What is a Pivot Point?
A pivot point is a technical analysis indicator, or calculations, used to determine the overall trend of the market over different time frames. The pivot point itself is simply the average of the high, low and closing prices from the previous trading day. On the subsequent day, trading above the pivot point is thought to indicate ongoing bullish sentiment, while trading below the pivot point indicates bearish sentiment.
The pivot point is the basis for the indicator, but it also includes other support and resistance levels that are projected based on the pivot point calculation. All these levels help traders see where the price could experience support or resistance. Similarly, if the price moves through these levels it lets the trader know the price is trending in that direction.
- When the price of an asset is trading above the pivot point, it indicates the day is bullish or positive.
- When the price of an asset is trading below the pivot point, it indicates the day is bearish or negative.
- The indicator typically includes four additional levels: S1, S2, R1, and R2. These stand for support one and two, and resistance one and two.
- Support and resistance one and two may cause reversals, but they may also be used to confirm the trend. For example, if the price is falling and moves below S1, it helps confirm the downtrend and indicate a possible continuation to S2.
The Formulas for Pivot Points:
P=3High+Low+CloseR1=(P×2)−LowR2=P+(High−Low)S1=(P×2)−HighS2=P−(High−Low)where:P=Pivot pointR1=Resistance 1R2=Resistance 2S1=Support 1S2=Support 2
High indicates the high price from the prior trading day,
Low indicates the price from the prior trading day, and
Close indicates the closing price from the prior trading day.
How to Calculate Pivot Points
The pivot point indicator can be added to a chart, and the levels will automatically be calculated and shown. Here's how to calculate them yourself, keeping in mind that pivot points are predominantly used by day traders and are based on the high, low, and close from the prior trading day. If it is Wednesday morning, use the high, low, and close from Tuesday to create the pivot point levels for the Wednesday trading day.
- After the market closes, or before it opens the next day, find the high, low and close from the most recent day.
- Sum the high, low, and close and then divide by three.
- Mark this price on the chart as P.
- Once P is known, calculate S1, S2, R1, and R2. The high and low in these calculations are from the prior trading day.
What Do Pivot Points Tell You?
Pivot points are an intra-day indicator for trading futures, commodities, and stocks. Unlike moving averages or oscillators, they are static and remain at the same prices throughout the day. This means traders can use the levels to help plan out their trading in advance. For example, they know that, if the price falls below the pivot point, they will likely be shorting early in the session. If the price is above the pivot point, they will be buying. S1, S2, R1, and R2 can be used as target prices for such trades, as well as stop loss levels.
Combining pivot points with other trend indicators is a common practice with traders. A pivot point that also overlaps or converges with a 50-period or 200-period moving average, or Fibonacci extension level, becomes a stronger support/resistance level.
The Difference Between Pivot Points and Fibonacci Retracements
Pivot points and Fibonacci retracements or extensions both draw horizontal lines to mark potential support and resistance areas.
Fibonacci retracement and extension levels can be created by connecting any price points on a chart. Once the levels are chosen, then lines are drawn at percentages of the price range selected.
Pivot points don't use percentages and are based on fixed numbers: the high, low, and close of the prior day.
Limitations of Pivot Points
Pivot points are based on a simple calculation, and while they work for some traders, others may not find them useful. There is no assurance the price will stop at, reverse at, or even reach the levels created on the chart. Other times the price will move back and forth through a level. As with all indicators, it should only be used as part of a complete trading plan.