What Is Pivot Point Indicator and How To Use It in Trading?
The pivot point is a leading technical analysis indicator used to foresee market direction, potential support and resistance levels. It’s widely implemented on different markets, such as forex, commodities, and indices, on various time frames. This article will provide you with a detailed explanation of the pivot point indicator, its features, types, ways to calculate it, benefits and limitations, trading strategies, and everything else you need to know to use this technical tool effectively.
What Is the Pivot Point Indicator?
The pivot point is a technical indicator that helps investors determine the direction of the market trend. Moreover, being an average of the High, Low, and Close price of the previous trading session it is also used to foresee when the asset price might experience support and resistance levels. Although pivot points are valid over any time frame, they have become particularly popular in day trading.
In contrast to some other indicators (like Moving Average, oscillator, etc.), the pivot point doesn’t change with each new candle, it remains static over a chosen time scale, usually on an intraday basis. When an asset is traded over the pivot point, it’s a sign of bullish market sentiment. Conversely, when the asset is traded below the pivot point, the market is believed to show a downtrend movement.
Pivot points are a type of predictive (aka leading) indicator, meaning that they have a forward-looking ability. However, it’s important to keep in mind that not all of the predictions may come true. Therefore, to increase the efficiency of this tool it’s recommended to use it in conjunction with other indicators, for example, Moving Average (MA), Fibonacci Retracement, and others.
Pivot Points vs. Fibonacci Retracements
Both pivot points and Fibonacci retracements are presented on the chart with horizontal lines and are used to predict potential levels of support and resistance. However, there are some differences between them. Fibonacci retracements can be stretched between two significant points (high and low), creating percentage levels between them. The lines usually represent 23.6%, 38.2%, 61.8%, and 78.6%, sometimes 50% as well. Pivot points, in contrast, have fixed values based on the previous high, close, and low prices. Moreover, they don’t present data in percentages. Being calculated in different ways, these two indicators go well together, helping traders confirm their expectations and decide more accurately on entry and exit trade points.
How Pivot Points Work
Pivot points can be implemented like regular support and resistance levels. As mentioned above, this indicator is static and doesn’t change throughout the trading period, thus, investors can plan their moves, enter trades earlier, and reap potentially higher profits. The basic rule suggests that if the price drops below the pivot point, traders are likely to enter short trades. Otherwise, if the asset price grows over the pivot point, traders are expected to open long positions.
Pivot Point Levels
The pivot point indicator is commonly represented by 7 levels on the chart: the pivot point line itself, 3 resistance lines, and 3 support lines. Let’s have a closer look at them.
The basic pivot point § is a middle line on the chart.
Resistance 1 (R1) is the first pivot level above the basic pivot point.
Resistance 2 (R2) is a pivot level above resistance 1 or the second line over the basic pivot point.
Resistance 3 (R3) is a pivot level above resistance 2 or the third line over the basic pivot point.
Support 1 (S1) is the first pivot level below the basic pivot point.
Support 2 (S2) is a pivot level below the support 1 line or the second line below the basic pivot point.
Support 3 (S3) is a pivot level below the support 2 line or the third line below the basic pivot point.
Not only can investors use pivot points to determine support and resistance levels, but also breakouts. When the asset price fails to stay within the levels and breaks through the pivot line, this movement is known as pivot point breakout.
How to Calculate Pivot Points
Pivot points can be added automatically on many trading platforms. However, if you want to calculate them on your own, here are the steps to follow.
- It’s important to keep in mind that pivot point calculation is based on the high, low, and close price of the previous trading period, usually day. Thus, when the trading day finishes, it’s necessary to find the high, low, and close price values of this day and then sum these values and find the average by dividing this number by three. This way, you will find the basic pivot point level marked on the chart as P.
P= (High (previous) + Close (previous) + Low (previous)) / 3
- Then you can calculate levels of support and resistance (S1, S2, S3, R1, R2, R3) following the formulas:
S1 = (P2) - High (previous)*
R1 = (P2) - Low (previous)*
S2 = P - (High (previous) - Low (previous))
R2 = P + (High (previous) - Low (previous))
S3 = Low (previous) - 2(High (previous) - P)
R3 = High (previous) + 2(P - Low (previous))
Note, that all formulas of pivot points levels include the basic pivot point §. Thus, it’s crucial to find the correct value of P, otherwise, all other calculations will be wrong.
