Pivot Point Trading Strategies 101

Support and resistance levels represent points in the market where the price action is expected to stall, pause, change direction, or build a base for a big move. There are many methods that day traders use to determine these levels, but one of the most popular and powerful is using the pivot point technical indicator.

Pivot points can also be used to identify entry points and key levels that need to be broken before a move qualifies as a breakout. They are also known as a rotation points, because the direction of the market can be determined based on where the price action is, in relation to pivot line. If the price action is above the pivot point, the market is said to be bullish, and bearish if the price action is below the line.

Pivot points are comprised of five lines: a pivot line, two support lines (S1 and S2), and two resistance lines (R1 and R2). See Figure 1 below. By definition, a pivot line is a technical indicator that is derived from calculating the numerical average of the previous period’s high, low and closing prices.

The most common method of applying pivot lines is to calculate them from the daily charts and then apply them to the intra-day charts (i.e. hourly, 30 minutes and 15 minutes). Even though they can be calculated from intra-day charts, doing so tends to reduce the accuracy and significance of the indicator.

The pivot lines can be calculated as follows:

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

Support and resistance levels can then be calculated using the following formulas:

First level support and resistance:

First Resistance (R1) = (2*P) - Low

First Support (S1) = (2*P) - High

Second level of support and resistance:

Second Resistance (R2) = P + (R1-S1)

Second Support (S2) = P - (R1- S1)

Third and fourth levels can also be calculated using the model explained above, but these have little value to the trader, since the rest of the market itself places little value on them. Nevertheless, they can be used to track the midpoints of other major levels.

Breakouts tend to occur when the market opens. This often occurs as financial institutions, businesses, consumers, and speculators tend to place the largest orders at the start of the business day. The breakouts may also occur as traders review how the market traded in the previous session and adjust their portfolios. This is the reason why pivot points are ideal for trading range bound markets, such as Forex.

If properly applied, pivot point trading strategies will often give day traders a look into what the market’s trading range will be, and afford them an opportunity to properly forecast entry and exit targets, in addition to determining the market trend, significant support and resistance levels and, trend reversal points.

Continue on to the next page for more pivot point trading strategies.