What is a pivot point?
A pivot point is a technical analysis indicator, or calculation, used to determine the general market trend over different periods. The pivot point itself is simply the average of the high, low and closing prices of the previous trading day. The next day, trading above the pivot point is expected to indicate a continuous bullish sentiment, while trading below the pivot point indicates a bearish sentiment.
The pivot point is the basis of the indicator, but it also includes other levels of support and resistance that are projected based on the calculation of the pivot point. All of these levels help traders to see where the price might find support or resistance. Likewise, if the price passes through these levels, it lets the trader know that the price is trending in that direction.
- When the price of an asset is trading above the pivot point, it indicates that the day is bullish or positive.
- When the price of an asset is trading below the pivot point, it indicates that the day is bearish or negative.
- The indicator generally includes four additional levels: S1, S2, R1 and R2. These represent support one and two, and resistance one and two.
- Support and resistance one and two can cause reversals, but they can also be used to confirm the trend. For example, if the price drops and goes below S1, this confirms the downward trend and indicates a possible continuation towards S2.
The formulas for the pivot points:
TheP=3high+Low+To closeTheR1=(P×2)–LowR2=P+(high–Low)S1=(P×2)–highS2=P–(high–Low)or:P=Pivot pointR1=Resistance 1R2=Resistance 2S1=Support 1S2=Support 2TheThe
high indicates the high price of the previous trading day,
Low indicates the price of the previous trading day, and
To close indicates the close price from the previous trading day.
How to calculate pivot points
The pivot point indicator can be added to a graph and the levels will be automatically calculated and displayed. Here’s how to calculate them yourself, keeping in mind that pivot points are mainly used by day traders and are based on the highest, lowest and closest to the previous trading day. If it’s Wednesday morning, use Tuesday’s high, low and close to create the pivot point levels for Wednesday’s trading day.
- After the market closes or before it opens the next day, find the highest, lowest and closest to the most recent day.
- Add up, down and close, then divide by three.
- Mark this price on the graph as P.
- Once P is known, calculate S1, S2, R1 and R2. The highest and lowest in these calculations are those of the previous trading day.
What do the pivot points tell you?
Pivot points are an intraday indicator for trading future, raw materials and stocks. Unlike moving averages or oscillators, they are static and remain at the same price throughout the day. This means that traders can use the levels to plan their trades in advance. For example, they know that if the price falls below the pivot point, they will likely short at the start of the session. If the price is higher than the pivot point, they will buy. S1, S2, R1 and R2 can be used as target prices for these transactions, as well as stop loss levels.
Combining pivot points with other trend indicators is a common practice among traders. A pivot point that also overlaps or converges with a moving average of 50 or 200 periods, or Fibonacci extension becomes a higher level of support / resistance.
The difference between pivot points and Fibonacci retracements
Pivot points and Fibonacci retracements or the extensions draw horizontal lines to mark areas of potential support and resistance.
Fibonacci retracement and extension levels can be created by connecting all price on a graph. Once the levels have been chosen, the lines are drawn at percentages of the price range chosen.
The pivot points do not use percentages and are based on fixed numbers: the top, the bottom and the end of the day before.
Pivot point limitations
Pivot points are based on simple calculation, and although they work for some traders, others may not find them useful. There is no guarantee that the price will stop, reverse or even reach the levels created on the graph. Other times the price comes and goes across a level. As with all indicators, it should only be used in the context business plan.