i. It is a technical indicator that applies formulas on price and plots lines on the chart.
ii. It gives traders a set of lines that can act as support and resistance for the next trading day.
iii. Can be used for breakouts or for reversals.
What are pivot points?
A basic definition of the word pivot is a central point. Anything that is at the focus or plays a central part is a pivot.
In trading, pivot points are a technical indicator that was first used by floor traders and are to date being used by traders. These floor traders were fast-paced traders that needed tools to help them take trade quickly.
Pivot points are levels that are automatically plotted on the price charts. The traders just have to select and apply the indicator on their price charts.
These lines that are plotted have lots of significance. Traders use these lines as important support and resistance levels.
Traders look to study price behavior on and around these levels and they take trades accordingly.
It is an intraday indicator that traders can use to spot trends as well as a reversal in almost every financial market.
The main advantage of this indicator is that the levels are static and do not change and are also different for different days. These levels are calculated based on the price behavior of the previous trading day.
Calculating pivot points
The pivot points are calculated based on the price data of the previous trading day. The calculation requires the high, low, and close price of the previous trading day.
The pivot points indicator basically consists of a set of lines. One line among these is the pivot point that is considered to be a neutral point or line. Then there are a number of support lines below the pivot line and resistance lines above the pivot line.
Pivot Point (PP) = (Previous Day High + Low + Close)/3
R1 = (2 x PP) - Daily Low
R2 = PP + (Daily High - Low)
R3 = Daily High + 2 x (PP - Daily Low)
S1 = (2 x PP) - Daily High
S2 = PP - (Daily High - Low)
S3 = Daily Low - 2 x (Daily High - PP)
The lines R1, R2, and R3 are resistances above the pivot point with R1 being the first resistance and R3 being the last.
The same is the case with the support lines. S1, S2, and S3 are the support lines, placed below the pivot point and S1 is the first support and S3 is the last support.
The traditional pivot points commonly have only three sets of support and resistance lines, but some trading platforms include additional support and resistance lines.
For traders, knowing the exact calculations of these lines are not essential. What’s essential is that you know how to use these lines properly and make trade decisions.
Types of pivot points
The calculations that I discussed above were of the traditional pivot points.
We know that pivot points are basic calculations, so different traders had different calculations for pivot points.
Hence, owing to the different calculations, there are different types of pivot points that are available to traders today.
1. Woodie’s Pivot Points
Woodie’s pivot point is almost similar to the traditional pivot points, the only difference being that it gives more weightage to the close price of the previous day.
It has a slightly different calculation as compared to the traditional pivot points.
2. Camarilla Pivot Points
These were introduced by Nicolas Scott in the 1980s. The Camarilla pivot points are similar to Woodie’s pivot points as to the extra focus on the closing price of the previous day.
The calculations of the Camarilla pivot points are also different.
Unlike other pivot points, the Camarilla pivot point incorporates a total of 9 horizontal lines on the price chart. 1 pivot point, 4 support lines, and 4 resistance lines.
3. Fibonacci Pivot Points
The Fibonacci tool is very famous among traders.
There are several traders out there that look to apply the various Fibonacci tools to the price charts and take trades accordingly. The Fibonacci is applied to pivot points too.
The 38.2%, 61.8%, and 100% levels are incorporated in the calculation of the Fibonacci pivot points.
4. Demark Pivot Points
Tom Demark introduced this type of pivot point.
The Demark pivot points are quite different from the other types of pivot points.
These pivot points have some conditions that are to be fulfilled and the calculations are done accordingly.
It looks to have some relation between the open and close price of the previous trading day and it also has more emphasis on the recent price action.
These are the 5 types of pivot points, including the traditional pivot points, which traders these days can use.
I haven’t mentioned the calculations part of the above-mentioned pivot points. When it comes to pivot points, you should not be concerned with what goes into the calculations part.
But rather you should work towards applying these different types of pivot points on the price charts and trying to spot trade opportunities.
All these pivot points have the same function, which I will discuss further.
What difference do the pivot points make?
Pivot points are just horizontal lines plotted on the price charts, why do traders even bother using them? Why should you bother using them?
The main difference that pivot points make that, traders can get the next day’s support and resistance lines before the trading day even begins.
These lines are the same throughout the day, hence traders can plan their trades in advance.
Pivot points also help traders in understanding the sentiment for the trading day.
If today’s price is at the upper side of the pivot points, then the day can be considered bullish and traders can take trades accordingly.
If the price is at the lower part of the pivot points, then the day is a bearish one.
How should you use pivot points?
Now that I have explored in detail the pivot points, let’s move on to the practical usage of them and how you should use the pivot points in live trading.
We know that the pivot points act as important levels of support and resistance. Owing to this, traders look to have two strategies to trade.
1. Pivot point breakout strategy
A breakout is when the price manages to clear a particular price level. Now, this level could be both a support and a resistance.
Traders often look to trade the price breakouts on the pivot points.
In this strategy, you can look to take long trades when the price breaks the S1, S2, or S3 pivot level to the upside.
Short trades can be taken when the price breaks the R1, R2, or R3 pivot level to the downside.
No trades should be taken on breakouts of the Pivot Point as this is a neutral level and does not have any bullish or bearish biases.
This is a very basic strategy and it works because these levels are followed by many traders around the globe.
Hence, whenever a breakout from these levels takes place, traders flock to take entries and the price automatically moves in the direction of the breakout.
2. Pivot point support and resistance strategy
In this second strategy, we will stick to the basics of support and resistance levels.
The support levels cause the price to bounce away from it to the upside while the resistance levels cause the price to bounce away from it to the downside.
Applying the same to pivot points will allow you to have quite a few trade opportunities.
You can look to take long trades whenever the price reverses from the S1, S2, or S3 pivot level.
Short trades can be taken when the price reverses from the R1, R2, or R3 level.
These are the two pivot point strategies that are used by traders to take trades.
Pivot point traders also use the pivot point levels to set targets and stop loss. For instance, if a trader spots a price breakout from the S1 level, then he will place the stop loss at the Pivot Point level and target at the S2 level.
These pivot lines are a good reference as to the location of the price on the price charts. And since these levels are used by many traders, it seems to work.
Just like they say for technical analysis, that it is a self-fulfilling prophecy, that’s the case with these pivot points.
The pivot point indicator is just not for daily pivot levels. Traders can also apply them to get weekly as well as monthly pivot levels.
Limitations of the pivot points
At the end of the day, pivot points are technical indicators and we know that technical indicators are not holy grails.
No matter how much we learn about technical indicator strategies and try to apply them in the best possible ways, they will fail.
Every breakout from the pivot level will not be successful and the price will not always have a clean reversal from these levels.
You should know this fact that nothing is certain in trading and that you will end up on the wrong side from time to time.
These technical indicators are developed to increase the trader’s chances of winning.
They are tools that traders can use to take better quality trades than to just randomly buy or sell at any random point on the price chart.
We would suggest that you use the pivot points along with another indicator or some method of analysis to get confirmations on the trades.
Having two forms of analysis will increase the quality of your trades and improve your odds of winning.
What do you think about the pivot point indicator?
Do read this blog post properly and you will be well informed about this wonder of an indicator.
Use these pivot points in trading and test them out in the live markets. You can then take the decision of whether to keep trading with it.
Let me know about your experience with the pivot points and whether this blog post helped you.
Share this blog post with others and let them gain knowledge about this indicator and maybe they could also use it to take trades.
Feel free to ask questions through the comments section and I will make sure to revert at the earliest.