There a few trading tools that help traders spot areas of value in the market, and pivot points are one of them.
This tool has been used by traders for many decades, even from the early days of technical analysis. It helps to identify potential support and resistance zones in the market, which give traders a rough guide to where they can find huge demand or supply.
Thus, pivot points are useful for identifying price levels that could possibly act as reversal levels and could serve as potential reference points for placing stop loss orders and profit targets.
The reason pivot points are often respected by the price is that the price usually moves relative to a previous limit, and if there are no significant external forces pushing the price beyond that limit, it is very likely to stop around that prior limit.
Hence, a pivot point strategy can be a powerful trading tool in the hands of an experienced trader, which is why we created this post to show you:
What are pivot points?
One of the most widely used technical indicators in day trading, pivot points are a system of seven lines at different price levels that act as support and resistance levels.
The tool consists of the pivot point itself and six other price levels, with three levels above the pivot point and the other three levels below it — all of which are plotted on the price chart. Thus, the indicator is an overlay.
The three levels above the pivot point are known as resistance 1, resistance 2, and resistance 3 or simply written in the short form as R1, R2, and R3 respectively. Those three levels below the pivot point are referred to as support 1, support 2, and support 3 or S1, S2, and S3 for short.
For most trading platforms, the indicator is created from the price data of the daily timeframe, and the levels are very useful to intraday traders as they search for potential price reversal levels on the lower timeframes.
However, many charting softwares make it possible to set the indicator to create the weekly and the monthly versions of the pivot points and their corresponding resistance and support levels.
Those weekly and monthly levels can be very useful to swing traders in finding price swing points but can also be helpful to intraday traders.Easily derived from the high, low, and closing prices of the previous trading session, the indicator was widely used by traders in equity and commodity markets, long before computers became readily available, to predict potential support and resistance levels in the current and upcoming trading sessions.
With the advent of the internet and digital devices for online forex trading, the indicator has become very popular among forex traders, especially the intraday traders.
The GBPUSD charts below show how the indicator appears on a price chart. It shows the pivot levels for 27th and 28thMay 2020.
You can see the pivot point itself labeled as P and the resistance and support levels labeled accordingly —they are even more visible in the second chart where different colors are used for the various S/R levels. Notice price reaction at the S1 on the 27th of May 2020.
How are pivot points derived?
Whether you are trying to calculate the pivot points for the daily, weekly, or monthly timeframe, it follows the same method — you calculate the pivot point itself by using the high, low, and closing prices of the preceding trading session and use the value to calculate the corresponding support and resistance levels.
Based on the number of lines plotted on the price chart, there are several versions of the pivot point indicator — there are some with seven lines, five lines, and eleven lines.
However, the most common version on most trading platforms has seven lines — the pivot point itself, three support levels, and three resistance levels.
The pivot point is calculated by adding those price data (high, low, and close) and dividing by three, just like the concept of ‘typical price’:
Pivot Point = [Previous High + Previous Low + Previous Close] / 3
The pivot point value is the reference point for calculating the values of the other six price levels — three resistance and three support levels, which are given as:
As you can see, these price levels depend a lot on the high and low prices of the previous trading session, so the wider the range of that previous trading session, the larger the distance between these indicator levels in the current trading session.
In the same way, the smaller the previous session’s range, the less the distance between the pivot levels in the current trading session. See the chart below: the current week’s pivot levels are more widely spaced.
How to attach pivot points to your chart
How you attach the pivot point indicator on your chart depends on your trading platform. On the TradingView platform, you simply search the indicator on the ‘Indicators & Strategies’ panel and select Pivot Points Standard from the dropdown, as you can see from the picture below.
After attaching it to your chart, go the settings to input your preferred parameters, such as the pivot timeframe, the number of pivots back, and the type. You can also click on the style to choose the color you prefer and the thickness of the indicator lines.
Note that the pivot indicator on the TradingView platform uses the 11-line system, which means that there are five resistance lines and five support line. But you can make the R4, R5, S4, and S5 redundant by selecting a color that matches the background color in the chart.
