Understanding Pivot Points and How to Trade Them
Pivot points are support and resistance levels that technical analysts use to pinpoint potential reversals in price over time. While the levels were originally used by floor traders to set key levels to watch during the day, technical analysts have expanded upon the concepts to develop at least five different types of pivot points used in the modern day. The rich history of pivot points has made them a widely followed indicator.
In this article, we’ll take a look at several popular types of pivot points, how they are calculated, and how they can be used by traders to improve performance.
Be sure to also read our Trader’s Guide to Tops and Bottoms.
Pivot Points and Variations
The original pivot point was a relatively simple concept – the average of the high, low, and close price for a given period was a crucial level for the following period. Working off of this figure, additional areas of support and resistance could be identified.
The original pivot point support and resistance is calculated as follows:
- Pivot Point = (High + Low + Close) / 3
- Support (S1) = (Pivot Point x 2) – High
- Support (S2) = P – (High – Low)
- Resistance (R1) = (Pivot Point x 2) – Low
- Resistance (R2) = P + (High – Low)
Over time, technical analysts have taken these basic concepts to develop new variations of the pivot point that incorporate other forms of analysis. Fibonacci Pivot Points, for instance, incorporate the golden ratio to attempt to make more accurate predictions. For example, the Support (S1) in that case is equal to P – (0.382 x (High – Low)) and Support (S2) is equal to P – (0.618 x (High – Low)), where 0.382 and 0.618 are variations of the golden ratio.
Be sure to also see our Ultimate Guide to Fibonacci Trading
Demark Pivot Points introduce additional complexity by making the calculations contingent upon the opening price relative to the closing price for the period. In addition to these changes, the Demark style is unique in that it only has one support and resistance level rather than two or more like many other styles. Trader should experiment with these various styles in order to find an option that works best for them and/or a particular security being analyzed.
Profiting from Pivot Points
There are many different ways to use pivot points to enhance trading performance, since they simply identify areas of support or resistance. At their core, pivot points set the tone for price action in a given security by establishing when it’s trading higher or lower than a key level set by the previous period. A stock trading above its pivot point could be considered bullish, while a stock trading below its pivot point could be considered bearish.
The support and resistance levels identified by pivot points can also be interpreted as key levels for traders to watch. For example, a trader may buy a stock that breaks out from its pivot point on high volume and put in a take-profit order when it reaches R1 resistance. Traders may also set stop-loss points for a position just below support levels in order to avoid losses if a stock begins to move significantly lower following an adverse event.
A final consideration when using pivot points is timeframes. Since pivot points can be calculated across any timeframe, it’s important for traders to look at more than just a single timeframe during their analysis. A 15-minute chart may show one key pivot point level, but a 1-day chart may show something entirely different. In addition, different equities may respond to different pivot points in different ways, which makes it important to look deeper.
The Bottom Line
Pivot points are a very useful form of technical analysis that were initially used by floor traders to set important price levels to watch during the day. Over time, the same concept has split into a variety of different techniques involving the same premise. Traders use these pivot points to identify potential areas of support and resistance and, combined with other forms of technical analysis, these insights can help improve trading performance over time.
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