Introduction to Pivot Points in Day Trading
Pivot points are a popular method used by day traders to quickly determine potential points of price action change. These points are calculated using the high, low, and closing prices from the previous trading day. The pivot point itself is the average of these three prices and serves as the basis for the pivot point calculation. From this pivot point, several levels of support and resistance are calculated. These levels can be used by day traders to make decisions about when to enter and exit trades.
Calculating Pivot Points
The Pivot Point Formula
The pivot point is calculated using the following formula:
Pivot Point (P) = (High (previous) + Low (previous) + Close (previous)) / 3
Support and Resistance Levels
Once the pivot point is calculated, it can be used to calculate two support levels and two resistance levels. These are calculated as follows:
First Resistance (R1) = (2*P) – Low (previous)
First Support (S1) = (2*P) – High (previous)
Second Resistance (R2) = P + (High(previous) – Low(previous))
Second Support (S2) = P – (High(previous) – Low(previous))
Using Pivot Points in Day Trading
Identifying Market Direction
One of the main uses of pivot points is to identify the overall trend of the market. If the current price is above the pivot point, it indicates a bullish market. Conversely, if the current price is below the pivot point, it indicates a bearish market.
Identifying Entry and Exit Points
Pivot points are also used to identify potential entry and exit points. The pivot point and its associated support and resistance levels serve as potential levels where the price could reverse. For example, if the price is approaching the first resistance level (R1), a trader might consider selling, expecting that the price will reverse and start to fall. Similarly, if the price is approaching the first support level (S1), a trader might consider buying, expecting that the price will reverse and start to rise.
Setting Stop Loss and Take Profit Levels
In addition to identifying potential entry and exit points, pivot points can also be used to set stop loss and take profit levels. For example, a trader might set their stop loss just below the first support level (S1) and their take profit just below the first resistance level (R1). This allows the trader to limit their potential losses and lock in their profits.
Conclusion
Pivot points are a versatile tool that can be used in many different ways by day traders. By providing a quick and easy way to identify potential points of price action change, they can help traders make more informed decisions and potentially increase their profits. However, like all trading tools, pivot points are not infallible and should be used in conjunction with other forms of analysis and risk management techniques.
