08 August 2020 , Al Hill

Table of Contents

## Pivot Points Explained

Today we will go through the most significant levels in day trading – daily pivot points. When you finish reading this article, you will know the 5 reasons why day traders love using them for entering and exiting positions. The information listed in this article can be included as a part of your overall trading plan.

## History of Pivot Points

Pivot points are technical analysis indicators. A pivot point uses a previous period’s high, low, and close price for a specific period to define future support. Then, they apply calculations to determine the points. Additionally, they determine stock market trends over different time periods.

Pivot points were originally used by floor traders on stock exchanges. They used the high, low, and close prices of the previous day to calculate a pivot point for the current trading day.

This calculation helped them notice important levels throughout the trading day. Pivot points have predictive qualities, so they are considered leading indicators to traders.

The main pivot point is the most important price level for the day. The pivot point is the balance between bullish and bearish forces. When prices are above the pivot point, the stock market is considered bullish. If prices fell below the pivot point, the market is considered bearish.

While pivot points were originally used by floor traders, now they’re used by many traders, especially in equities and forex.

## Pivot Point Levels

Daily pivot points are calculated based on the high, low, and close of the previous trading session.

There are seven basic pivot levels on the chart:

Basic Pivot Level (PP) – This is the middle and basic pivot point on the chart.

Resistance 1 (R1) – This is the first pivot level above the basic pivot level.

Resistance 2 (R2) – This is the second pivot level above the basic pivot point, and the first above R1.

Resistance 3 (R3) – This is the third pivot level above the basic pivot point, and the first above R2

Support 1 (S1) – This is the first pivot level below the basic pivot point.

Support 2 (S2) – This is the second pivot level below the basic pivot point and the first below S1.

Support 3 (S3) – This is the third pivot level below the basic pivot, and the firs below S2.

When you add the seven pivot levels, you will see five parallel horizontal lines on the chart.

The above chart is zoomed out in order to show all 7 pivot levels.

## Pivot Point Calculation

Let’s now discuss the way each of the five pivot points is calculated. First, we need to start with calculating the basic pivot level (PP)– the middle line.

## PP Calculation

Below is the formula ^{[1]} you should use to determine the PP level on your chart:

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

## R1 R2 S1 S2 Pivot Levels Calculation

Now that we know how to calculate the PP level, let’s proceed with calculating the R1, R2, S1, and S2 pivot levels:

R1 = (2 x Pivot Point) – Daily Low

R2 = Pivot Point + (Daily High – Daily Low)

S1 = (2 x Pivot Point) – Daily High

S2 = Pivot Point – (Daily High – Daily Low)

## R3 S3 Pivot Levels Calculation

We are almost done with the pivot point calculation. There are two more levels to go – R3 and S3.

R3 = Daily High + 2 x (Pivot Point – Daily Low)

S3 = Daily Low – 2 x (Daily High – Pivot Point)

See that the formulas for R1, R2, R3, S1, S2, and S3 all include the PP value.

This is why the basic pivot level is crucial for the overall pivot point formula. Therefore, you should be very careful when calculating the PP level. After all, if you incorrectly calculate the PP value, your remaining calculations will be off.

You are now looking at a chart, which takes two trading days. Each trading day is separated by the pink vertical lines. We use the first trading session to attain the daily low, daily high, and close.

Daily High = 14.39

Daily Low = 14.28

Close = 14.37

Then we apply the three values in the formulas above, and we get the following results:

PP = 14.35

R1 = 14.42

R2 = 14.46

R3 = 14.53

S1 = 14.31

S2 = 14.24 (not visible)

S3 = 14.20 (not visible)

## What are the different kinds of pivot points?

Here are five types of the most popular pivot points.

## Standard pivot points

Standard pivot points are the most basic pivot points that day traders can calculate. First, traders start with a base pivot point. That’s the average of high, low, and close from a previous period. Below is the complete calculation for standard pivot points.

- To calculate the Base Pivot Point: (P) = (High + Low + Close)/3 calculate the First Support Level: Support 1 (S1) = (P x 2) – High
- When calculating the Second Support Point: Support 2 (S2) = P – (High – Low)
- To calculate the First Resistance Level: Resistance 1 (R1) = (P x 2) – Low
- When calculating the Second Resistance Level: Resistance 2 (R2) = P + (High – Low)

## Fibonacci pivot points are most popular

The Fibonacci pivot point is perhaps the most popular one. Fibonacci extenstions, retracements, and projections are commonly used in forex, but are used with stocks as well. The Fibonacci retracement levels are named after a mathematical sequence.