The pivot point indicator is not primarily available on the MT4 platform by default, but you can create one if you are good at coding and familiar with the MQL4 language. Alternatively, you can get the MetaTrader 4 Supreme Edition plugin, which comes with a lot of complementary indicators, including pivot points.
Uses of pivot points
There are many creative ways traders make use of the pivot point indicator in their trading, and being a leading indicator, the pivot point is quite popular among day traders, especially in the stock and futures markets. Some of the common uses include:
Support or resistance levels
The pivot point indicator lines are known to act as potential price turning points, and the reason is not unconnected to the fact that the indicator is followed by a lot of traders, many of whom place limit orders around the indicator lines or enter the market whenever the price reaches any of those lines.
Ordinarily, the indicator has the pivot point, which is the middle line and three named resistance levels — R1, R2, and R3 — above, as well as three support levels (S1, S2, and S3) below.
Being mostly above the opening price of the new trading session, the R1, R2, and R3 levels are likely to act as resistance levels.
Similarly, the S1, S2, and S3 levels tend to be lower than the sessions open, so they are likely to act as support levels, which is why they are named support levels.
Depending on where the pivot point itself is in relation to the current price, it may likely act as a support or resistance level.
As with typical support and resistance levels, the polarity changes once the price breaks beyond any of the levels.
So, if the price breaks above any of the R1, R2, and R3 levels, that level may act as a support level when the price falls back to it.
Similarly, if the price breaks below any of the S1, S2, and S3 levels, that level can act as a resistance level when the price rallies again to that level.
It is interesting to note that the pivot point indicator is a leading indicator, which means that you already know where the indicator lines are and their potential support or resistance effect before the price gets to that level.
In the US30 chart below, the previous day’s R1 was acting as resistance, while the current day’s S1 is presently supporting, even though it may still break later as the day progresses.
The NZDUSD chart below shows the change in polarity. The previous week’s R1 started acting as a support level when the price broke above it. If you look at the current week’s R1, you can see that it is presently supporting but might break later on.
Gauging price movements
At the basic level, it is believed that when the price is trading above the pivot point, the market has a bullish sentiment for that day, and conversely, if the price is trading below the pivot point, the market sentiment is considered bearish.
But this simple rule is not cast in stone — the price can still trade lower after going above the pivot point, and it can still rise after trading below the pivot point.
Some advanced day traders also use the various support levels (S1, S2, and S3) and resistance levels (R1, R2, and R3) to gauge the probability of the price sustaining its present direction. For the daily pivot levels, some traders think that the price doesn’t often go beyond the R2 or S2.
The price getting beyond the S3 or R3 is even a rarer occurrence. However, they believe that if the price goes above the R1 or R2, there is a high chance that it will close beyond that level. Note that all these are just probabilities. Anything can happen in the market at any point.
Pivot points for placing stop losses
Since the various pivot levels can act as a price turning point, traders normally see them as one of the significant market structures beyond which they can put their stop loss orders.
Just like the usual support and resistance levels, it is believed that if the price breaks a specific pivot level, the price is probably determined to continue in that direction, so, in that case, it’s better to exit with the loss.
When using pivot indicator levels as a guide for where to place a stop loss order, most traders make use of the next level beyond the level where they enter their trades.
For instance, if the price reversed at S1 level and a trader is to go long at that level, placing the stop loss some pips below the S2 level is a good idea.
Take a look at the EURUSD chart below. Notice the position of the stop loss below the S1 for an entry around the pivot point.
Pivot points for placing profit target
As with the stop loss orders, the pivot point indicator levels can also be used as a guide for placing take profit orders.
Of course, with those levels acting as potential price reversal levels, it makes sense for traders to want to take their profits before those levels so as to avoid giving back their profits if the price reverses after hitting that level.
The particular pivot level used for a profit target depends on the trader’s analysis, style of trading, entry level, the number of pips at risk, the anticipated reward/risk ratio, and current market conditions, including volatility changes.
For instance, it is possible to enter a long position at the S2 or S3 level and have your profit target at the R3 level.
At the same time, another trader can enter a long position at the pivot point itself and decide to have his profit target at the R1 level. The same is true for short positions.
