Pivot Points Indicator: Traders use different tools to analyse and help them predict market trends consistently. Technical analysis has its value in tracking market sentiments to help traders build their strategies for the session and manage risk-reward ratios to be profitable.
Under many technical indicators, the pivot points indicator has a significant role in identifying potential trend reversals, price movement, support and resistance levels.
We shall explore here what are pivot points, how to calculate and how a trader can build strategies with the pivot points indicator.
What are Pivot Points Indicator?
Pivot Points are price-level technical indicators used to determine trends and potential support/resistance levels of the security. It is a numerical mean of the prior period’s high, low and closing price of a security.
If the price of a security is above the pivot point then it is bullish in momentum, and if the price is below the pivot point then a security is said to be in bearish momentum.
Along with the pivot point, the indicator includes Support 1(S1), Support 2(S2), Support 3(S3) and Resistance 1(R1), Resistance 2(R2), Resistance 3(R3) and so on in the downward and upward of the pivot point level respectively.
A trader can identify proper stop loss, breakouts and profit targets of the security based on support/resistance and pivot point levels.
How to calculate Pivot Points?
Let us now understand how the pivot point, support and resistance levels are calculated in this indicator.
The calculation of this indicator includes 1 pivot point, 2 resistance levels and 2 support levels.
Pivot point formula:- PP = (Low + High + close)/3
S1 = (PP X 2) – High
S2 = PP– (High – Low)
R1 = (PP X 2) – Low
R2 = PP – (High + Low)
Low = the lowest price from the previous trading day.
High = the highest price from the previous trading day.
Close = the closing price of the previous trading day.
PP= Pivot Point
S1 = Support 1
S2 = Support 2
R1 = Resistance 1
R2 = Resistance 2
Trading strategies with Pivot Points Indicator
There are two strategies involved in trading using pivot points, they are:-
- Pivot Point Bounce.
- Pivot Point Breakout.
Pivot Point Bounce
Here, we will discuss how a trader can enter or exit a position based on the price movement from pivot point levels.
If the price of a security is above the pivot point then a bullish momentum of the security will be registered. If a security retests the pivot point and bounces back in an upward direction then the trader can enter a long position.
The trader can consider resistance levels as profit targets for the long position. Based on the risk-to-reward ratios, profit targets can be set to any of the resistance levels and the stop loss can be a few points below the pivot point.
When the price of a security is trading below the pivot point, it is said to be bearish momentum.
If the security retests the pivot point and bounces back in a downtrend direction, then a fresh short position is signalled. The support levels of the indicator act as a profit target and it can be set to any support level subject to risk reward ratio. Stop loss for the position will be a few points above the pivot point level.
Pivot Point Breakout
In this strategy, we shall see how to enter a trade when the price of security breaches the pivot point in an upward or downward direction.
When the price of security opens below the pivot point level and if the price breaks above the level then the trader can enter a fresh long position. In the upward direction resistance levels can be set as profit targets depending on the risk-reward ratio. Stop loss should be a few points below the pivot point.
If the price of security opens above the pivot point and when it breaks below the level then the trader can enter a fresh short position. In the downward direction support levels will work as a profit target to the existing short position. Stop loss should be placed few points above the pivot point.
Day Trading Using Pivot Points Indicator
Including the above strategies mentioned, here is one of the ways to use pivot points for intraday trading.
We have discussed above that if the price of the security opens above the pivot point level it is bullish. If it breaks above the R1 level, then you can buy the security by setting a profit target at the R2 level.
If the price opens below the pivot point, then the security tends to be bearish, as the price breaks the S1 level, then you can short the security by setting a profit target at the S2 level.
The levels of the indicator fluctuate every day based on previous sessions’ closing prices.
Pivot Points vs Fibonacci Retracements
Fibonacci Retracements are horizontal lines used to mark potential support and resistance levels of security.
The pivot points Indicator are fixed levels for a long period, it is based on the high, low, and closing prices of the previous day.
Whereas, Fibonacci Retracements use percentages and the support/resistance levels can be drawn by choosing any high and low of security.
Limitations of Pivot Points Indicator
- Pivot Points rely on the previous day’s high, low, and closing prices of the security.
- As it is based on prior data, the price may stop, reverse, fluctuate in levels or even reach the levels created on the chart.
- Sudden changes in the market will not affect the indicator, the levels remain unchanged.
- The false signals generated affect the trader to exit early or miss out on the entry of security.
Pivot points provide valuable insights into the market sentiments with key price reversals, support and resistance levels. The above strategies of pivot points indicator help traders analyse the security for better buy and sell signals and it can be adjusted to any of the time frames based on the trader’s viewpoint.
It is necessary to practice the use of pivot points along with other technical analysis tools like Fibonacci retracements, moving averages, chart patterns etc. for strong and confirmed decisions.
Hence, traders can use pivot points by the above methods to analyse the entry/exit opportunities and manage the risks involved in their positions effectively.
Written by: Deepak M
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