|
Pivot Points
A pivot point is a price level of significance in technical analysis of a
financial market that is used by traders as a predictive indicator of market
movement. A pivot point is calculated as an average of significant prices (high,
low, close) from the performance of a market in the prior trading period. If
the market in the following period trades above the pivot point it is usually
evaluated as a bullish sentiment, whereas trading below the pivot point is seen
as bearish.
A pivot point and the associated support and resistance levels are often
turning points for the direction of price movement in a market. In an up-trending
market, the pivot point and the resistance levels may represent a ceiling level
in price above which the uptrend is no longer sustainable and a reversal may
occur. In a declining market, a pivot point and the support levels may represent
a low price level of stability or a resistance to further decline.
Calculation
Several methods exist for calculating the pivot point (P) of a market. Most
commonly, it is the arithmetic average of the high (H), low (L), and closing
(C) prices of the market in the prior trading period:
P = (H + L + C) / 3.
Sometimes, the average also includes the previous period's or the current
period's opening price (O):
P = (O + H + L + C) / 4.
In other cases, traders like to emphasize the closing price, P = (H + L +
C + C) / 4, or the current periods opening price, P = (H + L + O + O) / 4.
Support and resistance levels
Price support and resistance levels are key trading tools in any market.
Their roles may be interchangeable, depending on whether the price level is
approached in an up-trending or a down-trending market. These price levels may
be derived from many market assumptions and conventions. In pivot point analysis,
several levels, usually three, are commonly recognized below and above the pivot
point. These are calculated from the range of price movement in the previous
trading period, added to the pivot point for resistances and subtracted from
it for support levels.
The first and most significant level of support (S1) and resistance (R1)
is obtained by recognition of the upper and the lower halves of the prior trading
range, defined by the trading above the pivot point (H − P), and below
it (P − L). The first resistance on the up-side of the market is given
by the lower width of prior trading added to the pivot point price and the first
support on the down-side is the width of the upper part of the prior trading
range below the pivot point.
R1 = P + (P − L) = 2×P − L
S1 = P − (H − P) = 2×P − H
Thus, these levels may simply be calculated by subtracting the previous low
(L) and high (H) price, respectively, from twice the pivot point value:[1]
The second set of resistance (R2) and support (S2) levels are above and below,
respectively, the first set. They are simply determined from the full width
of the prior trading range (H − L), added to and subtracted from the pivot
point, respectively:
R2 = P + (H − L)
S2 = P − (H − L)
Commonly a third set is also calculated, again representing another higher
resistance level (R3) and a yet lower support level (S3). The method of the
second set is continued by doubling the range added and subtracted from the
pivot point:
R3 = P + 2×(H − L)
S3 = P − 2×(H − L)
This concept is sometimes, albeit rarely, extended to a fourth set in which
the tripled value of the trading range is used in the calculation.
Qualitatively, the second and higher support and resistance levels are always
located symmetrically around the pivot point, whereas this is not the case for
the first levels, unless the pivot point happens to divide the prior trading
range exactly in half.
An example
of pivot points on a PowerScan chart. In this 5-minute interval chart, the price
bounces off of the first support level (left side of the chart), Later, the
price stalls at the first resistance level at R1 (middle-right) and falls
back, then it powers ahead and breaks through R1, which can indicate strong
momentum upwards.
Trading tool
The pivot point itself represents a level of highest resistance or support,
depending on the overall market condition. If the market is directionless (undecided),
prices will often fluctuate greatly around this level until a price breakout
develops. Trading above or below the pivot point indicates the overall market
sentiment. It is a leading indicator providing advanced signaling of potentially
new market highs or lows within a given time frame.
The support and resistance levels calculated from the pivot point and the
previous market width may be used as exit points of trades, but are rarely used
as entry signals. For example, if the market is up-trending and breaks through
the pivot point, the first resistance level is often a good target to close
a position, as the probability of resistance and reversal increases greatly.
|
