Veteran traders often remark that no one analytical technique provides all the trading answers. It would seem, then, that one of the keys to successful trading is to know how to combine technical tools to best effect.

John Person, president of NationalFutures.com and a 26-year veteran of the futures and options markets as trader, teacher, author, and commentator, finds pivot point analysis and candlestick charting to be one such powerful combination. Person says that using these two tools to study futures price action "can truly give traders an edge in the markets". Person likens this combination of trading tools to epoxy glue which requires two compounds, neither of which will bond separately but which create incredibly strong bonds in combination. He says, "Combining candlestick charting with pivot point analysis can give you a similarly strong result if, as always, you apply proper risk management in your trading strategies".


The Tools

For Person, one value of candlestick charting, which he calls a "basic building block method", is that it reveals the connection among the four most important aspects of price analysis - the open, high, low, and close of a given session - in a clear, visual way.

He says, "A candlestick chart illustrates and helps identify the current market environment, especially by creating a graphic representation of the acceptance or resistance of specific support or resistance levels in a particular time period".

The shapes of the candles make the message instantly obvious and easy to decode. (The sidebar, Candlestick Rudiments, provides definitions of key formations.) To illustrate, Person uses two examples: "If prices move higher from the opening price of a session and close near the highs, this shows strong buying interest. However, if after the open the market trades up, establishes the high, and then falls, the distance formed from those points of interest, called 'the shadow', shows rejection of that price level".

Of special interest to Person is a candlestick shape called a Doji. In this formation, Person says, "There is no real body because the market closes at nearly the same level as the open. This kind of candlestick identifies 'swing points', or 'pivot points', which are points where momentum changes direction". Person emphasizes that these moments should not be confused with pivot point analysis which can be used to predict support and resistance levels. Rather, this use of the terms "swing point" or "pivot point" refers to moments in the progress of a market when momentum wanes and the market is likely to change direction. However, pivot point analysis is the second tool in the mix. Person likes this tool because it gives traders an easy way to predict where a market will find support or resistance. Calculating the pivot point (P) and the first and second levels of support and resistance are simple. Assume the CBOT® mini-sized DowSM high (H) on a given day was 11,310, the low (L) was 11,233, and the close (C) was 11,248. Given these data, P is 11,264, which is the sum of H, L, and C divided by three. The resistance and support levels follow from this initial calculation given a set of simple formulas:





According to Person, the main goal of pivot point analysis is to pinpoint price targets in a specific time period.



Combining the Tools

Per Person's methodology, the real trading payoff comes when traders combine pivot point calculations with the visual aid of certain candle patterns. By doing this, they can find superior guidance concerning when and where to enter and exit positions.

During his many years of trading, Person has found that "more often than not, Doji candlesticks form at these pre-defined support or resistance levels". It follows that in planning their trades, Person says, "traders should concentrate on market behavior at support and resistance levels, especially when Dojis appear at those levels. The key is to watch for confirmation of a transition and to act on momentum shifts".

A typical candlestick development for which to be alert in the search for a change in market behavior, Person says, is for the market to close higher than a Doji high at or near a pivot point support level. Person calls this a High Close Doji, or HCD, pattern. Exhibit 1 provides a close-up of such a situation. Person says to "notice that once the market closes above the Doji high, there is an immediate reaction in which momentum becomes positive and there is a continuation of higher prices".


Person calls this a "high probability intraday trading pattern".



Putting the Tools to Work

In Exhibit 2, each candlestick represents a 15-miniute segment of trading in the December 05 CBOT mini-sized Dow futures contract. The day shown is September 28, 2005.





Based on the high, low, and close shown on the exhibit, you can calculate the relevant support and resistance levels. The three blue horizontal lines show support 1, resistance 1, and resistance 2. These levels indicate places where you may see momentum changes. You won't necessarily see them, but these are price levels you should be alert to.

"Notice", Person says, "how the Doji forms right on the pivot point support Line [ed: which occurs at 11:20]. Here the candle right after the Doji [ed: note the green arrow and the label "High Close Doji Trigger"] not only closes above the Doji high, but see how it entirely engulfs the real bodies of the two candles prior to the Doji as well. The extent of this candle helps signal the power behind the reversal".

A further signal of this power and that the reversal is taking hold, Person says, is the development of additional green candles. A green candle, remember, indicates a period in which the close is higher than the open and is a sign that buyers are dominating the market.

Following the sequence of candles on the chart, you can see that the Dow maintained this upward momentum all the way from the 10,459 first support line to the 10,592 second resistance line, where it lost momentum and tailed off to end the day at 10,577. The presence of three red candles along the way might be moments to exercise caution. But the emergence of a Doji and a Hammer (see the sidebar for definitions of these candle forms) at the 12:35 and 12:50 periods suggest this to have been a pause and not a reversal.

Seeing this, you may well have decided to stay the course. In any case, if you had bought futures upon seeing the Doji at 10,459 or shortly thereafter and held fast until the first resistance level or slightly beyond, this trade could have earned you 100 points, give or take a little depending on exactly where you exited the position.



Statistics Support the Generalization

While the evidence of Exhibit 2 seems to bear out Person’s claims about the meaning of the Doji candles and the usefulness of using support and resistance levels as clues about when to look for Doji formations, he created a backtest that gives his observations further substance.

In this study, Person looked at three candle formations as they emerged on 15-minute charts of daily CBOT mini-sized Dow trading: Dojis, Hammers, and Shooting Stars.

Exhibit 3 shows that 26 percent of the lows were established by Dojis while 35 percent of the lows were established by Hammer formations. Combined, that accounts for a 62 percent chance that lows will be established by a Doji or Hammer - based on these 15 minute time intervals. Conversely, 26 percent of the tops were established by Dojis while 39 percent were established by ShootingSstars. So Dojis and Shooting Stars combined to account for 65 percent of the tops covered in this study.






This strong statistical foundation suggests that the methods Person introduces can indeed help traders watch and study current price action or, as Person says, "Focus on the now".

The candle patterns provide visual confirmation of price momentum, and pivot point analysis can show you where to look for potential turning points. Clearly, a combination of these two methods can help you develop a solid trading program.


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