What Are Pivot Points? How Are They Useful?

What are Pivot Points?

Pivot points refer to a technical analysis indicator used to identify the overall market trend over various time frames. This is just the average of the high and low prices for the given trading day and the closing price from the previous trading day. On the following day, it is believed that trading above the pivot point indicates continued bullish sentiment, while trading below the pivot point indicates the continuing bearish sentiment.

Pivot points were initially created by floor traders who operated in the volatile equity and commodities markets. They would determine the pivot for the current trading day at the beginning of each trading day using the high, low, and close prices from the previous day.

The next step is to determine the two support and two resistance levels for the day using the pivot point. The distance between the pivot point and the price range’s high and low for the previous day. However, it is used to calculate the support and resistance levels.

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How to calculate Pivot Point

The five-point system is the primary method used by the majority of traders to determine pivot points. The system makes use of the support and resistance levels as well as the high, low, and close prices from the previous day. The following equations are used in the five-point system:

• Pivot point (P) = (Previous High + Previous Low + Previous Close)/3
• S1= (P x 2) – Previous high
• S2 = P – (Previous High – Previous Low)
• R1 = (P x 2) – Previous Low
• R2 = P + (Previous High – Previous Low)

Where:

• S1= Support 1
• S2 = Support 2
• R1 = Resistance 1
• R2 = Resistance 2

Note that:

• High represents the highest price from the previous trading day,
•  Low represents the lowest price from the last day of trading.
• Close represents the closing price from the last day of trading.

Uses of Pivot Points

1. Identify market trends

Depending on how the price action is moving, traders can use this to identify market trends. The market is bearish when the price action stays at or deviates from the pivot level. The market is bullish, however, when price action stays above the pivot or crosses above it.

2. Market entry and exit

This system is another tool traders can use to determine when to enter and exit the market. A trader could, for instance, place a stop-loss order close to any of the identified support or resistance levels.

Restrictions of Pivot Points

These are based on a straightforward calculation, and while they may be useful to some traders, others may not. The levels drawn on the chart are not guaranteed that the price will stop, turn around, or even get there.

In other cases, a level’s price will alternately rise and fall. It should only be used as a part of a comprehensive trading plan, as with all indicators.

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