Trading the pivot points




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Trading the pivot pointsTrading the Pivot Points

There are major advantages when trading with support and resistance lines, and they should be a staple in every trader's arsenal. Another effective method of deriving multiple, horizontal based support and resistance lines uses a formula derived from yesterday's high, low and close bar. The formula maps out pivot point levels consisting of the pivot, and three levels of support and resistance, and these levels can be traded much the same way as trading from the regular support and resistance levels and trendlines, using a mix of breakout and bounce trading strategies.

The major advantage posited for this pivot point technique is that is "objective," in that so many traders are using the same levels based on the same formula. There is no discretion involved. In contrast, the method of drawing support and resistance levels and trendlines can be more subjective and impressionist (every trader can notice and draw different lines), even though there have been attempts by DeMark and others to make them more objective.

A second related advantage of using them is that because so many people are looking at these levels they become self-fulfilling. The reason pivot points are so popular is that they are predictive as opposed to lagging. You use the information of the previous day to calculate reversal points (or breakout levels) for the present trading day. Because so many traders (including the large institutional traders) follow pivot points, the market reacts at these levels, giving you an opportunity to trade them. Just like we have seen with price action support and resistance levels, traders can choose to trade the bounce or the break of these levels.

How are these levels calculated?

Here is the magic formula:

Resistance 3 = High + 2*(Pivot - Low)

Resistance 2 = Pivot + (R1 - S1)

Resistance 1 = 2 * Pivot - Low

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

Support 1 = 2 * Pivot - High

Support 2 = Pivot - (R1 - S1)

Support 3 = Low - 2*(High - Pivot)

I find it is interesting that from just having the previous days high, low, and close you can eventually finish up with 7 points: the actual pivot point, 3 resistance levels, and 3 support levels. The three most common levels are the PP, R1 and S1.

If you hate algebra and the thought of working every day with a calculator and drawing tool to derive and plot these levels, you need not fear. The above formula is the just an explanation of the theory and not something you have to calculate each and every day. There are many MT4 indicators that can do that for you, automatically calculating the levels and clearly drawing them for you on your chart. The indicator I prefer is:

PivotPointsDaily(shifted)

I recommend the above indicator for a number of reasons:

it draws clear and distinct lines with price levels on the chart.

it draws the historical levels of previous days, useful for deeper analysis

it allows you to switch on bigger picture levels, such as weekly and monthly levels

it allows you to adjust the time shift, making the levels correspond to the most popular timezone, whether it be EST or GMT.

So there you have it. An indicator you can plop on the chart and it sets all the levels clearly for you, and that even considers the possibility that you might want the levels to correspond to a particular timezone. Very nice.

There is a compliment indicator to the above that charts the intermediate levels or mid-point levels:

PivotPointsDaily(mid).

These are basically mini levels between the main pivot and support and resistance.

There are a number of ways to trade with these calculated pivot points, and we will discuss three of them:

Strategy #1: Trading the Bounce (Reversal) from Pivot

If you have a good idea of the general direction of the market, you can take bounce trades off the Pivot Point in the direction of where the market was relative to PP at open of day.

Many traders see the Pivot Point as the major arbiter for determining if the market is up or down. If the market starts its day above the Pivot Point, it is said to be up (bullish), and if it starts its day below, it is said to be down (bearish).