Pivot points are an indicator which can be used to gain a directional bias and highlight potential support and resistance levels (S/R) for the day ahead. As they project potential S/R levels, they can also be used for profit objectives and stop placement.
Originally calculated by hand and used by pit traders on the stock exchange floors, traders can now overlay them as an indicator on their charts. And, whilst they have remained a popular tool for intraday traders, they are equally suited to higher timeframes and used by traders of forex, commodity, equities and stock market indices.
Using OHLC data from the prior session, the ‘pivot point’ itself is a simply average of yesterday’s high, low and close price. Whilst there are other variations which include the open price from the current or prior session, the most common calculation is as follows:
Pivot Point = (Prior High + Prior Low + Prior Close) / 3
Support and resistance levels are also derived from the pivot point. Mostly commonly, S/R 1-3 are displayed above and below the pivot, although some indicators provide S/R 1-5 and even 0.5 levels, which sit halfway between traditional S/R levels.
Pivot point S/R levels can be calculated as follows:
- Resistance 3 (R3) = Prior High + (2 x (Pivot – Yesterday Low))
- Resistance 2 (R2) = Pivot + (R1 – S1)
- Resistance 1 (R1) = (2 x Pivot) – Yesterday Low
- Pivot (P) = (Prior High + Prior Low + Prior Close) / 3
- Support 1 (S1) = (2 x Pivot) – Prior High
- Support 2 (S2) = Pivot – (R1 – S1)
- Support 3 (S3) = Prior Low – (2 x (Prior High – Pivot)
Pivot Points Can Provide A Directional Bias
A directional bias can be attained by checking where today’s pivot point opens in relation to yesterday’s pivot point.
- Bullish bias: Today’s pivot point is higher than yesterday’s pivot point
- Bearish bias: Today’s pivot point is lower than yesterday’s Pivot pointy
With the directional bias in place, traders could seek bullish setups above the pivot point and use the R1, R2 or R3 levels as intraday targets. Conversely, they could seek bearish setups if the current pivot is beneath the prior day’s pivot point and target S1, S2 or S3 levels.
However, common sense should be used. Traders should also consider where the market opens in relation to the pivot point to help decide whether a tradable opportunity exists. Alternatively, the trader could switch their bias if prices reverse and cross the other side of the pivot point from which it opened.
Using the M30 gold chart, we provide a walkthrough of hypothetical decisions to make:
- Today’s pivot point was above yesterday’s, yet the market opened beneath the pivot point. The trader could have waited to see if the pivot point acted as resistance to consider short opportunities. Alternatively they could have waited to see if prices broke above the pivot point before considering a long position and targeting R1.
- Today’s pivot was above yesterday’s pivot to provide a bullish bias, but the market opened quite a lot higher than the pivot point. It was therefore too close to R1 for a tradable opportunity. However, the trader could have waited for a retracement towards the pivot point to see if it held as support before considering a long position. Ideally, they could wait until a bullish reversal pattern around the pivot point before considering a long trade.
- Today’s pivot was above yesterday’s, although the market opened right on the pivot point. So, the trader could have waited for bullish momentum to move higher from the pivot before considering a long position.
- Today’s pivot was above yesterday’s, but the market opened beneath it. As the market never broke above the pivot point, they decided not to trade long. Prices instead moved lower towards S1 and S2. Before considering short positions, they could have decided to wait to see if tomorrow’s pivot is lower and if the market opens beneath the pivot point.
Pivot Points in Action
It should be remembered that pivot points are not a trading system, but a tool to compliment analysis. In then makes sense that a trader should consider using pivot points alongside their usual forms of analysis to help identify trends and trend exhaustion.
Trend Analysis and Pivots
Some intraday traders use the daily trend to choose their bias for the intraday sessions. For example, if a trader identified a bullish trend on a currency pair, they could seek bullish setups near or above the daily pivot point. If these conditions are not met, the could decide not to trade that market and only focus on ones that meet do that criterea.
In the example above, EUR/JPY was in a very strong bullish trend on the daily chart. We have included the 10 and 20-day eMA on the M30 chart to show that prices were accelerating away from the eMA’s to denote a strong trend.
