What are Pivot Points?
Pivot points refer to technical indicators used by day traders to predict the performance of the securities market. They are based on the previous day’s high, low, and closing prices. Traders use pivot points and the support and resistance levels to determine the entry and exit points for stop-losses and profit-making trades.
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Originally, pivot points were developed by floor traders who work in a fast-moving environment in the equity and commodities market. At the start of each trading day, the floor traders use the previous day’s high, low, and close prices to calculate the pivot points for the current and future trading days.
The pivot point is then used to set two support and two resistance levels that are incorporated into the day’s trades. The support and resistance levels are determined based on the difference between either the previous day’s high or low prices and the pivot point.
The main technique that most traders use to calculate pivot points is the five-point system. The system uses the previous day’s high, low, and close prices, as well the support and resistance levels. The five-point system uses the following equations:
Pivot point (P) = (Previous High + Previous Low + Previous Close)/3
S1= (P x 2) – Previous high
S2 = P – (Previous High – Previous Low)
R1 = (P x 2) – Previous Low
R2 = P + (Previous High – Previous Low)
- S1= Support 1
- S2 = Support 2
- R1 = Resistance 1
- R2 = Resistance 2
Day Trading with Pivot Points
When calculating pivot points, the point acts as the primary support or resistance level, since the largest price movements occur at such a point. The following are the main trading strategies used in calculation:
1. Pivot point bounces
When you identify a price action moving towards the pivot point, you should treat it as a normal occurrence. However, if the price action hesitates and bounces back before reaching the pivot level, you should enter the trade in the direction of the bounce. If you are testing the trade above the pivot line, and the price action moves closer to the pivot line and bounces back, you should also enter that trade.
On the other hand, if you are testing a pivot line from the lower side and the price bounces back, you should short the trade. The stop-loss for the trade is located above the pivot line if the trade is short, and below the pivot line if the trade is long.
2. Pivot point breakout
When the price action breaks through the pivot line, the trade should continue in the direction of the breakout. If the breakout is bearish, the trade should be short, while for a bullish breakout, the trade should be long. A good place to implement a stop-loss order would be at the top or bottom that is located below the breakout. This will protect the trade from unexpected price movements that may result in losses.
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Why Day Traders Prefer Pivot Points
Day traders prefer using pivot analysis over other technical analysis indicators for several reasons. They include:
1. High accuracy
The pivot point is one of the most accurate indicators in the market, and it explains why a majority of day traders love using it to determine when to enter or exit a trade. The tool allows traders entering the market to follow the overall flow of the market since it uses the previous day’s trade to predict the current or future trades.
2. Short time frames
Unlike other trading tools that use long time frames, the pivot point indicator obtains data from a single day trading. It takes the previous day’s high, low and close prices to predict these points. The best timeframes for the indicator include one minute, two minutes, five minutes and 15 minutes.
3. Ease to use
The pivot point indicator is an easy to use tool that’s been incorporated in most trading platforms. The platforms automatically calculate support and resistance levels, and therefore, the trader is not required to calculate the figures manually. After getting the figures for the separate levels, the trader is then required to trade the bounce and breakouts of the point.
Uses of Pivot Points
1. Determine market trends
Traders can use pivot points to determine market trends depending on the direction of the price action. When the price action drops through the pivot level, it shows a bearish market. On the other hand, when the price action breaks the pivot point in an upward direction, it shows that the market is bullish.
2. Enter and exit the market
Traders can also use the pivot point system to make a decision on when to enter and exit the market. For example, a trader can set a stop-loss when the price nears the support level.
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