Pivot point is a redictive indicator of market movement.
It is Simply an Average
A pivot point is calculated as an average of significant prices, namely the High, Low, and Close from the performance of a market in the previous trading period. If the market in the following period trades above the pivot point it is usually evaluated as a bullish feeling. On the other hand, trading below the pivot point is viewed as bearish. It is a price level of significance in analysis of a financial market, and traders use it as a predictive indicator of market movement.
In a market, a pivot point, along with its associated support and resistance levels, are often turning points for the direction of price movement. If the market is trending up, the pivot point and the resistance levels may represent a ceiling level in price above which the uptrend is no longer sustainable. A reversal may also occur when this happens. A pivot point and the support levels may represent a low price level of stability or a resistance to further decline in a declining market.
The custom is to calculate additional levels of support and resistance, below and above the pivot point, respectively, by subtracting or adding price differentials calculated from previous trading ranges of the market.
How to Compute For the Pivot Point
There are many methods 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 or the current period’s opening price (O):
P = (O + H + L + C) / 4.
In other situations, traders like to highlight the closing price, P = (H + L + C + C) / 4, or the present period’s opening price, P = (H + L + O + O) / 4.
Price Support and Resistance Levels: Key Trading Tools
In any market, price support and resistance levels are key trading tools. Depending on whether the price level is approached in an up-trending or a down-trending market, their roles may be interchangeable. It is 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.
By recognizing the upper and the lower halves of the prior trading range, the first and the most significant level of support (S1) and resistance (R1) is obtained. It is 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) = 2P – L
• S1 = P − (H − P) = 2P − H
This level may be calculated by subtracting the previous low (L) and high (H) price, respectively, from twice the pivot point value.
The second set of resistance (R2) and support (S2) levels are above and below the first set. It is 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)
A third set is calculated again, as common practice. This represents another higher resistance level (R3) and a yet lower support level (S3). Here, 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)
Furthermore, this concept is sometimes extended to a fourth set. The tripled value of the trading range is used in the calculation.
For quality, the second and higher support and resistance levels are always located symmetrically around the pivot point. Unless the pivot point happens to divide the prior trading range exactly in half, this is not the case for the first levels.
The Pivot Point can be Used as a Trading Tool
Depending on the overall market condition, the pivot point itself represents a level of highest resistance or support. If the market is direction-less, meaning it is undecided, prices will often fluctuate greatly around this level. The fluctuation will not stop until a price breakout develops. The pivot point is a leading indicator that provides advanced signaling of potentially new market highs or lows within a given time frame.
We can use the support and resistance levels calculated from the pivot point and the previous market as exit points of trades. It is however rarely used as entry signals. As an example, if the market is trending upwards and breaks through the pivot point, the first resistance level is usually a good target to close a position. This is because the chance of resistance and reversal increases by much.