Pivot point calculation
- Pivot Point Calculation
Pivot points are a technical analysis tool used to identify potential support and resistance levels. They are calculated using the previous day’s high, low, and closing prices, and are used by traders to spot entry and exit points, and to set stop-loss orders. Understanding pivot points is fundamental to many trading strategies, and this article will provide a comprehensive guide for beginners on how they are calculated and used. We will cover the basic calculation, variations, and how to integrate them into your overall Trading strategy.
What are Pivot Points?
Pivot points are levels that indicate where the market may 'pivot' or change direction. They are based on the idea that yesterday’s price action can influence today’s trading. They are not foolproof predictors of future price movement, but they offer potential areas of support and resistance that traders can use to make informed decisions. A key concept is that once a pivot point is broken, it often acts as support or resistance in the opposite direction.
They’re widely used across various markets, including stocks, forex, futures, and commodities. The simplicity of the calculation and the visual clarity they provide on a chart make them incredibly popular among both novice and experienced traders. They are often used in conjunction with other Technical indicators to confirm trading signals.
The Basic Calculation
The core calculation for pivot points revolves around three key price points from the previous trading period (typically a day, but can also be applied to weeks or months):
- High (H): The highest price reached during the previous period.
- Low (L): The lowest price reached during the previous period.
- Close (C): The final price at the end of the previous period.
Here's how the standard pivot point calculation is performed:
- Pivot Point (PP): (H + L + C) / 3
- Resistance 1 (R1): 2 * PP - L
- Resistance 2 (R2): PP + (H - L)
- Support 1 (S1): 2 * PP - H
- Support 2 (S2): PP - (H - L)
Example:
Let's say yesterday's trading data was:
- High (H): $110
- Low (L): $100
- Close (C): $105
Applying the formulas:
- Pivot Point (PP): (110 + 100 + 105) / 3 = $105
- Resistance 1 (R1): 2 * 105 - 100 = $110
- Resistance 2 (R2): 105 + (110 - 100) = $115
- Support 1 (S1): 2 * 105 - 110 = $100
- Support 2 (S2): 105 - (110 - 100) = $95
These values ($95, $100, $105, $110, $115) will then be plotted on today's chart as potential support and resistance levels. Many charting platforms automatically calculate and display these levels.
Variations of Pivot Point Calculations
While the standard calculation is the most common, several variations exist, each designed to cater to different trading styles and market conditions. These variations adjust the multipliers used in the formulas, resulting in different levels of sensitivity and potential support/resistance areas.
- Fibonacci Pivot Points: These use Fibonacci ratios (often 38.2%, 50%, 61.8%) to calculate the pivot point and support/resistance levels. The formulas are more complex, but aim to identify levels that align with Fibonacci retracements, a widely used concept in Fibonacci trading.
* PP = (H + L + C) / 3 * R1 = PP + 0.382 * (H - L) * R2 = PP + 0.618 * (H - L) * S1 = PP - 0.382 * (H - L) * S2 = PP - 0.618 * (H - L)
- Woodie’s Pivot Points: Developed by Woodie McCormick, these incorporate classic pivot points with Fibonacci levels and are designed to identify potential trading opportunities with higher probability. They involve a more involved process of identifying "Tom DeMark" setups, and are considered more advanced.
- Camarillo Pivot Points: This method, popular among futures traders, uses daily ranges and multiple pivot points to identify intraday trading opportunities. It is based on the work of Nick Camarillo.
The choice of which variation to use depends on your trading style. For example, Fibonacci pivot points might be preferred by traders who incorporate Fibonacci retracements into their analysis, while standard pivot points are often used for simple support/resistance identification. Experimentation and backtesting are crucial to determine which method works best for you.
How to Use Pivot Points in Trading
Pivot points are versatile tools that can be incorporated into a variety of trading strategies. Here are some common applications:
- Identifying Support and Resistance: The primary use of pivot points is to identify potential areas where the price might find support (bounce upwards) or resistance (encounter selling pressure and fall). Traders often watch for price to test these levels.
- Entry Points:
* Breakout Trading: A breakout above a resistance level (R1 or R2) can signal a buying opportunity, anticipating further upward movement. Conversely, a breakdown below a support level (S1 or S2) can signal a selling opportunity. * Retracement Trading: After a breakout, the price often retraces back to the broken level (now acting as support or resistance). Traders may enter positions during these retracements, anticipating a continuation of the original trend.
- Setting Stop-Loss Orders: Pivot points can be used to strategically place stop-loss orders. For example, if you enter a long position after a breakout above R1, you might place your stop-loss order just below R1. This limits your potential losses if the breakout fails.
- Setting Profit Targets: Subsequent pivot point levels can be used as potential profit targets. For instance, if you buy after a breakout above R1, you might set your profit target at R2.
