An Intern Learns - Making the Most of Pivot Points
In the last blog I discussed chart patterns and how by training your eye to look out for patterns you can make an estimate of where the price is likely to head. The more I thought about it, the more I realised that a technical analysis of the charts is mostly concerned with patterns! Even though this is often coupled with calculations of some sort, patterns are what a technical analysis is all about. These could be anything from resistance and support levels, Elliot wave theory, Fibonacci lines to moving averages etc.
One particular tool that has not yet been discussed on An Intern Learns series relates to Pivot Points. These can be found under the ‘Trends’ section of the indicators tab on the MahiFX platform. It’s really straightforward to set up a demo account with MahiFX. Just click the 'Log in' tab on the home screen and then Demo Account. Of course you are also most welcome to start a live account, but the demo account is great as it’s an exact duplicate of the live account, and it gives you a chance to practice your trading as well as check out all our features
Anyway lets get stuck into pivot points shall we!
Pivot points are lines put over the chart based on specific calculations. These horizontal lines show resistance and support levels. There will be a Pivot Point (PP) line, typically central on the charts and then 1 to 2 lines above and bellow the PP line indicating levels of support and resistance. Pivot points were originally used by floor traders to set key levels for the days trading using the previous days high, low and close prices to determine the pivot points for the current days trading. These pivot points are calculated as follows:
Pivot Point (P) = (High + Low + Close)/3
Support 1 (S1) = (P x 2) - High
Support 2 (S2) = P - (High - Low)
Support 3 (S3) = P - 2 * (High - Low)
Resistance 1 (R1) = (P x 2) - Low
Resistance 2 (R2) = P + (High - Low)
Resistance 3 (R3) = P + 2 * (High - Low)
Looks like a lot of calculations! First of all, don’t worry, they’re all automatically generated for you. Secondly, let me describe what’s going on in basic terms: the pivot point is calculated on the average high, low and closing prices of the previous day’s trading. Therefore price movement above the pivot point is thought to indicate a bullish trend, while below would indicate a bearish sentiment.
Have a look at the image below from a trade I was looking to do on my MahiFX demo account, it shows the pivot points inserted. These lines serve as indicators to price actions and can function in a number of ways, depending on what you’re looking for. These lines are considered points where price action could potentially change. These can either indicate small price movements, identify reversal points or key breakout areas. They are very much like support and resistance levels, but with the added bonus that they are inserted for you – there is no subjective-ness about where they should go. Pivot points are calculated on numbers only, and therefore are objective. Pivot points have become such a popular technique that some traders even consider them to be self-fulfilling. What I mean by this is that with so many traders looking at the same chart using the same indicator, all thinking ‘oh wow, looks like the price is going to bounce off that lower support level’ and then going long on the pair, it is likely that all this collective influence will in fact send the price up.
Now there are different ways that you can use pivot points in your trading. One of the more straightforward ways is to use them in a ranging market, in a similar way that you would use traditional resistance and support levels. As the price nears a line and pivots away from it, this would be a good time to go short, putting your stop loss just near the pivot line. Conversely if the price is bouncing off one of the bottom support level, it might be a good time to buy. When it comes to setting your Take Profit (TP), the other pivot lines can offer a clue as to where they should go. For example if you were selling you could set your TP at the next pivot line down, or if you were going long it would be at the next pivot point up.
Another way in which PP can be used is to gauge market sentiment. As you may recall, market sentiment is the overall feeling of the traders: is the price going to go up or is it going to go down? With pivot points, if the price opens above the main pivot point, it is likely that for the near future it will stay there, and conversely, if it opens below the pivot point line, it will continue to go on a down trend.
Pivot Points are great tools; however take this advice with a pinch of salt, as the market doesn’t always play by the rules. As much as it often sticks to what I’ve described above, sometimes the price may do the opposite to what you expected. Therefore it is always recommended that you use other technical indicators in conjunction with pivot points to make a call on price movement. Other trend spotting tools such as ADX, RSI and Bollinger bands can be great supplements when trading using pivot points.