The futures markets exist to facilitate trade, and price must constantly fluctuate according to supply and demand. Futures prices cannot remain static, otherwise there is no market. The majority of liquidity in futures comes from traders on the exchange floor of the CME, known as ‘locals’, who act as market-makers and liquidity providers for institutional and retail order flow (although they trade for their own accounts and have no obligation to deal).
When there is no ‘paper’ (orders brought by brokers from off the floor) coming into the market, the locals will take prices up and down within tight trading ranges, exploring and testing the limits of valuation. Trading on any given day will persist within these narrow limits unless the locals are successful in attracting outside buying interest, and large off-floor paper orders start to flow into the market. The limits of these trading ranges therefore act as support and resistance in futures, and a breakout from these ranges tends to indicate that new buying or selling interest has entered the marketplace.
If we knew the range of support and resistance levels used by the floor traders, then we would have a good idea of the key price areas around which breakouts and reversals might occur.
Before the computerisation of the markets, floor-traders used to take nothing more than a pencil and paper into the futures pits with them, and they would calculate a very simple series of average price levels, based on the prior day’s price action, before the opening bell. The price levels they calculated were known as Pivot Levels, and consisted of support and resistance levels above and below a central ‘daily pivot’. On days where there is little or no outside buying or selling interest, then the locals will trade amongst themselves and the pivot levels may dominate the session. As the locals move price up or down to these levels they hope to generate interest from off-floor traders; when this happens you will often see a breakout or sell-off initiated around the pivots.
To calculate the pivots for the next trading day you will need to use the High, Low, and Close of the previous day’s regular cash session, and the following formulas:
R3
R1 + (HIGH – LOW)
R2
PIVOT + (HIGH – LOW)
R1
(PIVOT x 2) – LOW
PIVOT
(HIGH + LOW + CLOSE) / 3
S1
(PIVOT x 2) – HIGH
S2
PIVOT + (HIGH – LOW)
S3
S1 – (HIGH – LOW)
Where the levels are more than around forty YM (e-Mini Dow Future) points apart, it is common to calculate the ‘mid’ points also; these are literally half way between each of the pivots. You should get these values you use to calculate pivot levels from the cash-session data, as the floor-traders are only trading during the cash session and have little in interest in 24 hour price action with contracts that trade electronically overnight.
But if we don’t know whether to anticipate a reversal or a breakout when price reaches a pivot, how can we use these levels in our trading? There are several ways that we can make an educated judgment about how price will react to the pivots:
If there is very little volume flowing into the market then this indicates the absence of outside buying and selling interest. On low volume days we can anticipate narrow trading ranges with price reversals around support and resistance at the pivots. Our strategy will be to fade the initial moves to these levels.
Rather than trying to predict a breakout at a pivot level, our strategy will be to watch and wait to see how price reacts to the pivots. If price does break through a pivot, we will then aim to buy (or sell) a pullback to the violated level. In other words, we want to see strong confirmation of a breakout before we participate. Fortunately, as you will recall, it is very common for old resistance, once broken, to become support, and for price to retrace and test this support (and vice versa for old support).
The guidelines that follow are for the YM. You will need to adjust mechanical stops and targets accordingly for other markets such as the ES, NQ, or TF. You would be ill-advised to use this setup in any market that is no longer pit-traded (such as FTSE or DAX futures).
You will need to know whether a small range, choppy day is to be expected, or a trending market. Look at the volume on a 5 minute chart of the ES (the mini-sized S&P500 futures contract). If the volume after 10am ET is consistently under 10,000 contracts per bar, then you can expect a choppy, narrow range day. If it remains above this the market should produce powerful and volatile price movements. Ignore the volume of the markets in the first half hour of trading: the volume is nearly always high as many queued orders are executed on the open and longer-term market participants will be establishing positions. It can also be helpful to bear in mind that large range trending days are often followed by small range consolidation days.
Trending Days - Parameters for Buys (Sells are reversed).
Choppy Days – Parameters for Buys and Sells.
Do not attempt to use any price-based indicators alongside the pivots – they are lagging, whereas the pivots are predictive. By the time the indicator-based traders have got their by or sell signals and reacted, you will already be looking to take profits and waiting for the next setup to take shape.
In summary: it is much better to think of pivot levels as ‘price areas where something may happen’, rather than as guaranteed support or resistance. Whether price either respects or ignores these levels will be significant and tell you something about the market’s behaviour. The setup above will force you to look at exactly what is happening in the markets around these levels and to respond accordingly.
When there is no ‘paper’ (orders brought by brokers from off the floor) coming into the market, the locals will take prices up and down within tight trading ranges, exploring and testing the limits of valuation. Trading on any given day will persist within these narrow limits unless the locals are successful in attracting outside buying interest, and large off-floor paper orders start to flow into the market. The limits of these trading ranges therefore act as support and resistance in futures, and a breakout from these ranges tends to indicate that new buying or selling interest has entered the marketplace.