Ken Ribet is professor of mathematics at the University of California, Berkeley. He points out that a Fibonacci number started out having a simple formula.

“A lot of things in mathematics and probably in the real world are governed by simple recursive rules, where each occurrence is governed by a simple formula in terms of the previous occurrence. And a Fibonacci number has the simplest possible formula, just the sum of the previous two,” said Ribet.

Katie Stockton is the founder and managing partner of the technical analysis firm Fairlead Strategies, LLC in Stamford, Connecticut. She spoke about the impact of the Fibonacci on gold last year.

“That was a big Fibonacci breakout that a lot of folks were watching, even to the extent that it became such a widely followed level that I think there becomes some self-fulfilling property to it,” Stockton said.

The main Fibonacci levels that traders monitor are the 38.2% and the 61.8% retracement levels.

Here is the calculation for the Fibonacci pivot point.

- To calculate the Base Pivot Point: Pivot Point (P) = (High + Low + Close)/3
- When calculating the First Support Level: Support 1 (S1) = P – {.382 * (High – Low)}
- To calculate the Second Support Level: Support 2 (S2) = P – {.618 * (High – Low)}
- When calculating the First Resistance Level: Resistance 1 (R1) = P + {.382 * (High – Low)}
- To calculate the Second Resistance Level: Resistance 2 (R2) = P + {.618 * (High – Low)}
- When calculating the Third Resistance Level: Resistance 3 (R3) = P + {1 * (High – Low)}

## Woodie’s pivot point

In the Woodie’s pivot point, there is more weight on the closing price. The calculation is similar to the standard pivots formula. The calculation is as follows:

R2 = PP + (High – Low)

R1 = (2 X PP) – Low

PP = (High + Low) + (2 x Closing Price) / 4

S1 = (2 X PP) – High

S2 = PP – (High + Low)

## Camarilla Pivot Points

Another pivot point that traders use are camarilla pivot points. Nick Scott invented the Camarilla pivot point in the 1980s. It’s similar to the Woodie’s pivot point. However, there are four resistance levels and four support levels. In contrast, the Woodie pivot point has two Resistance levels and two Support levels. This is the calculation for the Camarilla pivot point:

R4 = Closing + ((High -Low) x 1.5000)

R3 = Closing + ((High -Low) x 1.2500)

R2 = Closing + ((High -Low) x 1.1666)

R1 = Closing + ((High -Low x 1.0833)

PP = (High + Low + Closing) / 3

S1 = Closing – ((High -Low) x 1.0833)

S2 = Closing – ((High -Low) x 1.1666)

S3 = Closing – ((High -Low) x 1.2500)

S4 = Closing – ((High-Low) x 1.5000)

## Demark Pivot Points

Demark pivot points have a different relationship between the opening and closing prices. Noted trader Tom Demark introduced the pivot point. The Demark pivot point uses the number X to calculate the lower level line and the upper resistance level. It also emphasizes recent price action. The calculation is as follows:

If Close > Open, then X = (2 x High) + Low + Close

If Close < Open, then X = High + (2 x Low) + Close

If Close = Open, then X = High + Low + (2 x Close)

Pivot Point = X/4

Resistance 1 = X/2 – Low

Support 1 = X/2 – High

## How the stock market today affects pivot points

The S&P 500 has been on a wild ride since the March bear market. In March, the S&P 500 lost the 38.2% Fibonacci retracement. However, in May, when the economy re-opened, the S&P roared back. The Fibonacci retracement rose over the 61.8% retracement.

Financial expert Steve Miley noted that the pivot point rebound was very quick over the last few months.

“Since 1970, there were only five other times where the S&P 500 retraced more than 34% that quickly. The chart below shows the forward performance. Returns were rock-solid,” wrote Miley.

With NASDAQ stocks soaring, pivot points can predict bullish or bearish trends. The recent upswing in tech stocks show that pivot points are bullish in the stock market.

## How to Draw the Pivot Point Stock Market Indicator

The pivot point stock market indicator should be applied to the chart as follows:

- PP level
- R1 and S1
- R2 and S2
- R3 and S3

When you follow this order there is a small chance that you might mistakenly tag each level. To avoid this potential confusion, you will want to color-code the levels differently.

