A pivot point is an indicator of technical analysis that is often used to determine the overall market trends within different time frames. In other words, a pivot point is an average of high, low and closing prices of the previous trading day. Hence, on the next day trading below the pivot point imply bearish trend or sentiment and likewise, trading above the pivot point shows a bullish sentiment.
Traders use pivot points to predict support and resistance levels in the current or upcoming trading sessions. These support and resistance levels thereby help traders to determine entry and exit points for stop-loss and profits.
Pivot point analysis is often used in synchrony with calculating support and resistance levels. In a pivot point analysis, the first support and resistance levels are computed by using the width of the trading range between the pivot point and either the high or low prices of the prior day. The second support and resistance levels are evaluated by using the full width between the high and low prices of the previous day.
Each resistance level is considered a pivot point. To expand the range, traders use additional pivot points to include up to four additional support and resistance pivot points. Traders usually put stop orders at or near pivot points.
Pivot points are often used as intra-day indicators for trading futures, commodities, commodities, and stocks. These points are known to be uniform and remain at the same prices throughout the day.
Pivot points can be calculated through various methods but the most commonly used is the five-point system. This system considers the previous day’s high, low and close, also two support levels called S1 and S2 and two resistance levels called R1 and R2 (totaling five price points), to generate a pivot point. The equations are as follows:
Pivot Point (P) = (Previous High + Previous Low + Previous Close)/3
Support 1 (S1) = (Pivot Point x 2) – Previous High
Support 2 (S2) = Pivot Point – (Previous High – Previous Low)
Resistance 1 (R1) = (Pivot Point x 2) – Previous Low
Resistance 2 (R2) = Pivot Point + (Previous High – Previous Low)
For a stock, which trades only during specific hours of the day, use the high, low and close from the day’s standard trading hours.
If the underlying security is trading higher than the pivot point then the pivot point is considered to be supportive, or a support level. On the other hand, a pivot point at a higher price than the underlying security is considered a price resistance level. When a pivot point is originally tested, prices pause or divert. This is because of the extensively followed nature of pivot points from retail traders to professional institutions.