Pivot Point Trading – Introduction
Many professional daytraders utilize pivot point trading in their trade plans.
We like to use them each morning to identify who was in control during the overnight session.
During the US session, we like to use them as potential price targets and levels of support/resistance to qualify trades from.
We’ll cover the nitty-gritty of pivot point trading soon, but first, let’s get you caught up with the basics!
Pivot Point Trading -The Basics
A little fun fact about pivot points is that they originated from floor traders in the equities and commodities pits.
These traders would use them to assist their trading throughout the session. By framing the day based on the range of the previous day, these traders would have a framework to analyze the market.
As pivot points estimate future support or resistance levels, they are considered to be leading indicators.
Also known as floor trader pivots, these are key technical levels that are calculated using an instruments previous high, low and closing price.
Daily pivot levels use the parameters of the previous days trading range in their calculation. While weekly pivots will consider the previous week’s trading range. And monthly pivots will base the calculation on the previous month’s range.
Standard pivot points consist of 5 pivots: two support levels, two resistance levels, and a daily pivot level.
The main pivot point (PP) sits in-between the support and resistance levels and acts as a sentiment indicator for the session.
Most trading platforms will automatically plot these levels on your charts. However, if you want to know how to calculate them manually, here are the formulas:
Pivot Point (PP) = Previous Day (High+Low+Close)/3
Support 1 (S1) = (PP X 2) – High
Support 2 (S2) = PP – (High – Low)
Resistance 1 (R1) = (PPx2) – Low
Resistance 2 (R2) = PP + (High – Low)
Since pivot points are drawn from the previous day’s data, they are put forth in the current period and remain static throughout the session.
Now that you’re all caught up with the basics, let’s dive into how to effectively use pivot points in your trading.
Interpreting Pivot Points – Sentiment Indicator
One of the primary uses of pivot points in our trading is to determine market sentiment for the current session.
When we log into our trade stations in the morning, we will often check to see where the market is trading in relation to these levels.
We place the most emphasis on the daily pivot point since it is the primary support/resistance and sets the general tone for price action.
When a market is trading above the daily pivot, we consider sentiment to be bullish for the session. Alternatively, if the market is trading below the daily pivot we favor bearish sentiment on the session.
Further to this point, if we see a breakout above the daily pivot this suggests strength with a target to the first resistance (R1). If price reaches R1 and breaks above it, this shows even more strength and the second resistance (R2) now becomes the target. Alternatively, a breakdown below the daily pivot will signal weakness with a target to the first support (S1). If the market trades below S1, this shows even more weakness and the second support (S2) now becomes the target for sellers.
The above example is taken from the December 06, 2018 session.
Crude Oil was trading below the daily pivot and between the S1 and S2 pivots into the US open.
This shows overnight weakness and confirms that the sellers are in control of the market at the moment. Knowing this, we will favor short trades for this session until the market proves otherwise.
As you can see with this example, pivot points provide a quick way to gauge market sentiment. This simple trick will prepare you for the current session and help keep you on the right side of the market.
Pivot Point Trading – Support and Resistance Levels
Now that you know how to determine market sentiment using pivot points, let’s look into how we use them to qualify trades.
In our trading plan, we use pivot points just like traditional support and resistance. The key for us is watching how price behaves as these levels come into play.
If a market successfully takes out a support or resistance level, there is a higher probability that it will want to test the next level.
Alternatively, when a pivot level is successfully breached, it should reverse its role and become support if it was previously resistance and vice versa. The target in this scenario is the next pivot level.
Rule of Thumb
One thing to note is that the market tends to spend most days trading within the range of resistance 1 (R1) and support 1 (S1).
When a market trades through these initial pivots, the secondary pivots (R2 & S2) then become the next objective for buyers/sellers. While this is an indication of strength or weakness in the market, these secondary pivots can also signal potential overbought or oversold conditions. To this point, many intraday reversals form around the secondary pivots so they often provide great tradeable setups.
