Pivot Point

Pivot Points are a popular technical analysis indicator used by traders in various financial markets, including stocks, commodities, and forex. The concept of pivot points stems from the idea that the market tends to have recurring patterns, and using these patterns can help traders identify critical support and resistance levels. These levels can be pivotal in determining entry and exit points for trades, thus aiding in the decision-making process.

Definition and Calculation

Pivot Points are calculated using the high, low, and closing prices from the previous period (day, week, etc.). The pivot point itself is considered a significant price level that serves as a basis for the indicator. From this central pivot point, additional levels are calculated to establish potential support and resistance levels.

Formula

The primary pivot point (P) is calculated as follows:

Pivot Point (P) = (High + Low + Close) / 3

Based on this pivot point, the following support (S) and resistance (R) levels can be calculated:

First Resistance (R1) = (2 * P) - Low
First Support (S1) = (2 * P) - High

Second Resistance (R2) = P + (High - Low)
Second Support (S2) = P - (High - Low)

Third Resistance (R3) = High + 2 * (P - Low)
Third Support (S3) = Low - 2 * (High - P)

Types of Pivot Points

Standard Pivot Points

The standard method of calculating pivot points relies on the straightforward formulas mentioned above. This type of pivot point is widely used in various markets for its simplicity and effectiveness.

Fibonacci Pivot Points

Fibonacci numbers are applied to pivot points to predict potential support and resistance levels. In this context, traders often use Fibonacci retracement levels (such as 38.2%, 50%, and 61.8%) to establish potential price targets.

Camarilla Pivot Points

Developed by Nick Stott in the late 1980s, Camarilla pivot points offer a unique perspective. The calculation involves multiple intraday levels, creating eight potential levels (four resistance and four support). The formula for R3 and S3 is similar to the standard pivot points method.

R1 = Close + ((High - Low) * 1.0833)
S1 = Close - ((High - Low) * 1.0833)
R2 = Close + ((High - Low) * 1.1666)
S2 = Close - ((High - Low) * 1.1666)

Woodie’s Pivot Points

Woodie’s pivot points use more weight on the closing price and are calculated as follows:

Pivot Point (P) = (High + Low + 2 * Close) / 4

Demark Pivot Points

Demark’s method is slightly more complex and adjusts the pivot points based on the relationship between the open and close prices.

If Close < [Open](../o/open.html):
Pivot Point (X) = High + 2 * Low + Close

If Close > [Open](../o/open.html):
Pivot Point (X) = 2 * High + Low + Close

If Close == [Open](../o/open.html):
Pivot Point (X) = High + Low + 2 * Close

Pivot Point (P) = X / 4

Resistance (R1) = X / 2 - Low

Support (S1) = X / 2 - High

Application in Trading

Pivot points serve as a predictive indicator and help traders in different ways:

• Trend Identification: When the price is above the pivot point, it generally indicates a bullish trend, while a price below the pivot point indicates a bearish trend.
• Entry and Exit Points: Pivot points can provide traders with specific levels to enter or exit trades. Breakouts above resistance levels or breakdowns below support levels can signal entry points.
• Risk Management: By identifying potential support and resistance levels, pivot points allow traders to set stop losses and take profits more effectively.

Day Trading

Day traders often rely on pivot points since they condense price data into clear and actionable levels. Given that day trading involves rapid decision making, having predefined levels for support and resistance simplifies the trading process.

Swing Trading

For swing traders who hold positions for several days or weeks, weekly or monthly pivot points are more useful. These provide higher-level economic insights and help in understanding broader market trends.

Pros and Cons

Pros

• Simplicity: Pivot points are straightforward and easy to calculate.
• Versatility: They can be used across all market types and timeframes.
• Effective Levels: Provide clear support and resistance levels, aiding in trading decisions.
• Predictive Abilities: Help in forecasting market movements.

Cons

• Lagging Indicator: As they are based on historical prices, they may lag current market conditions.
• False Signals: In volatile markets, pivot points can sometimes give false signals.
• Subjectivity: Different types of pivot points can yield different support and resistance levels.

Automation and Algo Trading

With the rise of algorithmic trading, pivot points can be integrated into trading algorithms for automated decision making. By programming pivot point calculations and associated trading rules, traders can design algorithms that automatically place trades when certain levels are reached. These algorithms can include:

• Breakout Strategies: Algorithms can be programmed to buy when the price crosses above resistance levels or sell when it crosses below support levels.
• Mean Reversion: Algorithms can execute trades when the price is expected to revert to the pivot point.
• Risk Management: Automated systems can set stop-loss and take-profit levels based on pivot points, ensuring disciplined trading.

Conclusion

Pivot points are a robust tool in the trader’s arsenal. Whether used alone or in conjunction with other technical indicators, they offer insightful levels that help traders make informed decisions. Their simplicity, combined with predictive abilities, makes them valuable for traders across all markets and timeframes. Although not without their drawbacks, the strategic application of pivot points can lead to more effective trading strategies and improved risk management.