One of the more popular tools used by day traders is daily pivot points. Pivot points are technical support and resistance levels calculated for stocks using mathematical formulas based on a stock’s high, low, and closing prices from the previous day. Here’s a look at what pivot point trading is and how it’s used.
Pivot points are technical price levels at which stocks will potentially face buying and/or selling pressure during a typical trading day.
The most important pivot point is called the basic or middle pivot point. The basic pivot level, sometimes abbreviated “PP,” is calculated by taking the average of the daily high, daily low, and closing price from the previous day. The calculation is represented by the following mathematical formula:
Pivot Point (PP) = (daily high + daily low + close) / 3
From there, subsequent resistance points (R1, R2, R3, etc.) and support points (S1, S2, S3, etc.) are calculated based on the PP. Here’s an overview of how each of these levels is calculated:
Resistance Point 1 (R1) = (2 x PP) – daily low
Resistance Point 2 (R2) = PP + (daily high – daily low)
Resistance Point 3 (R3) = daily high + 2 x (PP – daily low)
Support Point 1 (S1) = daily high + 2 x (PP – daily low)
Support Point 2 (S2) = PP – (daily high – daily low)
Support Point 3 (S3) = daily low – 2 x (daily high – PP)
If looking at those formulas brings back childhood nightmares of algebra classes, don’t worry. There are plenty of interactive charts online that can calculate important pivot points and overlay them on charts automatically.
As the term implies, pivot points tend to serve as levels at which a stock could change direction, or pivot, in the short-term. In other words, support points are potential buy signals and resistance points are potential sell signals.
Many traders consider the PP itself as the most important level of them all. The PP potentially serves as both support and resistance. If a stock approaches the PP from above and bounces, that is typically seen as a buy signal. If it approaches the PP from the bottom and pulls back, that is typically sell as a sell signal.
The strategies mentioned above are just a handful of the ways traders use pivot points. Of course, any trading strategy comes with certain caveats. Pivot points are used because traders see them as potential key levels, but these strategies are based on trends over time and not absolute rules.
Just like fishermen know the best fishing spots, traders see pivot points as the best levels for trading action. That doesn’t necessarily mean they will catch a fish on every cast.
In other words, on any given day, a stock may blow right through its pivot points and not look back.
To help mitigate the risk of surprising price action, pivot point traders also often use adjacent pivot point levels to place stop-loss orders to mitigate risk.
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