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Pivot points: learn how they work and how to use them in trading
One of the most important technical analysis indicators when you want to do fast trading (such as day trading) is the pivot points. This gives you a lot of information, as it detects price zones that can be important for the day.
Below, we will give you all the information you need to understand pivot points and how to apply them, even today.
What are pivot points?
Pivot points are a technical analysis tool used by traders to identify possible key levels in the market, such as support and resistance. They are calculated by averaging the high, low and closing prices of the previous period, which can correspond to a day, a week or a month.
Pivot points are significant levels used in technical analysis to identify possible trend reversal points on a price chart of a financial asset, such as stocks, currencies, commodities or indices.
They are calculated from the opening, closing, high and low prices of a previous period and serve as a reference to determine support and resistance levels.
These points are considered important because many traders and investors believe they can influence the asset's price behavior. Pivot points help identify key areas where price can find support or resistance and possibly change direction.
The main types of pivot points are the Primary Pivot Point (MP) and the Support and Resistance levels. The Pivot Point is calculated as the arithmetic mean of the high, low and close of the previous period. From the Pivot Point are derived the Support levels (S1, S2, S3) and Resistance levels (R1, R2, R3), which traders use to define possible entry, exit and stop-loss points in their trades.
Example of pivot points
Suppose Bitcoin is trading below the previous day's pivot point (P), indicating a possible downtrend. You decide to sell short at its current price and you could set as a profit target the S1, S2 or S3 support levels, which will be more relevant if the market has previously bounced off them. Another strategy is to wait for the Dow to bounce off a support level, such as S1, and then buy on the reversal, setting P or R1 as a possible profit target.
How are pivot points calculated?
The standard pivot point indicator includes seven lines: three support levels (S1, S2, S3), three resistance levels (R1, R2, R3), and a central pivot point (CP), which acts as a reference for calculating the other levels. Below is the basic formula:
Standard pivot points:
- PP = (High + Low + Closure) / 3
- S1 = (PP * 2) - High
- S2 = PP - (High - Low)
- S3 = Low - 2 (High - PP)
- R1 = (PP * 2) - Low
- R2 = PP + (High - Low)
- R3 = High + 2 (PP - Low)
This approach is based on the high, low and closing prices of the previous period, which can be a day, week or month, providing key support and resistance levels for traders. However, there are other variations of the pivot point calculation that are also popular.
Woodie pivot points
Woodie' s version gives greater weight to the closing price in the calculation of the PP:
- PP = (High + Low + 2Close) / 4
- R2 = PP + (High - Low)
- R1 = (2 x PP) - Low
- S1 = (2 x PP) - High
- S2 = PP - (High - Low)
Camarilla Pivot Points
The Camarilla formula focuses on the average of prices, deriving support and resistance lines using multipliers:
- PP = (High + Low + Close) / 3.
- R1, R2, R3, R4 and S1, S2, S3, S4 are calculated by multiplying the price range with values such as 1.0833, 1.1666, 1.2500 and 1.5000.
Fibonacci pivot points
Based on the standard PP calculation, Fibonacci pivot points derive support and resistance levels using Fibonacci percentages:
- PP = (High + Low + Close) / 3
- Resistance (R1, R2, R3) and support (S1, S2, S3) levels are calculated by multiplying the range (High - Low) by 38.2%, 61.8% and 100%.
Each of these variations provides different perspectives to interpret market behavior, adjusting to the trading strategies and risk tolerance of each investor.
Pivot points are calculated in a similar way for different time periods, but the specific values change depending on the periodicity of the data used. The basic formula for calculating pivot points is the same regardless of the time period considered.
The above calculations can be adjusted for different time periods, such as daily, weekly, monthly, etc., using the opening, closing, high and low prices of the specific period in question.
For example, to calculate daily pivot points, the previous day's opening, closing, high and low would be used. For weekly pivot points, you would use the previous week's data, and so on.
The periodicity of the data will directly influence the calculated pivot point values, as they are based on historical prices for the period under consideration. Therefore, it is important to adjust your calculations according to the time period you wish to analyze in order to obtain pivot points relevant to your trading operations.
It should be noted that, although these are very good indicators, other trading indicators such as the moving average, MACD or even the Fibonacci retracement should be used.
How to use pivot points in trading
Traders use pivot points in a variety of ways in their trading strategies to identify buying, selling and risk managementopportunities. Here are some of the main ways pivot points are used:
Identifying support and resistance levels:
- Pivot pointsare used to identify significant support and resistance levels on the price chart. The main pivot point (MP) is usually considered a neutral level. Support (S1, S2, S3) and resistance (R1, R2, R3) levels around the PP are considered areas where price can reverse direction.
Trading decision making:
- Traders use pivot points to determine entry, exit and stop-loss points in their trades. For example, a trader may decide to buy when the price exceeds resistance (R1) and set a stop-loss just below the pivot point (PP).
Confirmation of trading signals:
- Pivot points are often used in conjunction with other technical analysis tools, such as momentum indicators or chart patterns, to confirm buy or sell signals. For example, if a buy signal is generated at a key support level, such as S1, the trader may consider this to be a stronger signal if it is confirmed by price action around the pivot point.
Specific strategies:
- Traders can develop specific strategies based on pivot points, such as trend reversal strategies (buy at support levels or sell at resistance levels), breakout strategies (buy when price breaks through resistance) and range bound strategies (buy at support levels and sell at resistance levels).
Risk management:
- Pivot points are also useful for risk management, as they allow traders to set stop-loss and take-profit levels based on identified support and resistance levels. This helps define acceptable losses and desired profit levels in a trade.
Tips for using pivot points
Here are some useful tips for using pivot points effectively in your analysis and trading strategies:
- Combine pivot points with other indicators.
- Adjust pivot points according to the time frame.
- Watch the market's reaction at support and resistance levels
- Use pivot points in conjunction with candlestick patterns
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