For example, you can always color the PP level black. Then the R1, R2, and R3 levels could be colored in red, and S1, S2, and S3 could be colored in blue. This way you will have a clear idea of the PP location as a border between the support and the resistance pivot levels.

Some trading platforms have a built-in pivot point indicator. This means that the indicator could be automatically calculated and applied on your chart with only one click of the mouse. This will definitely save you a ton of time.

## How Pivot Points Work

Pivot points provide a standard support and resistance function ^{[2]} on the price chart.

When price action reaches a pivot level it could be:

- Supported/Resisted
- Extended (breakouts)

If you see the price action approaching a pivot point on the chart, you should treat the situation as a normal trading level. If the price starts hesitating when reaching this level and suddenly bounces in the opposite direction, you can then trade in the direction of the bounce.

However, if the price action breaks through a pivot, then we can expect the action to continue in the direction of the breakout. When price clears the level, it is called a pivot point breakout.

## Day Trading with Pivot Points

Now that we understand the basic structure of pivot points, let’s now review two basic trading strategies – pivot point bounces and pivot level breakouts.

## Pivot Point Breakout Trading

To enter a pivot point breakout trade, you should open a position using a stop limit order when the price breaks through a pivot point level. These breakouts will mostly occur in the morning. If the breakout is bearish, then you should initiate a short trade. If the breakout is bullish, then the trade should be long.

You should always use a stop loss when trading pivot point breakouts. A good place for your stop would be a top/bottom which is located somewhere before the breakout. This way your trade will always be secured against unexpected price moves.

You should hold your pivot point breakout trade at least until the price action reaches the next pivot level.

This is the 5-minute chart of Bank of America from July 25-26, 2016. The image illustrates bullish trades taken based on our pivot point breakout trading strategy.

The first trade is highlighted in the first red circle on the chart when BAC breaks the R1 level. We go long and we place a stop loss order below the previous bottom below the R1 pivot point. As you see, the price increases rapidly afterwards.

We hold the trade until the price action reaches the next pivot point on the chart. When this happens, the price creates a couple of swing bounces from R2 and R1.

After bouncing from R1, the price increases and breaks through R2. This creates another long signal on the chart. Therefore, we buy BAC again.

There is a long lower candlewick below R2, which looks like a good place for our stop loss order. The price then begins hesitating above the R2 level. In the last hours of the trading session, BAC increases again and reaches R3 before the end of the session. This is an exit signal and we close our trade.

## Pivot Point Bounce Trading

This is another pivot point trading approach. However, this time we will stress the cases when the price action bounces from the pivot levels.

Here you should open trades if the price reaches a pivot point and bounces.

If the stock is testing a pivot line from the upper side and bounces upwards, then you should buy that stock. If the price is testing a pivot line from the lower side and bounces downwards, then you should short the security.

The stop loss order for this trade should be located above the pivot level if you are short and below if you are long.

Pivot point bounce trades should be held at least until the price action reaches the next level on the chart. This is how it works:

Above is a 5-minute chart of the Ford Motor Co. from July 14, 2016. The image shows a couple of pivot point bounce trades taken according to our strategy.

Our pivot point analysis shows that the first trade starts 5 periods after the market opening. The price goes above R2 in the opening bell. Then we see a decrease and a bounce from the R2 level. This creates a long signal on the chart and we buy Ford placing a stop loss order below the R2 level.

The price enters a bullish trend and we will stay with the trade until Ford touches the R3 level. We close the trade when this happens.

However, the price bounces downwards from the R3 level. This is another pivot point bounce and we short Ford security as stated in our strategy. A stop loss order should be placed above the R3 level as shown on the chart.

After a short consolidation and another return and a bounce from the R3 level, the price enters a bearish trend. We hold the short trade until Ford touches the R2 level and creates an exit signal.

## 5 Common Mistakes when Trading with Pivot Points

## Trades that Clear S4 or R4

These are the setups you really want to hone in on. Think about it, why buy a stock that has resistance overhead. You can just as easily invest in a stock that has the wind to its back and you can ride the wave higher.

If there is no one looking to sell at a pivot point resistance level and there are no swing highs – that equals odds in your favor.

I mean even when things go wrong, you are still likely to come out even or at least have a fighting chance.

This going with the trend, of course, works just as well with shorts that clear S4 support.