More often than not, we can see that when prices broke above the pivot point from below, it usually resulted in a move towards R1. Whilst this method alone is probably too simple for a strategy, it does demonstrate the power that a strong trend can have on lower timeframes, once combined with pivot points.
Using Pivot Points with Bollinger Bands
Using reversal candles around a Bollinger Band is a simple approach to swing trading. However, we could further refine this idea by only using reversal candles that occur near one of the pivot points.
In the example above, EUR/GBP tested the Bollinger Bands multiple times throughout the day on the M30 chart. Whilst five of those tests produced a reversal candle, few of them provided a decent R:R (reward to risk) to justify a trade. Yet had we used the pivot points as an additional filter, there were now only two occasions when a reversal candle closed back inside the bollinger band whilst also testing a pivot point or S1. Both occasions provided a better looking opportunity on this occasion.
Of course, it doesn’t always turn out this way. Yet as pivot points are widely used, they can help filter out trades located in between the pivot points, with the aim of selecting fewer but higher quality trades.
Using Weekly and Monthly Pivot Points
Whilst pivots are traditionally an intraday tool, they can also help identify probably zone of support or resistance from higher timeframes.
Here we have combined monthly and weekly pivot points onto a USD/CAD chart. Note how bullish momentum stalled around weekly R2 with a series of bearish candles, then sold off towards the monthly pivot and weekly R1 zone.
Using Pivot Points to Aid With Profit Targets and Stop Loss Placement
This is a recent example from one of our market reports which shows how weekly and monthly pivot points can be used to project targets.
EUR/NZD had warned of a change in trend with an RSI bullish divergence and break of its bearish trendline. After retracing and finding support at the weekly pivot point, a bullish outside candle started to form to warn that further bullish pressure was building.
Within that report, we suggested the resistance zones around Weekly R1 and R2 could be used as targets, and that a break below the pivot point could invalidate the bullish bias.
Pivot Points: Things To Be Aware Of
Like any indicator, pivot points also have their drawbacks and pitfalls to avoid. But as long as they are used with common sense and not blindly followed, they can make an excellent tool to use alongside other indicators and forms of analysis.
Beware of Abnormal Daily Ranges
If the prior session has been particularly volatile, then pivot points tend to be less reliable for the next day. This is because the volatility of the prior session has significantly increased the width of the pivot point S/R levels.
In this example, GBP/JPY was the largest moving FX pair the prior day and far exceeded its usually daily range. This caused the daily S1 and R1 levels to exceed the ranges of the prior sessions, making them less likely to achieve S1 or R1 targets that day.
Whilst it should be possible to tell if the prior trading range is far wider than usual, it can also help to know the daily ATR (average true range) of that market for comparison quantified comparison.
Following a wide-ranging day, the trader has three options:
- Ignore S2/R2, S3/R3
- Use a pivot point indicator with ‘half’ levels (S0.5/R0.5)
- Remove the pivot points and refer to other forms of analysis
Of course, the opposite problem comes from narrow ranged days, as the projected pivot levels are too close together to provide realistic S/R levels.
Under this scenario, a trader could:
- Include S4/R4, S5/R5
- Remove the pivot points and refer to other forms of analysis
Not All Brokers Use the Same Closing Time
Simply applying pivot points to a chart may not always provide the correct levels you desire. Firstly, some brokers have their servers set to London or European close, which means they have 6 candles per week on a chart. Not only is this annoying for candlestick chartists, but it can change the levels of pivot points, longer-term moving average and wreak havoc with EA’s (expert advisors) which depend on time-of-day trade execution.
FXTTRADING.com use New York close to calculate the end of a forex day. This not only means our traders enjoy 5 daily trading candles per week, but they do not need to remember to incorporate a GST-offset to their indicator when the clocks change in the US or UK.
Not All Data Providers Use The Same OHLC Data
There are websites available which provide pivot points for multiple markets. However, unless you are going to trade from the same platform their pivot points are derived from, there are likely to be discrepancies between the levels you read and what is useful to your chart.