest paid managers in the world. In 2003, he trailed the leader, George Soros but passed him on the latest list. Now that you have a brief background on Mr. Cohen, I will pass on some words of wisdom from his interview with Mr. Schwager in the Market Wizards book.

Mr. Schwager Question:
When you put on a trade and it goes against you, how do you decide when you’re wrong? (The question actually relates to him and his traders)

Mr. Cohen Answer:
“This is not a perfect game. I compile statistics on my traders. My best trader makes money only 63% of the time. Most traders make money only in the 50 to 55 percent range. That means you’re going to be wrong a lot. If that’s the case, you better make sure your losses are as small as they can be, and that your winners are bigger”

Mr. Cohen Answer (to another question):
“If you think you’re wrong, or if the market is moving against you and you don’t know why, take in half. You can always put it on again. If you do that twice, you’ve taken in three-quarters of your position. Then what’s left is no longer a big deal. The smart thing is to start moving your feet. I find that too many traders just stand there and let the truck roll over them.”

Mr. Schwager Question (asked in early 2000 – before the bear breakdown):
Do you have a scenario about how the current long-running bull market will end?

Mr. Cohen Answer:
“It’s going to end badly; it always ends badly. Everyone in the world is talking stocks now.”

Mr. Cohen Final Words:
“You can’t control what the market does, but you can control your reactions to the market. I examine what I do all the time. That’s what trading is all about.”

I decided to write this blog entry because our philosophy here at MSW is similar to the wisdom that Cohen shares. Market wisdom and education such as the inserts above typically go in one ear and out the other for most novice traders and investors. His rules and words sound so simple yet 90% of all traders fail to follow the basic rules for stock market success.

Similar to what I say every night in the daily commentary, you can control your own actions but not the market’s actions. From 2000 to 2002, Mr. Cohen did not have one losing month with his hedge fund and the fund was actually up over 100% during this two year bear stretch. I would listen to his advice as he may be the best living trader on the planet.

Piranha