What Are The Different Kinds of Pivot Points?
Although pivot points have gained widespread popularity among traders, not everyone knows that there are different types of them. Let’s have a look at the most popular ones.
Standard Pivot Points
Standard pivot points, also known as Classical pivot points, are the most common type of this indicator. It is based on a basic pivot point §, which is calculated using high, low, and close prices of the previous trading day, and several levels of support and resistance (R1, S1, R2, S2, etc.). Standard pivot points can be easily calculated individually following the formulas presented above.
Fibonacci Pivot Points
Well-known Fibonacci retracements can be incorporated with pivot points, resulting in a robust combination for trading. The calculations of Fibonacci pivot points are similar but still slightly different from the Standard pivot points. Like in the previous type, first, it’s necessary to find the value of P by summing the previous day’s high, low, and close prices and dividing this number by 3. However, the formulas for support and resistance levels are different.
R1 = P + (.382 * (High (previous) - Low (previous)R2 = P + (.618 * (High (previous) - Low (previous)
R3 = P + (1 * (High (previous) - Low (previous)
S1 = P - (.382 * (High (previous) - Low (previous)
S2 = P - (.618 * (High (previous) - Low (previous)
S3 = P - (1 * (High (previous) - Low (previous)
Woodie’s Pivot Point
In contrast to the above-mentioned pivot point types, Woodie’s pivot points put more weight on the asset closing price. Therefore, in the formula of the basic pivot point, the closing price is multiplied by two. The calculation of P looks like this:
P = (High + Low) + (2 * Closing Price) / 4
Once having calculated the value of P, it’s possible to find two support levels and two resistance levels.
R1 = (2*P) - Low
R2 = P + (High - Low)
S1 = (2*P) - High
S2 = P - (High + Low)
Camarilla Pivot Point
Camarilla pivot points, as well as Woodie’s, add more weight to the closing price. However, compared to the latter one, it is presented on the chart with 9 lines: basic pivot point level, 4 support levels, and 4 resistance levels. P is calculated like in the Classical version of pivot points. However, the formula for support and resistance levels is different and includes a certain multiplier.
R1 = Close + (High - Low*1.0833)
R2 = Close + (High - Low)*1.1666)
R3 = Close + (High - Low)*1.2500)
R4 = Close + (High - Low)*1.5000)
S1 = Close - (High - Low)*1.0833)
S2 = Close - (High -Low)*1.1666)
S3 = Close - (High -Low)*1.2500)
S4 = Close - (High-Low)*1.5000)
Demark Pivot Points
Demark pivot points are much different from the previously mentioned ones. They represent the relationship between opening and closing asset prices. This pivot point type comes with only one level of support and one level of resistance. Moreover, to calculate them, it’s necessary to find the value of X. There could be three different conditions:
- The closing price is less than the opening price:
X = High + (2Low) + Close*
- The closing price is more than the opening price:
X = (2High) + Low + Close*
- The closing price is the same as the opening price:
X = High + Low + (2Close)*
Once having calculated the X, it’s possible to find P, S1, and R1.
P = X/4
S1 = X/2 - High
R2 = X/2 - Low
How to Use Pivot Points
The pivot points indicator is an efficient tool that can be used by traders in several ways. Here are the most common of them.
- To identify the trend. If the asset price is over the basic pivot point level, the market is considered bullish. Conversely, if the asset price is below the pivot point level, the market is considered bearish.
- As support and resistance levels. When the market is in an uptrend, traders tend to open long positions and close them when the price reaches the resistance level. When the market shows a bearish movement, traders tend to enter short trades and close them when the price declines to the support level.
- To define entry/exit trade points. When the price reaches the support level, it could be a signal to enter long trades. Otherwise, when the price goes up to the resistance level, traders are likely to open short positions.
- As potential trade areas. When the asset price breaks over one of the pivot point lines, the next higher pivot level can be interpreted by traders as a potential profit target. When the price breaks below one of the pivot points, the next lower level could be considered the profit target.
Pivot Point Trading Strategies
Pivot point indicator can be effectively used for a big choice of financial markets (including, stocks, commodities, forex, etc.) and over different timeframes, which makes it suitable for many trading strategies. Here are some of them.
