Using Pivot Points for Predictions

Reviewed by Charles PottersFact checked by Jiwon MaReviewed by Charles PottersFact checked by Jiwon Ma

Pivot points are used by traders in equity and commodity exchanges. They’re calculated based on the high, low, and closing prices of previous trading sessions, and they’re used to predict support and resistance levels in the current or upcoming session. These support and resistance levels can be used by traders to determine entry and exit points, both for stop-losses and profit-taking.

Key Takeaways

• A pivot point is a technical analysis indicator, or calculation, used to determine the overall trend of the market over different time frames.
• The pivot point itself is simply the average of the high, low, and closing prices from the previous trading day.
• On the subsequent day, trading above the pivot point is thought to indicate ongoing bullish sentiment, while trading below the pivot point indicates bearish sentiment.

How to Calculate Pivot Points

There are several different methods for calculating pivot points, the most common of which is the five-point system. This system uses the previous day’s high, low, and close, along with two support levels and two resistance levels (totaling five price points), to derive a pivot point. The equations are as follows:

Pivot Point=3(Previous High+Previous Low+Previous Close)​

Support 1 (S1)=(Pivot Point∗2)−Previous High

Support 2 (S2)=Pivot Point−(Previous High−Previous Low)

Resistance 1 (R1)=(Pivot Point∗2)−Previous Low

Resistance 2 (R2)=Pivot Point+(Previous High−Previous Low)

For stocks that trade only during specific hours of the day, use the high, low, and close from the day’s standard trading hours.

In 24-hour markets, such as the forex market in which currency is traded, pivot points are often calculated using New York closing time (4 p.m. EST) on a 24-hour cycle. Since the GMT is also often used in forex trading, some traders opt to use 23:59 GMT for the close of a trading session and 00:00 GMT for the opening of the new session.

While it’s typical to apply pivot points to the chart using data from the previous day to provide support and resistance levels for the next day, it’s also possible to use last week’s data and make pivot points for next week. This would serve swing traders and, to a lesser extent, day traders.

Alternative Methods

Another common variation of the five-point system is the inclusion of the opening price in the formula:

Pivot Point=4(Today’s opening+Yesterday’s High+Yesterday’s Low+Yesterday’s Close)​

Here, the opening price is added to the equation. The supports and resistances can then be calculated in the same manner as the five-point system, except with the use of the modified pivot point.

Yet another pivot-point system was developed by Tom DeMark, founder and CEO of DeMARK Analytics.

This system uses the following rules:

As you can see, there are many different pivot-point systems available. 

While knowing how to calculate pivot points is important for understanding what you’re using, most charting platforms calculate pivot points for us. Simply add the pivot-point indicators to your chart and choose the settings you prefer.

Interpreting and Using Pivot Points

The pivot point itself is the primary support and resistance when calculating it. This means that the largest price movement is expected to occur at this price. The other support and resistance levels are less influential, but they may still generate significant price movements.

Pivot points can be used in two ways. The first way is to determine the overall market trend. If the pivot point price is broken in an upward movement, then the market is bullish. If the price drops through the pivot point, then it is bearish.

The second method is to use pivot point price levels to enter and exit the markets. For example, a trader might put in a limit order to buy 100 shares if the price breaks a resistance level. Alternatively, a trader might set a stop loss at or near a support level.

While at times it appears that the levels are very good at predicting price movement, there are also times when the levels appear to have no impact at all. Like any technical tool, profits won’t likely come from relying on one indicator exclusively. 

The success of a pivot point system lies squarely on the shoulders of the trader and depends on their ability to effectively use it in conjunction with other forms of technical analysis. These other technical indicators can be anything from a MACD to candlestick patterns, or using a moving average to help establish the trend direction. The greater the number of positive indications for a trade, the greater the chances for success.

How Accurate Is Pivot Point Trading?

Pivot points generally have high accuracy. No trading indicator is perfect, so pivot point trading is not going to always be accurate; however, it has been shown to be successful in helping traders determine entry and exit points.

What Are the Disadvantages of Pivot Points?

The primary disadvantage of a pivot point in trading is that it is not always guaranteed to be successful, meaning that the price of the asset being watched may never reach the levels indicated on the trader’s chart.

What Are the Pivot Point Time Frames?

Common time frames for pivot points are one minute, two minutes, five minutes, and 15 minutes.

The Bottom Line

Pivot points are a great way to identify areas of support and resistance, but they work best when combined with other kinds of technical analysis. They are based on a simple calculation, and while they work for some traders—like traders of binary options—other traders may not find them useful.

There is no assurance the price will stop at, reverse at, or even reach the levels created on the chart. Other times, the price will move back and forth through a level. As with all indicators, it should only be used as part of a complete trading plan.

Read the original article on Investopedia.