Pivot Points Identify Critical Information for Traders
Traders routinely make use of technical analysis tools to better understand market activity. One such measure routinely used by forex traders, share traders, and options traders alike is Pivot Points. These are important indicators for day traders since they are powerful indicators of support and resistance levels.
One of many reasons cited by traders for the high utility value of Pivot Points is the objectivity provided by this strategy. Traders needn't worry about manually plotting out support and resistance levels since Pivot Points automatically reflect such levels. In order to understand the importance of the Pivot Points strategy, it is worth pointing out that floor traders typically base the current day’s anticipated activity on the previous day's trading performance.
These popular day trading indicators are made up of multiple support and resistance levels, and the objective is to calculate intraday TPs (turning points) in the market. This technical analysis indicator can be extrapolated to understand general market trends over different time frames. The actual Pivot Point is simply an average of the high and low for the day, as well as the previous day's closing price.
If trading activity on the new day moves above the pivot point, expectations of bullish market sentiment ensue. If trading below the pivot point ensues, market activity is deemed bearish. The pivot point itself is one of many levels that is evaluated and used to determine when prices will meet support or resistance. If pricing extends beyond these pivot point levels, traders immediately understand that a trend is developing.
How Do We Know What Pivot Points Mean for Trading Purposes?
Let's say you’re trading gold bullion on the Australian Securities Exchange at a spot price of AU$2,156 per ounce. If the price of gold bullion trades above its pivot point, it is fair to assume that bullish sentiment is the order of the day. However, if the price of gold starts trading below the pivot point, we can safely assume that the day is bearish.
As a trader, you will invariably see several levels associated with pivot points. These include S1, S2, R1, and R2. Simply put, these refer to Support Level I, Support Level II, Resistance Level I, and Resistance Level II. It's interesting to point out that the formula used to determine Pivot Points is the sum of (high + low + closing price)/3.
Naturally, the pricing is from the previous trading day. Traders extrapolate data from the previous day, hoping to understand key support and resistance levels, trading trends and other technical data. Assuming it's Tuesday morning, you’re bright-eyed, bushy-tailed and ready to trade. If you are a proponent of Pivot Points, you would take the high, low, and closing price from Monday’s trading session, divide it all by 3, and use that value as the pivot level for the present day. That level is known as the Pivot level, and it is associated with S1, S2, R1 and R2.
Pivot points are calculated by averaging the numerical value of an asset’s high, low, and closing price.
Pivot Point traders utilise an easy-to-understand system known as the 5-Point System. This takes into consideration the high, low, and closing price of the asset, support levels I & II, as well as resistance levels I & II. Generating profits off Pivot Points is a simple matter of identifying support and resistance areas. Perhaps you’re tracking the prices of popular ASX 200 components like Commonwealth Bank, BHP Billiton Ltd, or National Australia Bank? You may want to use pivot points to help you in your trading decisions.
If these securities are trading above their pivot point, they are deemed bullish. Shares trading below their pivot point are considered bearish. The S1, S2, R1, R2 levels help to set parameters for profit-taking or stop loss. Take-profit orders automatically sell the security when a resistance level is reached, and stop-loss orders sell the security once its price falls beneath a support level.
Of course, all of this must be viewed within a specific timeframe. Depending on the charts you are studying, you may see a 1-Day Chart reflecting multiple Pivot Point levels, or a 1-Hour chart reflecting limited pivot points. Our frame of reference is influenced by the types of charts we are looking at, and the timeframe can skew our judgement. As a technical analysis tool, pivot points are terrific indicators for observing price levels.
Why Pivot Points Are Indispensable in Life and in Trading Activity
‘A car’s pivot point is the fixed point around which the automobile rotates while it is turning.’
Many traders wonder which pivot points are the best to use. As with other indicators, there is no one size fits all approach to employ. Trading gurus recommend combining your chosen pivot point with other technical indicators like Relative Strength Index (RSI), candlestick charts, and Moving Average Convergence Divergence (MACD). Fortunately, you won't have to worry too much! Many popular trading programmes automatically include Pivot Points as part of the package.
Pivot Point indicators on software programmes automatically plot these levels on charts for you. As soon as these technical indicators are represented on a chart, support and resistance levels come into play. Remember: The horizontal price levels above a pivot point are resistance levels indicated by R1, R2, or R3 et cetera. The horizontal price levels below a pivot point are known as support levels, represented by S1, S2, or S3 et cetera.
Pivot levels will vary from one trading day to the next. Now that you understand a little more about pivot points, let's look at some ways that you can trade financial instruments like the AUD/USD currency pair by using Pivot Points to help you.
- Always short the asset when the price bounces from R1, or R2
- Always go long if the price bounces from S1, or S2
- Be bearish (sell) if the price falls below the main pivot point
- Be bullish (buy) if the price rises above the main pivot point
There will always be a whipsaw activity with financial instruments. Prices will rise, prices will fall, and prices will consolidate. This is normal. However, pivot points help you to determine exactly where important price levels are based on the previous day's high, low, and closing price. You will be able to see price reversals around pivot points, given that these are important barriers to breach.
If you decide to carry over a trade from one day to the next, be advised that your pivot points will have to be readjusted. Make sense?