Profit potential is increased when a trader understands and uses pivots. The term pivot refers to a turning point in the price of an asset and often coincides with key levels of support and resistance. There are two basic types of price pivots: calculated pivots (those determined by using mathematical formula) and price pivots, which are determined by looking at the price action on a chart. In this article we'll introduce price pivots and show how they can be successfully implemented into an active trading strategy.

Types of Pivots
A calculated pivot, often called a floor trader pivot, is derived from a formula using the previous day's high, low and closing price. The result is a focal price level about which price action is likely to turn, either up or down.Calculated pivots represent potential turning points in price, while price pivots are actual historic turning points. (For more on calculated pivots, see Using Pivot Points For Predictions.)

Price pivots are not calculated. The pivot is defined by the structural relationship between price bars. Price pivots form on all time frames, are building blocks of trend and provide objective entry and exit points for trading.

Price pivots are best conceptualized with three bars. A three-bar pivot low represents support and is formed when buying pressure turns price from down to up. It is designated by a price bar with a higher low that closes above the previous bar's high, where the previous bar's low is lower than the bar that preceded it. This is true in every time frame.

A three-bar pivot high represents resistance and is formed when sellers turn price from up to down. It is seen where a price bar with a lower high closes below the previous bar's low, where the previous bar's high is higher than the bar that preceded it. Structural pivots are more easily recognized and understood when seen in a diagram or on a price chart. This is true in every time frame. (See Figure 1)

Figure 1: These three-bar formations create the pivot low/high.

Price pivots represent reversals and are the building blocks of trend. A series of lower pivot highs and lower pivot lows is a downtrend, and the pivot highs are connected to form a down trendline. A series of higher pivot lows and higher pivot highs is an uptrend, and the pivot lows are connected to form an up trendline, as shown in Figure 2.

Source: TradeStation
Figure 2: A series of higher pivot lows create an uptrend.

Strategic Uses for Price Pivots
Pivots are also essential for seeing when the trend changes to the opposite direction. A trend reversal is seen by a change in the sequence of pivots. A downtrend will have a series of lower highs and lower lows, and a down trendline is drawn on the pivot highs. Once there is a higher high and higher low, there is presumptive evidence of a trend reversal to the upside (Figure 3).

The strength of the signal is increased when the higher pivot low forms above the down trendline. Aggressive traders can enter at the closing price on the same day the higher low completes the pivot formation. (For related reading, see Retracement Or Reversal: Know The Difference.)

Source: Tradestation
Figure 3: Downtrend reversal in Nasdaq futures. The higher pivot low triggers a reversal in the uptrend. This signal is strengthened when the higher pivot low closes above a descending trendline.

Pivots also help in the management of risk. In the example in Figure 3, the stop-loss order is placed under the previous pivot low. Confirmation of the trend reversal from down to up is seen when price makes another higher pivot high and low. If price cannot make a higher high, then a trend reversal has not occurred, and the trader will exit the trade. If price does make a higher high and higher low, then the stop-loss is moved to the next higher pivot low, and the stop is trailed under subsequent pivots as the trend progresses. (For more see, Trailing Stop Techniques.)

An uptrend reverses to the downside with the opposite pivot sequence. An uptrend will have a series of higher lows and higher highs, and an up trendline is drawn on the pivot lows. Once there is a lower low and lower high, there is presumptive evidence of a trend reversal to the downside (Figure 4). Again, the strength of the signal is increased when the lower pivot high forms below the uptrend line. Traders can enter at the closing price on the same day the higher low completes the pivot formation. An initial stop is placed at the previous pivot high and trailed in accordance with the trend.

Source: Telecharts, Worden Brothers Inc.
Figure 4: Uptrend reversal in Goldman Sachs. The lower pivot high/low triggers a reversal.

Pivots frame out price, allowing us to see when the trend enters a period of change. Price normally cycles between trend and range conditions. When pivots form a series of variable highs and lows, price enters range consolidation, or a sideways trend. In a range, the pivots are not moving consistently up or down. Price moves back and forth between support and resistance, testing for levels of buying and selling pressure. During these periods of price consolidation, trendlines can be drawn on the boundaries of the pivot highs (resistance line) and lows (support line) to show price patterns. (To learn more, read Price Patterns - Part 1.)

Using Patterns as Confirmation
A rectangle, or channel pattern, appears when both support and resistance lines are horizontal (Figure 3 and Figure 5). A triangle pattern is seen when one or both of the lines are slanted (Figure 4 and Figure 5). Small penetrations of these lines can be faded in the opposite direction. The lines also help identify when range conditions change back into trend. A new pivot high with price that remains above the resistance line suggests a breakout into an uptrend. A new pivot low with price that remains below the support line suggests a breakout into a downtrend.

Source: TDAmeritrade Strategy Desk
Figure 5: Chart patterns

One of the major benefits of using pivots for trade signals is that they are objective price points and can make trading less emotional. Either price has reversed or not, based on the structure of the price bars. Stops are placed according to specific pivot points. There is no need to guess where to put a stop or make predictions on the future direction of price. Pivots show us what is really happening as opposed to what we hope will happen. Traders who understand pivot structure will no longer have to wonder what price is doing: they will know.

The ability to read structural pivots provides a major edge in trading. Pivots can be used to increase profits with stocks, mutual funds, exchange-traded funds, currencies and futures. Pivots show the presence of trend and when the trend changes into a reversal, consolidation, or a breakout from consolidation. Structural pivots help outline important price patterns and give real-time signals for entry, exit, and stop-loss placement.

Related Articles
  1. Chart Advisor

    2 Short-Term and 2 Longer-Term Trade Ideas

    Two shorter-term and two longer-term trade ideas to consider, based on trends and the possibility of a breakout.
  2. Chart Advisor

    ChartAdvisor for November 27 2015

    Weekly technical summary of the major U.S. indexes.
  3. Chart Advisor

    Pay Attention To These Stock Patterns Playing Out

    The stocks are all moving different types of patterns. A breakout could signal a major price move in the trending direction, or it could reverse the trend.
  4. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  5. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  6. Technical Indicators

    Using Pivot Points For Predictions

    Learn one of the most common methods of finding support and resistance levels.
  7. Chart Advisor

    Watch These Stocks for Breakouts

    These four stocks are moving within price patterns of various size, shape and duration, and are worth watching for a breakout
  8. Trading Strategies

    How to Trade In a Flat Market

    Reduce position size by 50% to 75% in a flat market.
  9. Chart Advisor

    ChartAdvisor for November 20 2015

    Weekly technical summary of the major U.S. indexes.
  10. Chart Advisor

    Like Ranges? These Are Stocks to Consider

    Whether you want to trade the price fluctuations within a range, or await a breakout, here are four stocks for you.
  1. Do hedge funds invest in commodities?

    There are several hedge funds that invest in commodities. Many hedge funds have broad macroeconomic strategies and invest ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  4. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  5. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  6. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Flier

    The slang term for a decision to invest in highly speculative investments.
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center