Pivot Points

1. Overview

Pivot points are a widely used technical indicator in financial markets to predict potential price turning points. Traders use pivot points as a reference to identify support and resistance levels and determine possible reversals or breakouts at these price zones. They are particularly popular in daily trading for forecasting the next day's market direction.

Pivot points are calculated from past price data—mainly the previous day's open, high, low, and close—and used to derive the key support and resistance lines.

2. How to Calculate Pivot Points

Pivot points are calculated using the following values:

Pivot Point (PP) = (Previous High + Previous Low + Previous Close) / 3

This is the basic pivot point (PP). Support and resistance levels are then calculated as follows:

• First Resistance (R1) = (2 × PP) - Previous Low
• First Support (S1) = (2 × PP) - Previous High
• Second Resistance (R2) = PP + (Previous High - Previous Low)
• Second Support (S2) = PP - (Previous High - Previous Low)
• Third Resistance (R3) = Previous High + 2 × (PP - Previous Low)
• Third Support (S3) = Previous Low - 2 × (Previous High - PP)

These calculations provide important price zones (support and resistance) for the following trading day.

3. How to Use Pivot Points

• Setting Entry Points
  If the price moves above the pivot point (PP), it can be interpreted as a buy signal; if it moves below, it can be seen as a sell signal.
• Checking Support and Resistance
  Based on the calculations, you can forecast support (S1, S2, S3) and resistance (R1, R2, R3) levels. When prices reach these levels, they may reverse, making them good points to set exits.
• Assessing Market Momentum
  A strong move above or below the pivot point may indicate strong momentum, which can be used to implement a trend-following strategy.

4. Advantages and Disadvantages of Pivot Points

Advantages

• Simple and Intuitive: Easy to calculate and visually intuitive, making them user-friendly for traders.
• Useful Support and Resistance Levels: Quickly calculate key daily support and resistance levels to help predict reversal points.
• Gauge Market Momentum: Helps determine whether the market is bullish or bearish.

Disadvantages

• Based on Historical Data: As they rely on past data, they may be less accurate during sudden market moves or news events.
• False Signals in Strong Trends: More effective in range-bound markets; strong trends may often break through support or resistance, producing false signals.

5. Practical Examples

• In a Strong Uptrend
  If the price breaks above PP and R1, it often signals the continuation of the trend. In this case, holding a buy position and aiming for R2 can maximize profits.
• In a Downtrend
  If the price drops below PP and S1, it often signals the continuation of a bearish trend. In this case, holding a sell position and aiming for S2 can be profitable.

6. Summary

Pivot points are a powerful tool for predicting price reversals. They offer a simple yet effective way to calculate support and resistance, clarify entry and exit points, and are especially useful in range-bound markets. In strong trends, following the direction of the move is equally important. Combining pivot points with other technical indicators can improve trading accuracy.

7. Frequently Asked Questions

Q1. What are pivot points?

A1. They are technical indicators calculated from the previous day's high, low, and close to forecast the day's support and resistance levels, particularly useful for identifying turning points in day trading.

Q2. In what type of markets are pivot points most effective?

A2. They are most effective in range-bound markets where prices tend to reverse at support or resistance lines. In strong trending markets, these levels are often broken.

Q3. Is it safe to trade using pivot points alone?

A3. Since they are based on historical data, using them alone carries risks. Combining them with other technical indicators like RSI or moving averages offers more accurate analysis.