Support-Resistance Levels: Moving Average, Murrey Math Lines and Pivot Points Article

In this article i’ll write about the Moving Average, Murrey Math Lines and Pivot Points, which can help find Support-Resistance levels in trading.

Moving Average

A Moving Average (MA) offers a dynamic form of Support-Resistance (S/R), when prices comes to test it from above or below. It’s one of the most widely used multi-purpose indicators among traders, trend analysis included.

Various versions of an MA can be calculated, the most popular are:

EMA (Exponential Moving Average) has less price lag and gives a more responsive & smooth MA as a result, as more weight is given to recent prices in the calculation.

SMA (Simple Moving Average) has more price lag and a less responsive & smooth MA.

The most common EMA & SMA’s:

5,10,13,20,50,100,200

The long term 200 EMA is an especially important one in terms of S/R, as it’s often watched by institutional investors. A break below it can trigger heavy institutional selling in any trading instrument used and vice versa.

Formula
Depending on the length of the MA, (let’s use a 50-day MA in this example) it can be calculated by taking the sum of the last 50 days of price Closes and then to find the average, simply divide it by 50.

The EMA & SMA can automatically be plotted on a chart. I.e. in a daily time frame, when data for the latest trading day comes in, the first day of i.e. a 50 EMA will be deleted from the calculation and the day 51 added, to always have an updated 50 EMA.

Below is an example moving average, a 50 EMA plotted on a Metatrader 4 (MT4) EURUSD chart:

example-moving-average-chart

 

 

 

 

 

 

 

 

 

 

 

A MA doesn’t have much predictive value in itself. So using it in combination with other non lagging analysis techniques like Price Action, Reversal Candlesticks, Tick Volume etc. is recommended.

Optionally, Momentum (overbought/oversold) can also be used to give increased confidence in a trade but it’s not recommended to use for entry purposes, since Momentum indicators also lags price.

Example Moving Average System

A useful EMA combination for trading practise in most time frames, (up to daily suggested) is the 5 & 20 EMA. For riding a bullish (positive) trend, when the 5 EMA crosses above the 20 EMA on a closing basis, only take trade setups on the Long (Buy) side.

Vice versa for Short (Sell) trades, when the 5 EMA crosses below the 20 EMA, which would indicate a bearish (negative) trend underway.

For market entries i’d wait for a price pullback towards the 20 EMA S/R (can be penetrated on an intra price basis but should not close on the other side) and then look for Reversal Candlesticks to form, before making an entry in the direction indicated by the 5 & 20 EMA.

Place Stop Loss one pip above/below the Reversal Candlestick. Risk/Reward 1:1.5-2, so ideally Profit Target should be double the Risk.

In this case, the 5 EMA is below the 20 EMA, so a bearish (negative) trend is underway, below is a chart example:

5-20-EMA-chart-example

 

Another convenient feature with using 2 MA’s is that the shorter one can sometime bounce off the longer one, alerting about a possible market reversal coming.

 

 

 

 

Metatrader Tutorial – How to plot an Exponential Moving Average on a chart

Below is a simple MT4 guide, in case you need help to put this indicator on a chart, which is freely available in the MT trading platform. Because of the frequent program updates, using the built in MT software Manual may give you a more up to date guide though.

With the desired price chart ready, click the ‘Insert’ button (circled in red on figure 1 below) on the Metatrader Menu, then go through the pop up menus in the order shown on the same figure and click on ‘Moving Average’.

A pop up box should appear, then put in the Parameters as shown on Figure 2, which is a 50 EMA example. After that, click the Ok button and the EMA should show up on your chart.

An alternative way to plot the EMA is to click the ‘Navigator’ button on the Menu, as shown on Figure 3. Another menu named ‘Navigator’ should then pop up on the left side.

Open the ‘Indicators’ folder by clicking the + symbol and eyeball down the menu until the ‘Moving Average’ is found, then double click it. The same Parameter pop up box as seen on Figure 2 should then show up.

Fig. 1

moving-averages-chart-mt4-tutorial

 

 

 

 

 

 

 

 

 

 

 

Fig. 2

ema-mt4-tutorial

 

 

 

 

 

 

 

 

 

 

 

 

Fig. 3

mt4-tutorial-ema-plot

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Murrey Math Lines

MML’s are based on W. D. Gann’s trading techniques, a discovery and evolvement by T.H. Murrey – http://murreymath.com a mathematical genius from Nashville, after he ‘saw’ Gann’s hidden secrets in his book ‘How to make profits in Commodities’, after reading it 6 times. In Murrey’s own words: “This is a perfect mathematical fractal trading system”.

If you want to go into the details of it, i recommend buying his book. I bought it myself and it’s a must have on the trading book shelf, giving insights, trading rules and general wisdom about the markets, both from himself and the many Gann snippets of wisdom he quotes in his book.

However, for practical trading purposes, since a part of the MML system gives useful Support/Resistance (S/R) levels for most stocks and markets traded, then what i can contribute with, is the below description of his MML’s and also a DL link to a Metatrader MML indicator, which is freely available out there on the net.

So these MML lines can be plotted automatically on a Metatrader chart at no cost. You can also of course draw these lines manually on the chart but then you also need to know how the system works in finer details, which is copyright T.H. Murrey and can’t be revealed here.

8/8th MML
This is one of the major MML’s in the Murrey Math theory. When prices are trending up, this MML will produce the strongest Resistance of them all on, when prices are heading into it. Bulls (Buyers) will have a tough time forcing prices through this stiff price roof and may make a significant pullback as a result of it, before possibly making another attempt to overcome it. It’s color is blue.

7/8th MML
The weakest line in the Murrey Math method is the 7/8th MML. A price move that has gone too far too fast tend to reverse sharply, if prices are stalling up against such a weak line. If it’s ignored, prices tend to go for a test of the next higher MML, the major 8/8th. It’s color is yellow.

6/8th MML
This is viewed as the Pivot & Reverse line, in terms of strength it’s only surpassed by the 4/8th MML in it’s tendency to cause price reversals, in both directions. It’s color is red.

5/8th MML
A line which marks the upper boundary of the 3/8th – 5/8th consolidation (trading range) zone. It’s difficult for prices to enter this range from both directions (from above or below) but once there, prices tend to stay there 40% of the time, regardless of the type of stock, market etc.

If prices are able to break above the 5/8th MML and stay above it for 10-12 days, then according to this theory the whatever instrument used is selling at a premium to what traders are willing to pay for it and prices could stay in this premium price zone for some time. It’s color is green.

4/8th MML
Let’s move on to a very important MML, like the 8/8th and 0/8th this line generates major Support/Resistance. In general, the 4/8th level is an excellent area to make buy/sell decisions at, in my opinion.

For educational purposes, (not an actual recommendation to buy or sell) here is an example of how this special line can be used in trading:

I.e. when prices comes from above and has traveled minimum 3 MMLs lower in terms of price length and finally test this line and at the same time a reversal type of bar/Candlestick is formed, along with oversold momentum and buying Volume coming in, then odds are good prices are heading higher from this 4/8th MML and i’ll open a Long (Buy) position.

I’ll place a Stop Loss right below the low of the reversal bar/Candlestick, i.e. a Hammer. Risk/Reward (R/R) should be minimum 1:2, so the Price Target should be double the Risk for this trade. Risk is measured from the entry price to where the Stop Loss level is.

In the same way, a trading opportunity can also show up when prices comes and test it from below and given the technical setup is right, (bearish reversal bar, overbought momentum and incoming selling Volume) a Short (Sell) position is considered opened. It’s color is blue.

3/8th MML
This is the line which marks the lower boundary of the 3/8th – 5/8th trading range (see 5/8th MML section above). It’s difficult for prices to overcome this line but if so and stays above it for 10-12 days, prices will tend to stay there 40% of the time, oscillating between the 3/8th – 5/8th lines. It’s color is green.

2/8th MML
Same function on this level line as with the 6/8th MML (Pivot & Reverse) above. Again, in terms of (Support/Resistance) strength, it’s only surpassed by the 4/8th MML in it’s tendency to cause price reversals, in both directions. It’s color is red.

1/8th MML
It’s the same weak line as the 7/8th MML above. In this case, i.e. if prices falls too far too fast and finds support on such a weak line, the reversal up could be sharp in nature. If it’s ignored, prices tend to go for a test of the next lower MML, the major 0/8th. It’s color is yellow.

0/8th MML
As with the 8/8th above, this is the other major MML in the Murrey Math theory. In this case, when prices are trending down, this MML will offer the strongest Support of all the lines, when prices have reached it. Bears (Sellers) may have a tough time pushing prices through this strong price floor and could result in a significant price bounce, before making another attempt to penetrate it. It’s color is blue.

A tip, these MML’s can even be plotted on top of a chart with Horizontal Lines (see article) drawn on it and serve as a confirmation and confidence increasing factor, as a horizontal line and the MML found on more or less the same level, is a fairly strong indication of a stiff resistance/support area to take advantage of in a possible trade, if the right trade setup shows up.

Resources
Bonnie Hill – http://bonniehill.net/pages/murrey.html is the author behind a very useful resource related to Murrey Math Lines and other systems too, well worth checking out.

Murrey Math Forum Thread & Indicators:

http://www.forex-tsd.com/metatrader-4/94-murrey-math-trading-system.html

Below is a chart with MML’s plotted, using an MML indicator available for Metatrader on the Net. This is a good example showing why the 4/8th MML can be an excellent Support/Resistance area to go Long (Buy) or Short (Sell) at. In addition, many of the trading opportunities were also alerted by reversal Candlesticks forming there. Personally, i would look for those setups only.

murrey-math-lines-chart

 

 

 

 

 

 

 

 

 

 

 

 

 

Pivot Points

Pivot Points or Levels are also called ‘floor pivots’ by some, which are Support-Resistance levels traders expect to show up in the market and because of this, they are used as Entry/Exit points for trading purposes.