If we knew the range of support and resistance levels used by the floor traders, then we would have a good idea of the key price areas around which breakouts and reversals might occur.
Before the computerisation of the markets, floor-traders used to take nothing more than a pencil and paper into the futures pits with them, and they would calculate a very simple series of average price levels, based on the prior day’s price action, before the opening bell. The price levels they calculated were known as Pivot Levels, and consisted of support and resistance levels above and below a central ‘daily pivot’. On days where there is little or no outside buying or selling interest, then the locals will trade amongst themselves and the pivot levels may dominate the session. As the locals move price up or down to these levels they hope to generate interest from off-floor traders; when this happens you will often see a breakout or sell-off initiated around the pivots.
To calculate the pivots for the next trading day you will need to use the High, Low, and Close of the previous day’s regular cash session, and the following formulas:
R3
R1 + (HIGH – LOW)
R2
PIVOT + (HIGH – LOW)
R1
(PIVOT x 2) – LOW
PIVOT
(HIGH + LOW + CLOSE) / 3
S1
(PIVOT x 2) – HIGH
S2
PIVOT + (HIGH – LOW)
S3
S1 – (HIGH – LOW)
Where the levels are more than around forty YM (e-Mini Dow Future) points apart, it is common to calculate the ‘mid’ points also; these are literally half way between each of the pivots. You should get these values you use to calculate pivot levels from the cash-session data, as the floor-traders are only trading during the cash session and have little in interest in 24 hour price action with contracts that trade electronically overnight.
But if we don’t know whether to anticipate a reversal or a breakout when price reaches a pivot, how can we use these levels in our trading? There are several ways that we can make an educated judgment about how price will react to the pivots:
If there is very little volume flowing into the market then this indicates the absence of outside buying and selling interest. On low volume days we can anticipate narrow trading ranges with price reversals around support and resistance at the pivots. Our strategy will be to fade the initial moves to these levels.
Rather than trying to predict a breakout at a pivot level, our strategy will be to watch and wait to see how price reacts to the pivots. If price does break through a pivot, we will then aim to buy (or sell) a pullback to the violated level. In other words, we want to see strong confirmation of a breakout before we participate. Fortunately, as you will recall, it is very common for old resistance, once broken, to become support, and for price to retrace and test this support (and vice versa for old support).
The guidelines that follow are for the YM. You will need to adjust mechanical stops and targets accordingly for other markets such as the ES, NQ, or TF. You would be ill-advised to use this setup in any market that is no longer pit-traded (such as FTSE or DAX futures).
You will need to know whether a small range, choppy day is to be expected, or a trending market. Look at the volume on a 5 minute chart of the ES (the mini-sized S&P500 futures contract). If the volume after 10am ET is consistently under 10,000 contracts per bar, then you can expect a choppy, narrow range day. If it remains above this the market should produce powerful and volatile price movements. Ignore the volume of the markets in the first half hour of trading: the volume is nearly always high as many queued orders are executed on the open and longer-term market participants will be establishing positions. It can also be helpful to bear in mind that large range trending days are often followed by small range consolidation days.
Trending Days - Parameters for Buys (Sells are reversed).
- If there is significant volume, wait for the violation of a pivot level (or mid). You want to see price trade up to the pivot, make a clean break through it, and then proceed at least half way towards the next pivot. Place a BUY LIMIT order at the violated pivot. If price pulls back to the pivot then your order will be filled.
- Your first target is the next pivot level (or mid) above your entry – exit half your position here, and move your stop-loss up to break-even.
- Your second target is the subsequent pivot level (or mid) – exit the remainder of your position here.
- Use a mechanical stop-loss of 20 points.
- Do not initiate new positions with the pivots during the last hour of the cash session.
- If any position remains open at the end of the session, exit it at the market at the close.
Choppy Days – Parameters for Buys and Sells.
- If there is very low volume, look at where price is currently trading and place a SELL LIMIT order at the first pivot overhead, and a BUY LIMIT order at the first pivot below.
- Your first target is 10 points from your entry – exit half your position for a 10 point profit and move your stop-loss up to break-even.
- Your second target is the next pivot from your entry level – exit the remainder of your position here.
- Use a mechanical stop-loss of 20 points.
- Do not initiate new positions with the pivots during the last hour of the cash session.
- If any position remains open at the end of the session, exit it at the market at the close.
- Do not use the pivot level indicators that come pre-programmed in your charting package – they use 24 or Globex session data.
Do not attempt to use any price-based indicators alongside the pivots – they are lagging, whereas the pivots are predictive. By the time the indicator-based traders have got their by or sell signals and reacted, you will already be looking to take profits and waiting for the next setup to take shape.
In summary: it is much better to think of pivot levels as ‘price areas where something may happen’, rather than as guaranteed support or resistance. Whether price either respects or ignores these levels will be significant and tell you something about the market’s behaviour. The setup above will force you to look at exactly what is happening in the markets around these levels and to respond accordingly.