- Confirmation with Other Indicators: Pivot points are most effective when used in conjunction with other Trend following indicators, such as Moving averages, Relative Strength Index (RSI), and MACD. For example, a breakout above R1 confirmed by a bullish MACD crossover would be a stronger signal than a breakout alone.
Combining Pivot Points with Price Action
Understanding how price *reacts* to pivot point levels is crucial. Here are some observations:
- Strong Reactions: When price decisively breaks a pivot point and shows strong momentum, it's a strong indication of a potential trend continuation.
- Rejections: If price tests a pivot point but is repeatedly rejected (fails to break through), it suggests that the level is acting as strong support or resistance. This can be a signal for a potential reversal.
- False Breakouts: Sometimes, price will briefly break a pivot point level only to quickly reverse direction. These "false breakouts" can trap unsuspecting traders. Using confirmation from other indicators and observing price action closely can help avoid these traps. Consider Candlestick patterns for confirmation.
- Pivot Point Congruence: When pivot point levels from different timeframes (e.g., daily and weekly) coincide, it creates a stronger level of support or resistance. This is known as confluence.
Advanced Considerations
- Timeframe: The timeframe used for calculating pivot points significantly impacts their relevance. Shorter timeframes (e.g., hourly, 15-minute) are suitable for day trading, while longer timeframes (e.g., daily, weekly) are more appropriate for swing trading or long-term investing.
- Market Volatility: In highly volatile markets, pivot points may be less reliable, as price movements can be erratic and unpredictable. Adjusting the calculation method or using wider stop-loss orders might be necessary.
- Backtesting: Before relying on pivot points in live trading, it's essential to backtest your strategies using historical data to assess their effectiveness. This involves applying your trading rules to past price data to see how they would have performed. Trading simulators can be very helpful.
- Dynamic Pivot Points: Some traders use dynamic pivot points, which are recalculated in real-time as new price data becomes available. This can provide more responsive levels, but also increases the complexity of the analysis.
- Psychological Levels: Pivot points often align with psychological levels (e.g., round numbers like $100, $50). These levels have a natural psychological significance for traders and can amplify the effect of pivot points.
Resources for Further Learning
- **Investopedia:** [1](https://www.investopedia.com/terms/p/pivotpoints.asp)
- **BabyPips:** [2](https://www.babypips.com/learn/forex/pivot-points)
- **TradingView:** [3](https://www.tradingview.com/support/solutions/articles/2000033680-how-to-plot-pivot-points)
- **School of Pipsology:** [4](https://www.schoolofpipsology.com/pivot-points/)
- **DailyFX:** [5](https://www.dailyfx.com/education/technical-analysis/pivot-points.html)
- **FXStreet:** [6](https://www.fxstreet.com/technical-analysis/pivot-points-explained)
- **Trading Signals:** [7](https://trading-signals.com/pivot-points/)
- **The Pattern Site:** [8](https://thepatternsite.com/pivot-points)
- **ChartNexus:** [9](https://www.chartnexus.com/indicators/pivot-points)
- **StockCharts.com:** [10](https://stockcharts.com/education/technical-analysis/pivot-points-628)
- **Learn to Trade the Market:** [11](https://learntotradethemarket.com/technical-analysis/pivot-points/)
- **Trading Strategy Guides:** [12](https://www.tradingstrategyguides.com/pivot-points-trading-strategy/)
- **Forex Factory:** [13](https://www.forexfactory.com/forum/showthread.php?t=494877)
- **Elite Trader:** [14](https://elitetrader.com/et/threads/pivot-points-explained.357214/)
- **Fibonacci Trading:** Fibonacci retracement
- **Trend Following:** Trend lines, Channel breakouts
- **Technical Indicators:** Bollinger Bands, Stochastic Oscillator, Average True Range (ATR)
- **Candlestick Patterns:** Doji, Engulfing Pattern, Hammer
- **Trading Psychology:** Fear and Greed, Risk Management
- **Market Analysis:** Fundamental Analysis, Sentiment Analysis, Intermarket Analysis
- **Trading Platforms:** MetaTrader 4, MetaTrader 5, Thinkorswim
- **Trading Strategies:** Scalping, Day Trading, Swing Trading, Position Trading
- **Risk Management:** Position sizing, Stop-loss orders, Take-profit orders
- **Chart Patterns:** Head and Shoulders, Double Top, Double Bottom
- **Volatility:** Implied Volatility, Historical Volatility
- **Market Trends:** Uptrend, Downtrend, Sideways Trend
Technical analysis is a crucial skill for any trader, and understanding pivot points is a great starting point. Remember to practice, backtest, and adapt your strategies based on your own observations and risk tolerance.
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