Price Action Pivot Points Strategy
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.
Pivot Points Explained
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.
Pivot Points
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 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.
Pivot Points 2
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)
How to Draw the Pivot Point Stock Market Indicator
The pivot point stock market indicator should be applied on the chart as follows:
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 on the price chart.
When price action reaches a pivot level it could be:
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 when the price breaks through a pivot point level. 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.
Pivot Point Breakout Strategy
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:
Pivot Point Bounce Strategy
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 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 Tradingsimplatform will do this for you. Your only job will then be to trade the bounces and the breakouts of the indicator.