Here is an example I literally just traded today for the stock Advanced Auto Parts (AAP).

Is there anything different on the chart that you weren’t expecting to see?

If you can’t point it out, it’s Fibonacci levels. Once a stock has cleared all of the daily pivot points, the next thing you need to look for are the overhead Fibonacci extension levels and swing highs from previous moves.

These levels can be used as your target areas for your trades. You can then use these levels to calculate your risk-reward for each trade.

Back to the trade example above, I bought AAP on the break of both the pre-market and intra-day high. After purchasing the stock, it’s now about holding on and riding the trend up to the next Fibonacci level up at 261.8% retracement.

At this point as previously stated in articles across the Tradingsim blog, I do not get greedy. I always look to clean off my trade slightly below the level.

Try applying these techniques to your charts to identify the levels tracked by professional traders.

### Pivot Points and High Float Stocks

This is something I will highlight quickly without the use of charts. One point I am really pushing hard on the Tradingsim blog is the power of trading high float, high volume stocks.

Nowadays so many gurus are talking about low float, momo stocks that can return big gain. Well, I am here to tell you that high float is still in ^{[3]}.

The beautiful thing about high float stocks is that these securities will adhere to and trade in and around pivot point levels in a predictable fashion.

If you are a trader just starting out in pivot points and want to get a handle on things, you will want to start with these large-cap stocks. Once you get a handle on things, you can always progress to the penny stocks.

However, to be totally clear – I am a high float man!

## How Pivot Points Helps Build Consistency

This is where pivot points honestly took me from pulling my hair out to consistent profits.

For me, I would obsess about when to exit my trade. My entries were solid but I always had sellers remorse. I would either regret getting out too early or holding on too long.

This is something I struggled with for years – not months.

To this point, once I included pivot points in my trading it was like going from the dark and stepping into the light. The beauty of using pivot points is that you have three clear levels: (1) where to enter the trade, (2) where to exit the trade and (3) where to place your stop.

If you are the type of person that has trouble establishing these trading boundaries, pivot points can be a game-changer for you.

To further illustrate this point, check out the below charts.

Do you see the beauty of the pivot points on the chart?

If you struggle with where to place your stops, entries and profit targets, pivot points take care of all of that for you.

You do not need some expensive trading system or AI program to accomplish this goal.

The other major point to reiterate is that you can quickly eyeball the risk and reward of each trade. Therefore over time, you will inevitably win more than you lose and the winners will be larger.

This, my friend, is how you build wealth – one trade at a time.

## Knowing When You are In a Losing Trade with Pivot Points

The other key point to note with pivot points is that you can quickly identify when you are in a losing trade.

### Cannot Hold Pivot Level

If you are going long in a trade on a break of one of the resistance levels and the stock rolls over and retreats below this level – you are likely in a spot.

### Time Lapse

This does not mean you need to run for the hills but it does mean you need to give the right level of attention to price action at this critical point. The other point is to consider the amount of time that passes after you have entered your position.

If you are sitting there below or right around the breakout level 30 minutes after entering the trade – the stock is screaming warning signals.

Do not over think exiting bad trades. If you find yourself in a trade that is stalling or not holding a level just exit the trade. Waiting around for something to happen will lead to more losses.

Beyond the money, the major issue you will face is the emotional turmoil of tacking such a loss. Remember, do not think – just close the trade!

## Pivot Points from Prior Days

Most charting software will allow you to select whether you want to see the current day’s pivot points or if you would like to see pivot points from prior days.

At first glance it’s easy to want to focus on the current day levels as it provides a clean chart pattern; however, prior days levels can trigger resistance on your chart.

In the above chart of NANO you can see that the R4 level was cleared. The next question you are likely to ask yourself is where will NANO stop?

Well looking at the pivot points for the day, you really have no way of making that determination.

### Multiple Days of Pivot Point Levels

Now let’s take another look at that example with more than one day’s worth of pivot point data.

As you can see in the chart, there are a number of resistance levels near our closing price on the day. Like any other indicator, there is no guarantee the price will stop on a dime and retreat.

The point of highlighting these additional resistance levels is to show you that you should be aware of the key levels in the market at play.

You will need to look at level 2 or time and sales to see which level you need to focus on. This is the real challenge. If you immediately sell you will possibly forego big profits.

For me personally, I sell out at the next resistance level up. While I am likely leaving money on the table, there is a greater risk of me being greedy and looking for too much in the trade.