Pivot Point Candlesticks Strategy
Pivot points used on the candlestick chart can help investors to determine the entry and exit trade points. Let’s consider an example with a forex pair.
On the chart above, it’s possible to see that while being over the basic pivot point level, the asset price is getting closer to the first resistance level (R1). According to the basic rule, when the price breaks over the R1, traders can consider placing long positions and aim at the R2 level. However, when using pivot points in combination with a candlestick chart, traders can wait for the next candle to appear to confirm their expectations.
In this example, after breaking through the R1, price forms a Doji candle. It doesn’t always indicate a market reversal but shows that the bullish momentum is off. Confirming this sign, the market stops growing and stays at approximately one level. Apart from the Doji pattern, traders can keep track of other potential reversal signs such as spinning top, shooting star, or hanging man.
What’s more, investors can make use of the engulfing candle. This is a big candle that follows another big candle of a different color. It’s recommended to open positions in the direction of the engulfing candle when it’s located close to the pivot point level.
Pivot Points Intraday Trading
Pivot points are widely popular for day trading, mostly because they can be efficiently implemented over different time frames, be it 1 second, 1 minute, or 1 hour. It’s necessary to keep in mind that the value of the pivot points is fixed and doesn’t change throughout the day. Therefore, in contrast to moving averages, this technical analysis indicator is presented on the chart with several horizontal lines. On an intraday basis, traders often implement pivot point bounce and breakout techniques.
- The pivot point bounce strategy implies that if the asset price touches the pivot point level and then bounces back, it’s a signal to open the trade. It’s recommended to enter long trades when there was an up bounce on the upside and short trades when there was a down bounce on the downside.
- The pivot point breakout strategy suggests that traders should open the trade when the price breaks through the pivot level. Investors are expected to open long trades when the market is in the uptrend and short traders when the market has a bearish sentiment. It’s recommended to use this technique in combinations with stop-loss orders.
Pivot Points in Forex
When implementing pivot points on forex, it’s necessary to remember that this market operates 24 hours 5 days per week. It can be confusing when trying to determine which values to use to calculate the basic pivot point. Therefore, to divide trading sessions from each other, the majority of forex traders use 23:59 GMT as a closing time and 00:00 GMT as an opening time. What’s more, since pivot points are calculated using the whole 24-hour timeframe, they may not be efficient for investors who operate only on one of the forex sessions during the day (for example, only the London session).
As for the rest, forex trading with pivot points complies with common rules. When the market is traded below the basic pivot point, it’s a signal to open short trades. When the market is over the basic pivot point, it could be a signal to open long positions.
Pivot Points in Other Markets
Apart from forex, the pivot points can be used with other financial assets, including commodities and indices. Traders can refer to different timeframes (hourly, daily, monthly, etc.), chart patterns (breakouts, engulfing candles, etc.), and types of pivot points (standard, Fibonacci, Demark, or Camarilla) to determine the overall market sentiment, potential support and resistance level as well as entry and exit trade points.
What Are The Advantages of Using Pivot Points?
Pivot points stand out with the following merits:
- Make it easy to define the trend. The market is supposed to be in an uptrend when the asset price is traded over the main pivot point level. Conversely, it’s believed to be bearish, when the asset price is located below the main pivot line.
- Reliable. Although the pivot points indicator is relatively simple to calculate and easy to plot, it provides traders with accurate and reliable information, especially when implemented on an intraday basis.
What Are The Limitations of Using Pivot Points?
When it comes to pivot points limitations, one of the most significant ones is limited relevance, caused by the simplicity of calculations.
- Limited relevance. Daily pivot points may not be useful for investors who trade only for a short time throughout the day. What’s more, it’s not guaranteed that the asset price will ever reach or stop at one of the levels established by this indicator.
The pivot point is a widespread technical analysis indicator used by traders to identify the direction of the market trend, set the support and resistance levels, and define entry and exit trade points. Although it can be implemented with various financial assets over different timeframes, it’s commonly used by day traders on forex, commodity, and indices markets. In contrast to some other technical tools, like Moving Average or RSI, it has a set value during the day, which makes it look like a horizontal line on the chart.
Pivot points are relatively simple to calculate and read. Moreover, they have proven to provide accurate information, especially for intraday trading. However, to improve their efficiency and mitigate some limitations, it’s advised to combine them with other indicators.