Trading with Pivot Points

Traders have always looked for a way to find out what a security they were interested in would trade during the day. Although pivot points cannot predict what will happen to a security for sure, they can spotlight important trading levels you will need to keep in mind. If you have never heard of pivot points or have no idea how to use them, allow me to explain what they are and show you how simple they are to calculate.

What Are Pivot Points?

Pivot points can give a trader an idea of where the market might be heading on any trading day. A pivot point is nothing more than a level or point at which the market direction changes. You have probably heard of support and resistance levels. Well, pivot points, once calculated, can give a trader some important support and resistance levels to work from.
Think of pivot points as markers on a map or a chart. It makes little difference what security you are looking at, pivot points only need a few basic pieces of data to calculate.

Pivot Point Calculations

One of the best things about pivot points is the ease of their calculations. Once they are calculated, you will get, at the very least, 2 resistance points and 2 support levels. To calculate pivot points yourself, you will need end-of-day data for the close, the high and the low of the security you want to trade. You will have to recalculate this data at the end of every trading day.
The Formula
Pivot Point = (Day’s High + Day’s Close + Day’s Low)/3
Once you have calculated this number, you will use it to figure out your support and resistance levels. Let’s start with your initial support and resistance levels.
Support 1 = 2*Pivot Point - High
Resistance 1 = 2*Pivot Point - Low
You can then use these calculations to figure out a second support and resistance level.
Support 2 = Pivot Point - (Resistance 1 - Support 1)
Resistance 2 = Pivot Point + (Resistance 1 - Support 1)
If you are not interested in calculating pivot points by hand, you can use one of many online pivot point calculators. You can even create a spreadsheet that can calculate these levels as well.

A Brief Review of Support and Resistance Levels

Wall Street has a language all its own, which, most of the time, is not easily understood by most investors. When it comes to the terms “support” and “resistance” or “floors” and “ceilings”, the meanings are pretty straightforward.
When a security is being sold (and sometimes heavily sold), it is because a lot of sellers are piling on, forcing the price down. There is usually a point at which the selling pressure seems to slow down, and the security does not continue to go down any further. This is called "support" or a "floor". The term simply means that, at this level, buyers are willing to come in and start buying the security.
These levels are viewed as important during trading. If selling breaks through this support level, it can mean the selling pressure will increase.
On the flip side, you also have resistance levels. This is when there is buying that forces the security to move upward. Just as there are influences on the market from selling pressure, so, too, buying pressure makes itself felt as well.
A resistance level is the ceiling, so to speak. This is a level at which buyers cannot move the security any higher, and sellers are coming in. Thus, a break of the resistance level can often lead to an increase in the number of buyers entering new orders, driving the price upward.
Many traders watch these support and resistance levels to get an idea of where the security might run into buying support or selling pressure.

A Pivot Point Trading Strategy

One of the easiest trading strategies is simply to see what the day might look like right at the open. If the market opens above your calculated pivot point, you will want to buy. You will remain a buyer as long as the market stays above the pivot point. On the flip side, if the market opens below the pivot point, you will want to sell. This is the most basic use of pivot point trading.
The formula given previously in this article has four more levels -- 2 resistance and 2 support. Here’s how you can use those. If the market trades above the first resistance level, you can add to your position. If the market continues to move upward and trades above the second resistance level, you should use this as an exit point or to take some profits or trim back your position.
Once the market crosses the second resistance level, you can view the market as overbought, and caution is needed. On the other hand, if the market crosses the first support level, you can add to your selling position. Keep in mind that, if the market crosses the second support level, you will want to close your position or trim it back, locking in any profits. The market, once the second support level is crossed, will be considered oversold.
You can ignore the pivot point altogether and only initiate trades at the break-outs. Another strategy is simply to trade the break above the first resistance level or the break below the first support level. You would initiate a position after a break of either first level. Then, you can use the second level as your selling point, or at the very least, as the level where you will want to begin to take profits.
You don’t have to use pivot points at all for trading. Many traders use them simply to get an idea of where the stock they are watching is trading. For example, day to day, you can see how the resistance and support levels change most noticeably on fast-trading stocks. Keep in mind that small price changes will result in narrower support and resistance levels.
Professionals, as well as novice traders, use pivot points. Once you start keeping track of them and / or using them to trade, you will begin to see that these levels move markets. This is simply because many traders are viewing these same levels and using them to make trading decisions.
Pivot points are a tool you can use to learn and a great way to follow a stock or security. Their calculations are easy and can be applied right away. So, why not give them a try?