In the last article we looked at Fibonacci. In part 14, we look at something that is visually similar: Pivot Points. I find that Pivot Points are one of the best tools for trading intraday FX or Stock Market Indices. Like Fibonacci, they give you a road map for price support and resistance. At times they behave like magnets towards the price action and because of this, a trader can use these pivot points to anticipate future short term price action. They can be used in the longer term, but in my experience, this approach isn’t so popular.
The main use of Pivots is to show, very clearly, levels of price support and resistance. This information can then be interpreted and used as either useful price target points or for setting risk management (stops) levels. I find them excellent on charts less than 240 mins. Anything greater and I switch back to Fibonacci. The pivot points are placed on top of the price.
It is a very simple calculation. To get the main / initial base line Pivot point (PP) you calculate (High + Low + Close) / 3
Further support and resistance levels are then calculated off the main pivot point (P):
- First resistance (R1) = (2 x P) – Low
- First support (S1) = (2 x P) – High
- Second resistance (R2) = P + (High – Low)
- Second support (S2) = P – (High – Low)
- Third resistance (R3) = High + 2(P – Low)
- Third support (S3) = Low – 2(High – P)
When drawn on a chart, a typical example could look like this:
GBPUSD 15 minute chart (Chart: TradingView)
Basic pivot point rules:
This isn’t an exhaustive list of rules, but they should help you to get a better handle on using pivot points:
- If the opening price > P = look for long trades.
- If the opening price < P = look for short trades.
- Always identify the long term trend first. Often, if the market is ranging, the price will fluctuate between PP and R1 or S1. With a stronger trend, pivot levels are broken more easily.
- Profit targets are often the next pivot level.
- Stop losses are set the other side of pivots or behind the moving averages / trend lines – but beware the stop hunters!.
- Never anticipate a breakout or reversal of a pivot point. Jumping in early can often lead to disaster – in FX, remember the stop hunters are laying in wait for that sort of activity! Wait for confirmation of price action/ momentum / the strategy rules etc.
- News, economic events etc – Can be a killer, but can also be a winner! If there is no news activity, then often the price will range between R1 and S1 (check news before the start of trading for potential warning areas). If there is news (especially the big impact stuff) then the price can do anything and can often range between R3 to S3 or greater.
- On the open, if the price > S1 or R1 there is a high probability that the price will mean revert back to P.
- At S2 the price with a high probability will head back to S1.
- At R2 the price with a high probability will head back to R1.
- S2 and R2 are perceived as the ‘collars’ of the day’s activity. In strong trends or news events, the price can go higher than these levels, but more likely not and it heads back to P.
- Rule: the further away from P, the weaker the trading opportunity.
- Often you can get a second bite at the cherry – so be patient!
As mentioned, the pivot points are very popular and useful intraday. Their impact can be further enhanced by using the pivot points in combination with other indicators and forms of technical analysis.
Example: using the same GBPUSD chart set up as in the previous example, (Charts: TradingView) we now add on RSI and Bollinger Band indicators to compliment the pivot points:
Further reading and learning:
If you are interested in learning more about pivot points, then the following reading may help:
- Technical Analysis, The Complete Resource for Financial Market Technicians, Charles D Kirkpatrick, FT Press, 2006.
Pivots, Patterns, and Intraday Swing Trades: Derivatives Analysis with the e-mini and Russell Futures Contracts, M.William Scheier, (Wiley Trading), 18 mar 2014.
Pivots, like Fibonacci, are a fantastic tool for letting you anticipate future price direction and laying the foundations of your trade management processes. For intraday traders in highly liquid markets, the pivot point concept takes some beating!
Next time: Technical Analysis (Part 15): Direct Price Analysis (DPA) – Ichimoku