Pivot points refer to technical indicators used by day traders to identify potential support and resistance price levels in a 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 they provide to determine potential entry, exit, and stop-loss prices for trades.
Originally, pivot points were developed by floor traders who worked in a fast-moving environment in the equity and commodities markets. At the start of each trading day, they would use the previous day’s high, low, and close prices to calculate the pivot for the current trading day.
The pivot point is then used to identify two support and two resistance levels for the day. The support and resistance levels are determined based on the difference between the previous day’s high and 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. High volume trading often occurs when price is at or near the pivot point. The following are the main trading strategies used with pivot points:
1. Pivot point bounces
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 with price above the pivot line, and the price moves close to the pivot line and bounces back to the upside, you should enter a long (buy) trade.
On the other hand, if you are testing a pivot line from the lower side and the price bounces back to the downside after hitting the pivot, you should sell short. 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 – such as crossing from below it to above it – 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 is slightly to the other side of the pivot line. For example, if buying long based on price crossing above the pivot line, a sell-stop would be placed a bit below the pivot line.
Day traders often prefer using pivot analysis over other technical indicators for several reasons. They include:
1. High accuracy
The pivot point is considered one of the most accurate indicators in the market. This explains why a majority of day traders like using it to determine trade entry or exit points. It enables traders entering the market to follow the overall flow of the market since it uses the previous day’s trading action to predict the current day’s likely action.
2. Short time frames
Unlike other trading tools that use long time frames, the pivot point indicator obtains data from a single day of trading. It takes the previous day’s high, low and close prices to predict probable support and resistance levels. Although pivot trading is primarily applied on the daily time frame, pivots can also be calculated for much shorter time frames, such as the hourly or 15-minute charts.
3. Easy 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, so the trader doesn’t have to do it manually. After getting the pivot levels, the trader can concentrate on figuring out their approach to the market for the day.
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 remains or drops below the pivot level, it shows a bearish market. On the other hand, when the price action remains or crosses above the pivot, 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 near any of the identified support or resistance levels.
Thank you for reading CFI’s guide on Pivot Points. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: