As a trader, one is constantly looking at support and resistance levels for entering and exiting markets as well as planning advance strategies. But how do traders read and decipher complex tools? And what is the role of pivot points in formulating trading strategies? Let us dive in!
Pivot points are a mathematically-backed technical indicator that uses data points of the previous day to predict trends and, more importantly, trend reversals.
This article covers:
- What are pivot points?
- Calculations for pivot point
- Intraday trading using pivot points
- How to execute trades using pivot points?
- Benefits of trading pivot points
What are pivot points?
‘Pivoting’ in light of trading means reversing from support and resistance levels. Pivot points reveal those crucial data points where the market’s sentiments or the price movement in the underlying security are expected to change direction. They use the previous day’s close, low and high price to calculate the price to estimate support and resistance during the next trading session.
Trading price above the pivot level indicates an ongoing bull run, while the trading price below the pivot point signifies a bear run. Traders use pivot points to decide their entry, exit, and stop losses in the market.
Calculations for pivot point
You can add the pivot point indicator to a trading chart and use the information yielded by it to trade in different time intervals. Alternatively, you can use the formula explained below to derive two support and resistance levels each.
Pivot point (P) = ( High + Low + Close)/3
S1 =First support = (Pivot point x 2) – High
S2 =Second support = Pivot point – (High – low)
R1 =First resistance = (Pivot point x 2) – Low
R2 =Second resistance = Pivot point + (High – low)
Note: Different trading platforms present pivot point indicators with multiple support and resistance levels beyond two.
Intraday trading using pivot points
Pivot point breakout
It is observed that when a pivot point breakout takes place, the same is backed by volumes and continues in the breakout direction.
So if you see a pivot point is being taken down from below on the upside, it establishes a bullish trend. This trend may continue, and traders may enter long positions keeping a stop loss just below the pivot point.
Similarly, when a bearish breakdown is observed on a pivot point, i.e., the price breaks the pivot point from above on its way down, the trend too may continue. Therefore, those with long positions may choose to exit or trade according to their risk appetite.
Pivot point bounces
In this technique, the price doesn’t break the pivot point but rebounds in the opposite direction after testing.
Price bouncing back from a pivot point in the opposite direction is an indication that the price is respecting the pivot level and the trend is reversed. If this bounce from the pivot point is on the upside, it’s a possible cue for traders to enter buy positions. However, if the bounce is on the downside, traders may enter sell positions.
How to execute trades using pivot points?
Open the stock/index chart
One can open multiple stock charts and apply pivot point indicators in each of them to identify the stocks approaching support or resistance levels.
The waiting game begins
Trading is all about patience and timely trades. Allow the price to approach the pivot point. For stocks in a bull run, wait for them to make new lows close to the pivot point and for those in a bear run, let them form new highs near the pivot point.
Allow the price to trade at the pivot point
Wait as long as the price doesn’t touch the pivot point. Then, when the price starts trading at the pivot level, you may choose to execute your trade.
Placing targets for the trades entered
For long trades entered, you can aim for a target price near the first resistance level. However, those with a slightly higher risk appetite may aim for the second resistance level as well. If the stock manages to surpass the buying at the first resistance level, it is most likely to move towards the second resistance.
For short trades, risk-averse traders should aim for the price to fall till the first support level and should place their targets near that price. Traders with slightly higher risk-bearing capacity can aim for the second support level as well.
Benefits of trading pivot points
Pivot points take close, high and lows of stock into account thus considering the ongoing sentiments of the market-leading to impressive accuracy.
Short time frames
While most other technical indicators have ‘one-day time frames’ as their base and are very rigid on the same, pivot point can work on shorter time frames like 15 minutes as well. Moreover, since pivot points give data for only one trading session, the information is highly precise and specific.
Ease of use
Most trading platforms provide a pivot point indicator; hence the user need not use multiple applications for trading.
Pivot points are highly specific in determining the support and resistance levels, and one can trade relying on the information yielded by them. Pivot points help identify exact places where the trend reverses. Still, there’s no technical indicator with guaranteed success and it is always beneficial to implement multiple indicators to smoothen out the possibility of false signals.
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