Pivot points are technical analysis indicators used by traders to determine the general market trend of a security over a specific period. It is named after its ability to signal potential regions of price movement, helping traders identify profitable trade opportunities and avoid losses.
Whether the market demonstrates a bullish or bearish trend, understanding the sustainability of the pattern is crucial. This blog explores the pivot point meaning and how it can be used in commodity exchanges and equity trading.
What Is Pivot Point?
Pivot Point is a popular technical analysis tool to gauge the overall market trend. It accounts for the previous day's high, low, and closing prices to determine the current day's potential support and resistance levels.
The pivot point trading averages the previous day's high, low, and closing prices. The resulting pivot point level is a baseline for the other support and resistance levels projected from it. These are used to identify potential trading opportunities and manage risk effectively.
Traders use pivot point indicators to identify the direction of the trend. If the price moves above the pivot point level, it is considered a bullish signal and bearish when it moves below. The other levels projected from the pivot point can also be used to identify potential entry and exit points and to set stop-loss orders.
How to Calculate Pivot Points?
One of the most common calculation techniques is the standard method, which uses the following pivot point formula.
Pivot Point (PP) = (High + Low + Close) / 3
Resistance 1 (R1) = (2 x PP) - Low
Resistance 2 (R2) = PP + (High - Low)
Resistance 3 (R3) = High + 2 x (PP - Low)
Support 1 (S1) = (2 x PP) - High
Support 2 (S2) = PP - (High - Low)
Support 3 (S3) = Low - 2 x (High - PP)
Where:
● High = highest price of the previous trading session
● Low = lowest price of the previous trading session
● Close = closing price of the previous trading session
Once you have calculated the pivot points, you can use them to identify potential support and resistance levels. For example, if the current asset price is trading above the pivot point, it may be considered bullish, and the next resistance level to watch out for is R1. Conversely, if the price is trading below the pivot point, it may be considered bearish, and the next support level to watch out for is S1.
How to Use Pivot Points for Intraday Trading?
There are mainly two methods for intraday trading with pivot points. These pivot trading methods are mentioned below.
1. Pivot point bounce
One of the main strategies in intraday trading involves using the pivot point as a gauge for asset price movement. Traders can decide when to enter or exit a trade based on whether the price bounces off the pivot point or breaks through it.
To buy an asset, traders wait for the price to touch the pivot point from above and then reverse direction. On the other hand, to sell, they wait for the price to test the pivot point from below and then bounce off it.
Prices hit a low point and bounce back when they reach the support level. Traders profit maximum by buying just before the price touches the support level. Conversely, prices often hit a high point and fall when they reach the resistance line. To avoid losses, traders can sell at the time or before the price reaches the resistance line and moves downward.
2. Pivot point breakout
In this particular pivot trading strategy, traders anticipate that prices will break through the pivot points and continue to trend upwards or downwards. As a result, they frequently use stop-limit orders to ensure that a position is opened when this happens.
A breakout is typically seen as bullish in this type of pivot trading, meaning that the price of an asset is likely to trend upwards when it rallies past a pivot point. In such a case, traders typically open a long position. On the other hand, if the price breaks below the support line, traders will initiate a short position as the breakout signifies a negative market sentiment.
To protect themselves against sudden price movements, traders usually place stop-loss or stop-limit orders slightly above or below the pivot points. It ensures that their interests are safeguarded during sudden price fluctuations.
How Significant are Pivot Points?
At the outset, pivot points are solely trend analysis indicators that showcase predictions on price movements. Relying solely on pivot points in the stock market or any other exchange platform is not recommended.
To mitigate this, it's standard practice to use pivot points with other indicators, such as Fibonacci Retracement, moving averages, and candlestick patterns. The effectiveness of this approach depends on the trader's skill in integrating pivot points with other tools.
In general, the accuracy of any analysis is reinforced when multiple indicators support it. For example, it becomes more probable if pivot points, moving averages, and candlestick patterns suggest an upward trend.
This method allows traders to execute profitable transactions and minimise losses more efficiently.
Why do Day Traders Prefer Pivot Points?
Day traders prefer using pivot analysis over other technical indicators for various reasons.
● The pivot point is one of the most accurate indicators in the pivot trading market. Its ability to predict the current day's likely action based on the previous day's trading activity enables traders to follow the market's overall flow.
● The indicator obtains data from a single day of pivot trading, making it an ideal tool for short time frames.
● The pivot point indicator is easy to use, requiring little manual calculation. Pivot trading platforms automatically calculate support and resistance levels, allowing traders to focus on determining their approach for the day.
Uses of Pivot Points
1. Determine market trends
Day traders utilise pivot points to identify market trends based on the direction of price action. It helps determine whether the market is going to be bullish or bearish.
2. Enter and exit the market
In addition to determining market trends, the pivot point system can also assist traders in making informed decisions about when to enter or exit the market. As an illustration, a trader can decide to place a stop-loss order near any of the identified support or resistance levels. This enables the trader to limit potential losses in an unfavourable market movement.
Pivot Points vs. Fibonacci Retracements
In technical analysis, traders often use a combination of tools to identify potential areas of support and resistance. Two popular tools for this purpose are pivot points and Fibonacci retracements/extensions.
While both tools of pivot trading involve drawing horizontal lines to mark key levels, they differ in their approach. Pivot points use fixed numbers based on the previous day's high, low, and close. In contrast, Fibonacci retracements/extensions use percentages to identify potential levels based on price movements between two points.
Traders may prefer one over the other depending on their pivot trading strategy and the market conditions they are analysing. Ultimately, one must use various tools to make informed pivot trading decisions.
Limitations of Pivot Points
Pivot points may benefit certain traders. It's important to acknowledge that these levels are not guaranteed to act as support or resistance to the price. The market may not reach these levels or break through them without a significant reaction.
The prices may oscillate around these levels rather than reversing at them. Thus, like any other indicator, pivot points should be used with other technical analysis tools as part of a comprehensive trading strategy.