According to its name, pivot points are a technical indicator that is used to determine the pivoting (turning) points of a trend in the market, and as such, they are an invaluable indicator.
In the same way, as many of the other indicators we have discussed on this blog, this is another tool you can add to your toolbox to make you a more profitable trader in the future.
A simple formula is used to calculate this indicator, which takes into account the day's High, Low, and Close prices to come up with an accurate result.
The calculation of pivot points varies according to the type of pivot point and the type of calculation. These pivot points can be classified into Standard Pivot Points, Woodie's Pivot Points, Camarilla Pivot Points, Fibonacci Pivot Points, and Demark Pivot Points. We will be covering only the Standard Pivot Points moving forward since the variations are quite slight.
There are typically seven levels in which pivot points can be defined, which are R3, R2, R1, Pivot Point, S1, S2, S3, and so on. Some lines show these levels on the chart. Essentially, their main function is to inform traders where the levels of strong resistance and support are positioned relative to one another.
In order to calculate pivot points, the following formula needs to be used:
Pivot point: = (H+C+L) / 3
Resistance 1: 2*PP - L
Support 1: 2*PP - H
Resistance 2: PP + (R1-S1)
Support 2: PP - (R1-S1)
Resistance 3: H + 2*(PP-L)
Support 3: L - 2*(H-PP)
Having understood the formula behind calculating each line on the pivot point, what is the most appropriate way to interpret the results?
In order to begin with, let us take a look at the pivot point line, PP, which is also known as the line that is usually visible close to where the price is at the moment. It is pertinent to note that this line is neither a support line nor a resistance line. By looking at this line, you will be able to determine where the price will probably go in the future. In the event that the price is trading below the pivot point, this is a sign that the market is likely to test the support lines (S1, S2, S3) soon. In contrast, if the market is trading above the pivot point, then this implies that the price is likely to test the Resistance line (R1, R2, R3).
As a next step, let's take a look at the Support and Resistance lines. There may be a question in your mind as to why we use three levels of support and resistance for each trend. It may depend on your charting software as to how this is displayed. There is a difference between each line in the degree of conviction: the higher the number, the less likely it is that the line will be broken. The likelihood of R1 being broken is greater than R3 since R1 is a more immediate resistance level.
Pivot points are a tool that can be used in the trading of futures, commodities, and stocks during the intraday period. The key thing to note is that unlike moving averages or oscillators, the levels remain static throughout the day and remain at the same price. Therefore, traders can use the levels as a guide to help plan out their trading strategy beforehand.
A trader will likely be shorting the price early on in a session if the price falls below the pivot point. Conversely, if the price rises above the pivot point, then they will likely be buying it. In addition to serving as target prices, you can also use stop-loss levels for such trades, such as S1, S2, R1, and R2.
The use of pivots in combination with other trend indicators is common practice among traders. When the pivot point overlaps or converges with a 50-period or 200-period moving average (MA), or Fibonacci extension level, it becomes a stronger resistance and support level.
It is imperative to note that pivot points are based on a simple calculation, and while they work for some traders, others may not find them extremely useful. There is no guarantee that the price will stop at, reverse at, or even reach the levels set out on the chart at any time.
The price can also move back and forth through a level at different times during the day. It is important to remember that pivot points, like other indicators, should only be utilized in conjunction with a comprehensive trading plan to achieve the most successful results.