Introduction to Pivot Points
Pivot Points are one of the most widely used indicators in technical analysis. They serve as a valuable tool for identifying potential support and resistance levels in the market. Originally developed for floor traders in stock exchanges, Pivot Points help traders predict market movements based on historical price action.
A Pivot Point is essentially the average of the high, low, and closing prices from the previous trading session. By using this key level, traders can determine potential turning points in the market. In addition to the central Pivot Point (PP), a set of support (S1, S2, S3) and resistance (R1, R2, R3) levels are derived to create a comprehensive trading framework.
How to Calculate Pivot Points
The standard formula for Pivot Points is:
Pivot Point (PP) = (High + Low + Close) / 3
The support and resistance levels are then calculated as follows:
- First Resistance (R1) = (2 × PP) – Low
- First Support (S1) = (2 × PP) – High
- Second Resistance (R2) = PP + (High – Low)
- Second Support (S2) = PP – (High – Low)
- Third Resistance (R3) = R1 + (High – Low)
- Third Support (S3) = S1 – (High – Low)
Different variations of Pivot Points include Fibonacci Pivot Points, Camarilla Pivot Points, and Woodie’s Pivot Points, which use slightly different formulas.
Trading Strategies Using Pivot Points
1. Pivot Point Bounce Strategy
Concept:
In this strategy, traders look for price action to approach the Pivot Point (PP) and then bounce off it, using it as a support or resistance level.
How to Trade:
- If the price approaches the Pivot Point from above and bounces upward, it signals a buying opportunity.
- If the price approaches the Pivot Point from below and bounces downward, it signals a selling opportunity.
- Traders often confirm this bounce with indicators like RSI or MACD to avoid false signals.
Example:
Suppose the Pivot Point for a stock is calculated at $150. If the stock price drops to $150 and then starts rising again, traders can enter a long position with a stop-loss slightly below $150.
2. Pivot Point Breakout Strategy
Concept:
When price breaks above or below a Pivot Point level, it can indicate a strong trend continuation in that direction.
How to Trade:
- If the price breaks above R1 with high volume, it suggests bullish momentum, and traders can enter long positions.
- If the price breaks below S1, it signals bearish momentum, and traders can enter short positions.
- Stop-loss is placed just below the breakout level for long trades and just above for short trades.
Example:
If the Pivot Point is $120 and the price breaks above R1 at $125 with strong volume, a trader can enter a long trade with a target at R2 ($130) and a stop-loss at $123.
3. Pivot Point Trend Trading Strategy
Concept:
Traders use Pivot Points in conjunction with trend indicators like moving averages to identify strong trends.
How to Trade:
- If the price is consistently above the Pivot Point and moving averages (such as the 50-day MA), it confirms an uptrend.
- If the price is below the Pivot Point and moving averages, it signals a downtrend.
- Traders enter trades in the direction of the trend with a stop-loss near the Pivot Point.
Example:
A stock is trading above its Pivot Point of $80 and the 50-day moving average is also trending upwards. A trader enters a long position at $82, targeting R1 at $85.
4. Pivot Point Reversal Strategy
Concept:
Traders look for price action signals near support and resistance levels that indicate a possible reversal.
How to Trade:
- If the price approaches R2 or R3 and starts showing reversal signs (like candlestick patterns such as Doji or Engulfing), traders consider short positions.
- If the price nears S2 or S3 and shows reversal signals, traders look for buying opportunities.
- Stop-loss is placed beyond the resistance or support level to avoid false signals.
Example:
A stock moves up to R2 at $100 but forms a Doji candle, indicating hesitation. A trader enters a short position at $99 with a stop-loss at $101.
5. Pivot Points with RSI Confirmation
Concept:
Traders combine Pivot Points with RSI (Relative Strength Index) to increase trade accuracy.
How to Trade:
- If the price is near support and RSI is below 30 (oversold), it signals a potential buy.
- If the price is near resistance and RSI is above 70 (overbought), it signals a potential sell.
Example:
A stock reaches its S1 level at $50, and the RSI is at 28. A trader enters a long position at $51 with a stop-loss at $49.
6. Scalping with Pivot Points
Concept:
Day traders and scalpers use Pivot Points on smaller timeframes (such as 5-minute or 15-minute charts) for quick trades.
How to Trade:
- If the price touches the Pivot Point and bounces, scalpers enter quick trades targeting R1 or S1.
- If the price breaks R1, scalpers quickly enter trades with small profit targets.
Example:
A currency pair touches PP at 1.2000 and immediately rises to 1.2020. A scalper takes a quick profit with minimal risk.
Conclusion
Pivot Points provide traders with a structured way to analyze price movements and identify potential trade opportunities. By using various strategies such as breakouts, reversals, and trend-following approaches, traders can effectively leverage Pivot Points for better decision-making.
To improve accuracy, combining Pivot Points with additional indicators like RSI, MACD, and moving averages can provide stronger confirmation. Additionally, traders should always practice risk management and backtest their strategies before live trading.
Whether you’re a day trader, swing trader, or scalper, understanding and applying Pivot Points can significantly enhance your trading performance. Start incorporating them into your trading plan and refine your strategies based on market conditions.