We will never set a blind limit at a pivot point because the market can blast right through it. We need to see certain confluence at the level in order to take a trade.
Does the pivot point line up with another key intraday level such as the Globex high or low? Does the context of price action make sense for the trade? Do we see price action patterns forming at the level to confirm it?
These are some of the things we consider before qualifying a trade using pivot point trading.
Let’s take a quick look at the 5-minute chart of crude below:
The blue lines above indicate the start and end of the GLOBEX session each day. After 6 pm EST, the daily pivots will calculate for the new session and we can start to scout for opportunities.
As you can see, the market likes to trade around these levels on an intraday basis. What you will notice, is that the market tests these pivots several times throughout the day as support and resistance. Not every test of a pivot will lead to a good trading opportunity, however, when qualified correctly there will be plenty of low-risk setups to take.
Case Study – Session #1 (Left Session)
If you focus your attention on the first session on the left-hand side, the market opened under the daily pivot. This indicates the shorts are in control of the market to start the session. In this scenario, the daily pivot (red) should act as resistance and the S1 pivot should act as support. The market rallies higher to test pivot during the London session and we see it stall at this level. A bearish price pattern forms and the market sells off below the initial support pivot (S1). After breaking this pivot (S1), the next target is the secondary pivot (S2).
The market eventually trades down below this level (S2) and then stages a rally back above it. Once we see this breakout above S2, we have two options:
(1) Look for a counter-trend long on a role reversal of S2 from previous resistance to support. If the market comes back down into this level we can look to qualify a long trade and target the S1 pivot for our exit.
(2) Alternatively, since the market is below the main pivot and above S2, we can wait to see how price behaves if it comes back in S1. This pivot held as support earlier in the session and was then breached to the downside. If the market trades back into this level, it should flip roles and act as resistance this time around.
In this scenario, both options would have led to valid trading opportunities. The market held S2 as support and moved into S1 which held as resistance. After this price action took place, the market spent the remainder of the session ranging between S1 and S2.
Case Study – Session #2 (Middle Session)
The previous session closes below S2 and the new session opens right at the daily pivot. There is an initial test of the pivot early in the Asian session and the market sells off. The Asian session is full of head fakes so we prefer not to trade during this time.
We see another test of the pivot into the London session which stalls the market again. This time around there is more volatility so we can look to qualify a short trade here. The pivot holds as resistance and the market pulls back again. We don’t quite reach the S1 and the market trades back into the pivot point again. At this point, each test of the pivot has led to a sell-off, however, each pullback is making a higher low indicating buying interest.
During the New York session, the market finally trades back above the pivot. At this point, you can look to qualify a long trade on a retest of the pivot as support. The context of price action supports this idea because there were three previous failed attempts to breach the upside of the daily pivot. The target for this setup is the next pivot level at R1, which is hit shortly after the retest.
After breaking above the R1 resistance, the market uses this level as support for several bounces until it finally breaks back below it. These bounces offer great short-term opportunities and the breakdown of this level, offers a counter-trend opportunity to target the main pivot.
Case Study – Session #3 (Right Session)
In the final session on the chart above, the market opens above the pivot level. We can see this pivot hold as support for several bounces during Asia/London sessions. None of these bounces show any follow through so we can disqualify longs at this level. After London open, the market sells off below the pivot level and we see an expansion of volatility. At this point, we can look for a retest of the main pivot to hold as resistance for a short opportunity. If the market reaches back into the pivot and stalls, we can look to qualify a short trade. Alternatively, if the market trades back up into the pivot, consolidates, and then breaches it back to the upside. We can look to qualify a long trade on a retest of the pivot as support and target the R1 pivot level above.
The Bottom Line
In this article, we demonstrated how pivot point trading can be a very advantageous technical tool for traders.
Pivot points allow you to gauge market sentiment for a session with a forecast of potential supports and resistances.
This, in turn, helps you get prepared to react to the market’s movement and capitalize on low-risk opportunities.
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The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.