Trading can be really confusing right? I mean – S&R, Heinki-Ashi candlesticks, shadows, hammers and retracements – I mean what do those even mean?! Well, I know because I write about them, but not everyone writes about trading on a daily basis. Ok let’s at least set a starting point….see what I did there? Pivot points are key price regions which an instrument’s price might reach resistance or support. The way pivot points are calculated are with standard metrics meaning they can stand as unbiased gauges of support and resistance. This is why many market veterans actually use pivot points to calculate S&R.
Pivot points are calculated with specific formulas; based on the instrument’s lasts day’s low, high and the last closing price. In general, three resistance, three support and one central pivot are plotted on a H1 (or one hour) chart. To calculated them:
- Central Pivot point (denoted as PP) = (Close+ Low + High) / 3
- First resistance (denoted as R1) = (2 x PP) – the instrument’s Low
- First support (denoted as S1) = (2 x PP) – the instrument’s High
- Second resistance (denoted as R2) = PP + (the instrument’s High – the instrument’s Low)
- Second support (denoted as S2) = PP – (the instrument’s High – Low)
- Third resistance (denoted as R3) = the instrument’s High + 2(PP – the instrument’s Low)
- Third support (denoted as S3) = the instrument’s Low – 2(the instrument’s High – PP)
You can find the values for closing, low and high by putting the chart in D1 (or daily mode), using the previous day’s candlestick.
You can also use various tools which automate pivot point calculation and plots the indicators on your chart.
What do Pivot Points Do?
As I mentioned in the intro pivot points are great tools to map the area between support and resistance. It not as cut and dry as that though because the lines R1, R2 and R3 can also work as support, depending of the vector of the price action. Inversely, S1, S2 and S3 can be stand-ins for resistance depending on the conditions, so keep that in mind as we go forth with pivot points.
Here are a few ways pivot points can be used:
a) Trading a Breakout
If the price of an instrument doesn’t break through a pivot point it can be considered either support or resistance. Sometimes though an instruments price fuelled by fundamental data can break through these pivots.
This gives the trader using pivots points to delineate support and resistance the opportunity to trade the breakout – although in most cases the price will test these levels it broke through again.
Although many traders use breakouts in their strategy, it can definitely be risky.
b) Trading Within a Range
You can also use the pivot points to designate an area, that has not experienced a breakout. Traders that use this strategy generally seek to buy towards the lower area of the region (thus at a lower price) and sell in the higher areas of the region (or a higher price). This is less risky than breakout, as a breakout can be momentary and in many cases may return to retest both support and resistance, whereas trading within a region, gives the trader more leeway. None-the-less there are multiple variables when using this, that can affect the outcome of a trade.
c) Gauging Market Sentiment
Pivot points can also be used to measure market sentiment, by watching what the price action does at the opening of markets in correlation to the central pivot point (which as you remember is an average of the Low, High and Closing of the previous day).
EA’s, chart indicators and tools such as pivot points are exactly that, tool. Every tool needs a competent user for it to work as it was intended. Keep in mind that trading has many variables which include both technical, fundamental and of course human factors.