## Placing Stops

Trading with pivot points allows you the ability to place clear stops on your chart. Now from my experience, what you do not want to do is simply place your stops right at the next level up or down.

You have to take more care when identifying your stop placement. Remember, you are not the only one that is able to see pivot point levels. Anyone with a charting application will know the R1, R2 and R3 levels.

So, how do you still protect your trade but without risking too much?

### Beyond Key Psychological Price Levels

For me what has worked is placing the stop slightly beyond the levels. To take it a bit further, you will want to hide the stop behind logical price levels.

For example, if you have an S1 level at $19.65, then you will want to place your stop at $19.44. Why at this level? 50 cents is a big mental price level for stocks under $20 bucks.

Therefore, you will likely have a large number of stops right at the level. Therefore, if you place your stop slightly beyond this point, you will likely avoid being stopped out of the trade.

### Volume at Price

Another method is to look at the amount of volume at each price level. If you are long and are eyeing an S1 level to stop the selling pressure you can also see how much volume is at a certain level.

You can then place your stop slightly below or above these levels. Let’s look at a chart to illustrate this point.

In the above example, notice how the volume at the support level was light. This shows you that there was not a lot of selling pressure at this point and a bound was likely to occur at support.

Next, notice how the price breached the S3 level by a hair and then reversed higher. For this type of setup, you want to see the price hold support and then you can set your target at a resistance level that has accompanying volume. After BLFS bounced, it ran up to the R1 resistance before consolidating which coincidentally had a decent amount of volume at the $19.15 price level.

Notice if you were long, a stop directly below the S3 level would have kept you in the trade.

## 5 Reasons Why Day Traders Love Pivot Points

### 1) Unique for Day Trading

The pivot points formula takes data from the previous trading day and applies it to the current trading day. In this manner, the levels you are looking at are applicable only to the current trading day. This makes the pivot points the ultimate indicator for day trading.

### 2) Short Time Frames

Since the pivot points data is from a single trading day, the indicator could only be applied to short time frames. The daily and the 30-minute chart would not work, because it will show only one or two candles.

The best timeframes for the pivot point indicator are 1-minute, 2-minute, 5-minute, and 15-minute. Therefore, the indicator is among the preferred tools for day traders.

### 3) High Accuracy

The pivot point indicator is one of the most accurate trading tools. The reason for this is that the indicator is used by many day traders. This will allow you to trade with the overall flow of the market.

### 4) Rich Set of Data

Pivot points on charts provide a rich set of data. As we discussed above, the indicator gives seven separate trading levels. This is definitely enough to take a day trader through the trading session.

### 5) Easy to Use

The PP indicator is an easy-to-use trading tool. Most of the trading platforms offer this type of indicator. This means that you are not required to calculate the separate levels; the Tradingsim platform will do this for you. Your only job will then be to trade the bounces and the breakouts of the indicator.

## Conclusion

- The pivot points are levels on the chart which are attained from previous day data and concern only the current day.
- The data which the pivot point indicator takes from the previous trading session is:

- Daily High
- Daily Low
- Close

- To calculate the pivot lines you should then apply the following formulas:

- Pivot Point (PP) = (Daily High + Daily Low + Close) / 3
- R1 = (2 x Pivot Point) – Daily Low
- R2 = Pivot Point + (Daily High – Daily Low)
- R3 = Daily High + 2 x (Pivot Point – Daily Low)
- S1 = (2 x Pivot Point) – Daily High
- S2 = Pivot Point – (Daily High – Daily Low)
- S3 = Daily Low – 2 x (Daily High – Pivot Point)

- Draw each of the levels one by one and color the levels differently in order to avoid confusions.
- Two of the most popular pivot points trading strategies are:

- Pivot Point Breakout Trading
- Pivot Point Bounce Trading

- Day Traders love the Pivot Point indicator because:

- It is unique for day trading.
- It uses short time frames.
- The pivot point levels are relatively accurate.
- The pivot point indicator gives a rich set of data – 7 levels.
- The indicator is very easy to use.

- Pivot points also work well with futures markets and forex.

## External References

- Pivot Points. Wikipedia
- Aspray, Tom. (2012). The Most Powerful Pivot Point Level. Forbes
- Miller, Terin. (2019). What are Blue Chip Stocks and Why Should You Invest in Them?. thestreet.com

Credit: Tradingsim

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