See the EURUSD chart below and note the position of the profit target just below one of the resistance levels for a long position.
The USDCHF chart below shows a possible position for a profit target after a short trade.
Identifying when the market is possibly in a range
It is possible to use the pivot point indicator to identify when the market is in a range. This you can do by observing the reaction of the price around the pivot point itself or any of the other levels.
If the price is moving to and fro about the pivot point, then, the market is probably in a range and still searching for the part of least resistance for the day.
In such situations, it is better to ignore that particular pivot point and focus on the boundaries of the range.
You may look to trade when the price breaks out of the range. Note that the other levels can still act as price reversal points when the price eventually gets to any of them.
Take a look at this USDCAD chart below. Notice how the price was oscillating around one of the pivot levels.
Formulating a trading strategy with pivot points
Now that you have seen the different ways other traders use pivot points in trading, it is fine to consider how you can develop a good trading strategy using the indicator.
If you are a day trader, you can use the daily and weekly pivot points on intraday timeframes like 5-minute, 15-minute, 30-minute, and 1-hour timeframes. For swing trading, you can use the weekly on the 4-hourly chart or the monthly pivot points on the daily chart.
While you can perfectly trade with the indicator alone if you are good at reading price action, it is better to combine it with other trading tools. Whatever you choose, these are the two common strategies you can trade with this indicator:
Pullback reversal strategy
The pullback reversal strategy is about entering a position in the direction of the trend at a price turning point. So, to trade this strategy, you should have a way of identifying the following:
Here, your pivot point and the accompanying R1, R2, R3, S1, S2, and S3 levels serve as the potential price reversal levels. However, you need other trading tools that can help you identify the trend, as well as tools that indicate when the price is about to reverse.
Some of the tools you can use to identify the trend direction are trend lines and moving averages. An upward-sloping trend line or moving average indicates an uptrend, while a downward-sloping moving average or trend line indicates a downtrend.
Some of the tools you can use to confirm that a pullback is likely to reverse include oscillator overbought/oversold signals, oscillator divergence, countertrend line breakouts, and reversal candlestick patterns, such as the pin bars, engulfing bars, and inside bars.
To trade this strategy in an uptrend, these are the step to follow:
In the EURUSD chart below, the 50-period moving average is ascending, indicating an uptrend. Notice a pullback to the pivot point (P), which coincidentally formed a confluence with the moving average line.
Both bullish engulfing and pin bars occurred there, which was a trigger to go long. Note the positions of the stop loss and profit target.
These are the step to follow when trading this strategy in a downtrend:
Here, the price is starting to descend gradually. It made a pullback to the R1 level and started dropping again. The breakdown of the countertrend line was the trigger to go short. Notice the bearish divergence in the stochastic.
Pivot level breakout strategy
Another trading strategy you can create with this indicator is trading the breakout of any of the pivot support or resistance levels.
These levels are often monitored by many traders, and there are many stop orders, including stop loss orders, lying around them. So, when a breakout occurs, the price usually moves very quickly.
The best way to trade a breakout strategy is when a new trend is emerging. Breakout trades work even better during the more volatile periods in the market, such as after the release of high-impact news and the periods around a market open — London or New York open.
Here is how to trade pivot level breakouts:
In this chart, you can see that the price broke below the pivot point (P), signaling a short trade. Note the position of the stop loss and profit target.
What you should know about pivot points and time zones
It is important to know that, in the forex market, pivot points may be different for different charting platforms, depending on the time zone the charting platform uses.
The reason is that pivot points are calculated from price data, including the closing prices of which the chart provider might be using a different time zone.
Thus, a charting platform using Hong Kong or Sydney time zone may have a different pivot level from a platform that uses London or New York time zone.
Since London and New York are the major financial centers whose time zones are followed by most traders, it is preferable to use a pivot indicator that is based on those time zones.
The pivot point indicator is a system of many horizontal lines that represent important price levels based on the price data of the preceding trading session — the previous day, week, or month.
Traders use those levels in many ways, including finding potential entry levels, setting stop losses and profit targets, and gauging price movements. The two common pivot point strategies you can use are pullback reversals and breakout strategies.