Predicting market trends is a significant part of a trader’s job, which enables them to execute profitable transactions or dodge potential losses. Whether a market is demonstrating a bullish tendency or a bearish, how sustainable that pattern is, and should they enter a short or long position, traders determine these using several technical indicators, one of which is a pivot point.
Pivot points are the indicators traders use in commodity exchanges, futures, and equity. It’s thus named because a pivot point signals potential regions of price movements by helping traders understand general market trends over a particular time frame.
In this article
What is a Pivot Point?
It is the numerical mean of previous trading day’s high, low, and closing price of a specific asset. Traders identify future price movements and base their trading plan partly on these pivot points.
If an asset trades above the pivot point on the next day, it signals a bullish trend. Conversely, it indicates a bearish trend if the asset is trading below the pivot point. This helps traders determine stop-loss points and profit-making points on the chart.
However, the pivot point is only one component of the indicator. Others include –
- Support 1
- Support 2
- Resistance 1
- Resistance 2
For pivot point calculation, a person first needs to reckon the primary mean, which then becomes the basis for computing these levels mentioned above. Traders can compute N number of support and resistance levels based on the timeframe for which they are analysing the trend.
The support and resistance levels act as the floor and ceiling of price movements, indicating regions where an asset’s price bounces, either upward or downward. Based on these upward and downward reversals, traders determine entry and exit points for their positions.
How to Calculate Pivot Points?
The most prevalent method of calculating this indicator is the 5-point system, which includes 1 pivot point, 2 resistance levels, and 2 support levels.
Here’s the pivot point formula –
PP = (Low + High + Close)/3
- Low gives the lowest price from the previous trading day
- High denotes the highest price from the previous trading day
- Close is the closing price from the previous trading day
S1 = (PP x 2) – High
S2 = PP – (High – Low)
R1 = (PP x 2) – Low
R2 = PP – (High + Low)
Alternatively, Tom DeMark developed a parallel system for calculating pivot points, as given in the table below –
|If yesterday’s open > yesterdays’ close||P = (Yesterdays’ high x 2) + Yesterday’s low + Yesterday’s close||Low = P/2 – Yesterday’s high
High = P/2 – Yesterday’s low
|If yesterday’s open < yesterday’s close||P = (Yesterday’s low x 2) + Yesterday’s high + Yesterdays’ close||Low = P/2 – Yesterday’s high
High = P/2 – Yesterday’s low
|If yesterday’s open = yesterday’s close||P = (Yesterday’s close x 2) + Yesterday’s low + Yesterday’s high||Low = P/2 – Yesterday’s high
High = P/2 – Yesterday’s low
Some analysts also apply the present day’s opening price to the equation to calculate the primary average.
The formula, in that case, is given by –
PP = (Today’s opening + Yesterday’s high + Yesterday’s low + Yesterday’s closing)/4
Previous day’s data is used predominantly by day traders. Swing traders, on the other hand, apply past week’s data to calculate pivot points of the following week. Position traders calculate these points on a monthly basis.
How to Use Pivot Points for Intraday Trading?
Primarily, there are two strategies of intraday trading using pivot points. These are –
- Pivot point bounce
Asset prices either move through a pivot point or bounce off it to the other direction. In this strategy, traders determine when to open or close a position based on the bounce.
If the price touches a pivot point from above and reverses thereby, that’s when an asset is bought. On the other hand, if it tests the point from below and bounces off downward, that’s when a trader sells.
Usually, prices hit their lowest only to assume a northward trajectory on hitting the support level. Thus, buying just prior to that touch allows traders to maximise their profit. Conversely, prices reach their highest only to fall when they hit the resistance line. Hence, selling at that point or before it moves southward allows investors to avoid losses.
- Pivot point breakout
Under this strategy, traders assume prices will violate the pivot points and continue trending either upwards or downwards. Thus, they often place stop-limit orders to ensure a position is opened when that happens.
Typically, a breakout is bullish, meaning it trends upward when the price of an asset rallies past a pivot point. Traders open a long position in that case. Conversely, if prices violate the support line, they open a short position because the breakout demonstrates a bearish bias.
Traders place a stop loss or stop-limit order usually a tad above or below the pivot points to safeguard their interests against sudden price movements.
How Significant are Pivot Points?
It’s necessary to note at the outset that a pivot point is a trend analysis indicator that merely predicts price movements. Hence, one cannot singly rely on a pivot point in the stock market or any other exchange platform.
That’s why it’s common practice to use pivot points alongside other indicators like Fibonacci Retracement, moving averages, candlestick patterns, etc. It majorly depends on the trader’s competence, and how well it can square pivot points with other tools.
Generally, the validity of any particular analysis consolidates when several tools indicate towards it. For instance, if pivot points, candlestick patterns and moving averages indicate an upward trend, it becomes more likely.
This way, traders can execute profitable transactions or avoid losses on their positions more effectively.