Trading On The Mini S&P 500: A Trend-Following Strategy Based On Pivot Points

Do Pivot Points work in systematic trading? This article will attempt to answer this question by defining precise rules and creating a trading system on the world's best-known and most traded future, the Mini S&P500.

Pivot Points have been used by many traders around the world since the markets were still "at the cries." It was actually a floor trader named Neil Weintraub who first invented and used them. Defined on the basis of multiple mathematical formulas, Pivot Points identify significant price levels, the breaking of which should lead to further price movements. Specifically, they are calculated based on prices beaten the previous day, according to the following formulas:

• PivotPoint = ((highd1+lowd1+closed1)/3) (red line)
• Support 1 (S1) = 2*PivotPoint-highd1 (blue line)
• Resistance 1 (R1) = 2*PivotPoint-lowd1 (blue line)
• Support 2 (S2) = PivotPoint - (highd1-lowd1) (yellow line)
• Resistance 2 (R2) = PivotPoint + (highd1-lowd1) (fuchsia line)

To better identify these levels and their behavior over time, Figure 1 shows graphically the price levels identified by the formulas and colors described above. The labels "highd1" and "lowd1" represent the high and low of the previous day, respectively. The central Pivot Point, to which all others refer, is nothing more than the simple average between the high, low, and close prices of the previous day.

Note that levels are calculated only once a day, this is because the data being fed to the indicator all refer to levels from the previous day, thus to the session that has already ended. Therefore they will remain the same throughout the flow of the next session.

Figure 1 - Graphical representation of Pivot Points.

Pivot Points in the collective imagination represent reversal levels. However, this indicator can also be used successfully with more traditional logic, such as trend-following, even on an index like the S&P500 that is known to have a more mean-reverting behavior.

We then proceed with the application of one of the classic uses of Pivot Points: trend following on the level R1 (for long) and S1 (for short). More specifically, we will buy with stop orders on the resistance level R1, and similarly we will sell on the support level S1. An example of the pattern in question can be seen in Figure 2.

Figure 2 - Examples of trend following entry patterns with Pivot Points

The strategy was constructed to work on the Mini S&P500 futures, using 15-minute bars. The opening of a long position will occur, as mentioned, when the resistance threshold (R1) is exceeded, while the short position will occur when the support (S1) is broken, after which the positions will be closed at the end of the session. Thus, it is an intraday strategy that will open and close its positions within the same session.

A trading session of the Mini S&P500 futures runs from 5:00 p.m. to 4:00 p.m. (exchange time at the CME in Chicago), but suppose we calculate the entry levels, i.e., the pivot points, based on the time of the cash session (the one in which the stocks that make up the index are traded) i.e., from 8:30 a.m. to 3:00 p.m. Our strategy can then trade from 9:00 a.m., namely, 30 minutes after the start of the session, just to avoid any unusual movements in the first few minutes of trading.

Also included in the strategy is a stop-loss exit condition at $1,000, and a take-profit condition at $3,500, as first-attempt values.

Figure 3 shows the equity line generated by the system just described, with data from the beginning of 2008 through the end of 2022. The trend is quite positive, although only in the last few years does it seem to have had noteworthy momentum.

Figure 3 - Equity line strategy Pivot Points on ES (e-Mini S&P500).

If you look at the system’s metrics, you can see how the strategy generates a net profit of almost $92k with a maximum drawdown of about -$13,000. This is largely due to short trades, which seem less effective than long trades, which is easy to expect with a stock index like this that has had a strong bullish trend over the years.

A sore point is the average trade, i.e. the average profit per trade, which is below $47, a pretty low figure to be able to cover trading costs. So, let's see if we can improve the metrics by optimizing some parameters.

Figure 4 - Strategy Performance Report - Pivot Points strategy on ES (e-Mini S&P500).

Figure 5 - Total Trade Analysis Pivot Points strategy on ES (e-Mini S&P500).

Since short entries are the least effective, we can first try to filter them by evaluating the presence or absence of specific price patterns. We will use a proprietary list of patterns that includes several conditions and assess the best one through optimization. After adding this filter to our system, the optimization on the default list tells us that we get an improvement in both average trade (which goes to $63) and total profit (which goes to $132k) when pattern 21 is not present. This pattern says that yesterday's high must be greater than the high from 5 days ago: if this is the case, the system cannot trade short.

Figure 6 - Pivot Points strategy pattern optimization on ES (e-Mini S&P500).

Since the number of trades is still quite high, we try to apply the same type of filtering to the long side and optimize the pattern list. In this case, it turns out that not trading long in the presence of pattern 13 (today's high is below 0.75% of today's low) further improves the metrics, with average trade on $93 and net profit above $144,000.

The equity line has definitely improved, and especially when you compare it to the performance of the S&P500, you can see how we could have avoided large drawdowns in times of sharp market declines with this strategy.

Figure 7 - Comparison of equity of the Pivot Points strategy on ES (e-Mini S&P500) and performance of the S&P500

In summary, trend following via pivot points proves an effective approach even for the S&P500, which typically has mean-reverting behavior. The trigger calculated at the pivot points of resistance R1 and support S1 has proven to be an excellent starting point which can certainly be extended in terms of live trading.

We invite you always to be curious and look for new ways to invest and trade in the financial markets. One will not always be able to achieve good results, but it will undoubtedly enrich the technical background of the trader who tries.

See you next time and happy trading!

Andrea Unger

This article is from an external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.