Intraday Action So Far – Gap Fade and Pivots

Feb 7, 2008: 11:41 AM CST

As we slide into the mid-day doldrums, I thought it would be interesting to look at the action in the DIA (Dow Jones ETF) so far to see some educational and trading opportunities in the price action so far.

Two lessons are forefront today from a technical picture:

First, the “Fade the Gap” strategy is experiencing some hiccups, as more traders have become aware of its recent “hot streak”

Second, the DIA has respected its daily pivot point levels very nicely so far.

First, let’s look at today’s “Fade the Gap” strategy.

I haven’t annotated it, but envision you see the overnight gap of approximately $0.80 (or 80 Dow Points) and you decide that you want to fade the gap back to $122.40 with a stop maybe 40 cents or so away from entry. Whatever the entry and stop you chose, you had immediate gratification in the first 10 minutes this morning (each bar represents 5 minutes of trading).

The market was off to fade the gap as you’ve been taught it would and you were excited. But wait! There was a reversal and a ‘hammer’ style candlestick just 25 cents shy of your target (yesterday’s close). How can that be?

If you held like the textbooks say (put a target in, put a stop in, and then let it ride and don’t micromanage – a tactic I recommend as well), then you watched your paper profits evaporate into a likely stop-loss on an otherwise excellent trade.

The market made a new low and violated its daily S1 (support 1) pivot (purple line calculated by TradeStation or your broker). You exit, exasperated.

In fact, you’re probably angry at this point and so you get “short” the market. Now you watch as price ejects in one massive up-bar candle and then rockets like you’ve never seen it before to fill the gap just as you expected it would.

But instead of a profit, you had a loss and if you got short, you had two losses!

Anyway, the point is that when a strategy becomes very popular and the crowd catches on, odds are that the market will act against those traders and foil them as only the market can do. Not only did the market come back and snatch their stops, but it embarrassed them mercilessly with a major price impulse from $121.40 to almost $122.20 in five minutes.

I would declare today’s pattern a “failed” or “busted” gap fade, even though the gap did fade.

The second lesson to learn is that of Market Pivot Points or Floor Trader Pivot Points.

My software calculates these automatically for me, but you can do so manually as well.

Notice how the market respects the pivots almost to the penny today.

The purple dotted line is the S1 pivot and the dotted blue line is the Daily Pivot Level. One can expect these to serve as initial support and resistance, and some traders trade exclusively off these numbers.

I have circled the points where the market hit the pivot and reversed. You can easily use these levels with other trade set-ups to provide targets, exits, and even stops.

Nevertheless, today’s intraday action has been baffling for some, and rewarding for others!

2 Comments

2 Responses to “Intraday Action So Far – Gap Fade and Pivots”

  1. Hardware IT Blog » Blog Archive » Intraday Action So Far – Gap Fade and Pivots Says:

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  2. Mike Lee Says:

    How do you calculate pivot point ! can you give 2 examples on daily charts and on 60 min charts !

    Thanks Mike Lee Denmark