Up to 9 points can be drawn, although this depends on the Pivot system used. These levels are calculated and drawn by first finding the Pivot Point, which is usually labeled PP. From the PP and up one can find Resistance levels, labeled R1 to R4. From the PP and down, the Support levels S1 to S4 are calculated.

Classic Pivot Points

Personally i haven’t used Pivot Points much but for those interested, it offers another Support/Resistance tool to consider for the trading tool box. Although there are several Pivot Points versions floating around, the following formula calculates the next trading day’s Pivot levels, based on the Classic (Pit Range) formula:

PP = (HIGH + LOW + CLOSE) / 3
S1 = (2 * PP) – HIGH
S2 = PP – RANGE
S3 = S2 – RANGE
R1 = (2 * PP) – LOW
R2 = PP + RANGE
R3 = R2 + RANGE

Source: http://tradingsuccess.com

Online Pivot Point Calculator:
http://ddata.over-blog.com/xxxyyy/0/00/38/66/calculator1.html

How effective the Classic Pivot Point system is, was back tested by Ray Barros at http://tradingsuccess.com/blog/ and he found the results were not better than random. However, here are his suggestions for improved accuracy, quote:

…”If you think about it, the problem lies with using the previous day’s range. The assumption behind the pivot formula is this: today’s range will be about the same as yesterday’s.

But this is not always the case. In fact, in the appropriate context, a small range today may mean a larger than normal range tomorrow; and a large range today may mean a smaller than normal range tomorrow.

Armed with this idea, I had the same pivot formula tested using the Average True Range for the pit session. But I made one change: this time I assessed whether the day’s Average True Range was to be normal, above normal or below normal.

I then used mean for normal, mean +1 stdev for above normal, and mean -1stdev for below normal and I used this figure to assess the ‘PP” value in the formula. The results obtained were superior to using yesterday’s range. This means of course the trader has to have some skills at assessing the likely strength day’s range.

In the way I use it, the formula’s of R1 and S1 tend to identify the high and low for the day. R2 and S2 tend to identify stronger or weaker than anticipated day and suggest I substitute the appropriate value (e.g. mean +1 rather than mean for the PP’s calculation).

A market’s acceptance below R2 or above S2, (where PP is normal), suggests a trend day (i.e. a strong directional day). While I would not use this idea as a stand-alone tool, it does play a part in helping me identify support and resistance for the various timeframes.”…

He also suggested checking out this free site http://pivotfarm.com which produce a convergence of support and resistance zones, found by calculating in the traditional way, most of the various types of Pivot Points and then combines them with MA’s (moving averages), Market Profile areas and Fibonacci zones.

Apparently they have later changed the domain name to http://tothetick.com  which, by the way, is a descriptive name. A free daily trader research sheet is available, Support/Resistance points included.
Camarilla Pivot Points

This is another formula version, other timeframes than the daily can be used as well.

R4 = C + RANGE * 1.1/2
R3 = C + RANGE * 1.1/4
R2 = C + RANGE * 1.1/6
R1 = C + RANGE * 1.1/12
PP = (HIGH + LOW + CLOSE) / 3
S1 = C – RANGE * 1.1/12
S2 = C – RANGE * 1.1/6
S3 = C – RANGE * 1.1/4
S4 = C – RANGE * 1.1/2

Resistance Levels = R1 to R4
PP= Pivot Point
Support Levels = S1 to S4
Range = High – Low for the timeframe used (normally daily)
C = Closing Price

Online Calculator:
http://mypivots.com/investment-calculators/pivot-point-calculator

For more on the Camarilla Equation:
http://camarillaequation.com/index.html

For a quick peek into what’s behind the Camarilla Equation, below is a quote from Nick Scott, allegedly the inventor:

…”Everyone asks me that. When I first started trading, I thought (as a lot of people do!) that the markets were controlled by a secret ‘insiders club’ of powerful organizations who manipulated prices for their own benefit.

I remember that at the time I was smugly sure that this was so, and was excited to be joining (as I then thought!) this secret ‘cabal’.

Of course, as I learned more about the markets, I realized that this was nonsense, and that the markets are far too big to be effectively controlled, even by gigantic financial corporations.

However, it still looked to me as though there was a pattern in what was supposed to be the ‘random walk’, a pattern that matched very closely what I imagined a ‘secret society’ would try to implement in order to maximize their revenues.

The obvious conclusion, of course is that if you have enough participants, statistically they start to behave in broadly predictable ‘over-ways’, and this leads to the patterning that the equation is so good at predicting.

The word ‘Camarilla’ is based on the Latin word for room (camera), and it means basically a small clique of ‘advisers’ who try to manipulate the person in power for their own ends. Frankly, it was just a joke, and I am always surprised at how seriously everyone took it.”…

Related Support-Resistance Article

Pivot Points Resources

http://www.pivotfarm.com/pzt-calculated-pivot-points.php
http://www.mataf.net/en/tools/pivot-points-woodie
http://www.mataf.net/en/tools/pivot-points-fibonacci
http://www.mypivots.com/investopedia/57/demark-pivot-points

-AM
 

Forex Trader, Analyst, Editor and Author

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