Pivot Point analysis

Pivot Point analysis originated many years ago in the grain pits.  Before the Pivots were developed, the only thing that pit traders could reference to trade off of was yesterday’s high, low and close. Pivot Point analysis was de- signed to give the trader a reference of where today’s prices were in relation to yesterday’s prices.  Since traders were not allowed to have electronic devices in the pits dur- ing trading hours, this was a big help. Of course, back then, even the smallest electronic device took a table to rest on. They were nothing like today’s microelectronic technology. The Pivot Point numbers were static and effective  for most of the trading day, if not all of it.

The numbers worked so well when they first came out.   Then, like many trading ideas in the markets, everybody started using them and they lost some of their strength. Also, people started using them think- ing that they were projecting the “exact” high or low of the day and the study was used improperly. This caused more opportunities for floor traders to fade these levels where the public bought or sold blindly on the projected numbers.

You see, back then there were only a handful of tech- nical studies to look at and there were lots of traders. Today, we literally have hundreds of studies to look at. For this reason, I believe that some of the more tradi- tional studies are starting to work well again.  With much more variety to trade from, the idea of too many people using one tool is not as likely.

Let’s look at the formula for calculating these levels

Pivot Calculation
Resistance 2 Daily Pivot +  Previous

Day’s Range

Resistance 1 (2 x Daily Pivot) – Prior

Days Low

Daily Pivot (Prior Day’s High + Prior Days Low + Prior Days Close) / 3
Support 1 (2 x Daily Pivot) – Prior

Day’s High

Support 2 Daily Pivot –  Previous

Days Range

By adding these extra levels to your trading arsenal, you will have 8 key levels to scrutinize for the next trading day. You can actually sort them in this manner so you can see the levels as price approaches them

Pivot Calculation
R 2 Resistance 2
High Previous Day’s High
R 1 Resistance 1
P Daily Pivot
C or O Previous Close or Today’s

Open

S1 Support 1
Low Previous Day’s Low
S2 Support 2

There are many variations on this model. Some peo- ple calculate the Pivot by adding in the day’s opening price. In this case, the formula looks like this:

Daily Pivot = (Prev. High + Prev. Low + Today’s
Open + Today’s Open) / 4

This variation puts more weight on the day’s opening price. If the market gaps up or down, your R1 level and S1 level can be skewed – meaning that R1 is actu- ally under the Pivot or that S1 is actually above the Pivot. By using the previous day’s high, low and close only, you can create a more static set of numbers that the markets will better respect and not be as distorted by gaps.

Another variation takes the Support and Resistance Levels out to 5 or 6 levels. After you exceed the R2 or S2 Level, you are basically multiplying the previous day’s range and adding or subtracting from the Daily Pivot. For example,

R3 = (Daily Pivot + Previous Day’s Range x 2) R4 = (Daily Pivot + Previous Day’s Range x 3)

This can go on forever. For Support, you subtract the multiples of the daily range from the Daily Pivot.

Now let’s look at some rules for using these numbers.

The Regular Trading Hours (RTH) is still the most liquid of the hours traded. This is the time when the open outcry pits (if available) are trading simul- taneously with the electronic platforms. You want to calculate your Daily Pivots using only the RTH ses- sion high, low and close. Why? Much like any Sup- port or Resistance level created, the more volume be- hind the high or low, the more significant. A Support or Resistance level created at night on maybe 30 or 40 contracts is not going to be as significant as one cre- ated during higher volume periods.

Do not get caught up in the title of the level. For example, just because a level says “S1” does not mean it cannot become Resistance at a later point. Just like traditional Support and Resistance Levels, the Pivot Levels can reverse roles. One of my favorite setups is old Resistance becoming new Support once it is violated. The same holds true with Pivot levels.

When using Daily Pivot Levels, look to the left of your chart for price Support and/or Resistance levels to confirm a Level that you are looking at.

You can also use indicators (Bollinger bands, Stochastics, RSI, Commodity Channel Index etc.) to time your entries around these levels.

These levels are calculated off of a daily chart so the larger time frame Support or Resistance Levels have more impact than intra-day price levels.

The Daily Pivot Level acts as a price magnet for the next day’s trading. A high percentage of the time, the market comes back to the Daily Pivot and touches it the next day. The Daily Pivot is actually a weighted average of the average price of where most people bought and sold at the previous day.

Watch the R2 and S2 Levels. The later in the day that these Levels are violated, the better the chances of a market move into the close in that direction.

Daily Pivots can also be used on weekly charts to provide perspective of where you are trading in reference to last week’s price range.

This chart of the E-Mini S&P shows a typical day of using the Daily Pivot Levels. Notice how the market opened and found good Support at the Daily Pivot. Then, the market rallied to the R1 level and met Resistance. Later in the day, the market broke the R1

Level and later that R1 Level became Support for the market to bounce off of.  A rally to R2 came late in the afternoon.

This is just one tool you can use to help with deter- mining Support and Resistance  levels in the markets you trade. As with all tools and strategies, always use stops and good money management. In my trading, I like to keep the daily and weekly Pivot Levels handy for the market I am trading.  Give these Daily Pivot Levels a try and see if they do not help give you that little extra edge in trading.

 

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