How To Day Trade Using Pivot Points

April 2, 2013 01:08 AM

 

Professional day traders have been using pivot points to trade the markets since the days of the floor. Back then, complicated technical indicators were not as freely available, so traders would rely on watching the tape and a couple of calculated levels called pivots. And since pivot point levels are so widely watched, they often manage to predict turning points in the market with extraordinary accuracy.

Pivot points can be used by traders in different ways and are generally combined with support and resistance levels; R1, R2 and R3, and S1, S2 and S3. Each level is usually a simple formula based on the previous day’s trading levels and can be calculated using a simple equation.

 

Calculation

P = (H + L + C) / 3

The pivot point uses the previous day’s high, low and close and is the mark from which all support and resistance levels are based. If the market trades under the pivot, it is generally a bearish indicator, while if it trades above the pivot, the market is in bullish mode. The pivot itself often acts as a strong level of support or resistance.

R1 = P + (P − L)

The first level of resistance (R1) is calculated using the pivot and yesterday’s low. It forms the first level where the market might be nearing an overbought condition.

S1 = P − (H − P)

Likewise, the first level of support (S1) represents the first level whereby traders might want to become bullish on the market.

R2 = P + (H − L)

The second resistance level (R2) is higher than the first and determined from the full width of the previous day’s trading range.

S2 = P − (H − L)

The second support level (S2) is exactly like R2 but in reverse and offers an even stronger level of support than S1.

R3 = H + 2×(P − L)

R3 is calculated by doubling the range of the previous day and gives a level that offers even stronger resistance.

S3 = L − 2×(H − P)

S3 is calculated in the same way as R3. The further away the support and resistance levels get the less likely the market will hit those points.

 

Using pivot points

Pivot points are generally used by traders in different ways. Typically, resistance levels are used as points to sell into the market and support levels places to buy.

However, the levels are also used by traders to indicate good levels to place stops or to take profits. Similarly, pivot levels can be used as entry points for trend traders just as well as for range traders. If the price smashes through a pivot point with a lot of strength, a trend trader may just as happily buy the market on the first resistance as a range trader might sell.

As well as this, pivot points can be combined with other indicators such as moving averages or calculated using more complex formulas to give supposedly better entry points.

 

Examples

 

EURUSD

As can be seen by the below example, pivot points often produce uncanny levels in which to enter the market. Yesterday’s pivot on EURUSD (1.2805) would have been an excellent place to buy and would have made nearly 20 pips on what was a quiet day of trading.

On Thursday, the market bounced strongly off the first resistance level and would have given a trader who was short at this level a quick and easy 20 pips.

Wednesday also shows the uncanny ability of pivot points to find the key levels in the market. EURUSD smashed through the pivot in the morning, through the first support and second support and then consolidated around the third support. A trader who had sold EURUSD as it smashed through the pivot could have used S1 and S2 to bring down his stop levels and used S3 as a great take profit level.

EURUSD. 1 hour chart with pivots. Charts supplied by IG Index

USDJPY

The pivot acted as a strong level yesterday for USDJPY with the market fluctuating around the mark for most of the day. The market did not quite hit the first support level in what was a quiet days trading due to the Easter holiday.

On Thursday, however, the market bounced strongly off the first support level (93.92). In fact, the pivot (94.42) and first support offered an excellent guide to the day’s range.

A similar story unfolded on Wednesday. USDJPY moved up towards R1 in the morning before trading through the pivot and then bouncing back off the first support level. The market then began to return back to the pivot point.

 

USDJPY. 1 hour chart with pivots. Charts supplied by IG Index.

As can be seen by the chart, there were great opportunities in EURGBP this week for trading the pivot levels.

On Wednesday, the market smashed through the pivot early on and then proceeded to the first support level and later the second support level. A trader could easily have sold EURGBP on the pivot, (placing his stop a few ticks above the pivot), then used S1 and S2 as levels to take profit. Either option would have given the trader a good day’s profit.

Thursday also showed the power of pivots, with the market bouncing off the first support level (84.26) aggressively, and hitting the pivot in a short amount of time.  The market then took off until it hit the first resistance level. It then reversed and proceeded to return back towards S1. As can be seen, pivot points can work especially well in volatile conditions.

 

EURGBP. 1 hour chart with pivots. Charts supplied by IG Index

 

Since pivot points use data from the previous day’s trading, they are continuously adapting to the characteristics and volatility of the market. This means that the key pivots and support and resistance levels are never too far away from the market. Traders therefore will nearly always have an opportunity to make a profit.

Whether used as entry points, price targets or stop loss levels, the sheer importance of pivot points lies in their ability to adapt to market conditions. The fact that they are watched by so many professional traders means that pivot points should be the first tool in any trader’s toolbox.


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