Introduction to Pivot Points
Pivot points are a popular technical analysis tool used by traders to determine the overall trend of the market over different time frames. They are calculated using the high, low, and closing prices from the previous trading day. Pivot points are used by traders as predictive indicators of market movement.
Understanding Pivot Points
Pivot points are based on mathematical calculations that consider the previous trading day’s high, low, and closing prices. The pivot point itself is simply the average of the high, low, and closing prices from the previous trading day. On the subsequent day, trading above the pivot point is thought to indicate ongoing bullish sentiment, while trading below the pivot point indicates bearish sentiment.
The Basic Pivot Point Calculation
The pivot point (P) is calculated as follows:
P = (Previous High + Previous Low + Previous Close) / 3
Using Pivot Points in Day Trading
Day traders use pivot points to identify potential support and resistance levels. These are levels where the price of an asset meets resistance or support to go higher or lower, respectively.
Identifying Support and Resistance Levels
There are multiple levels of support and resistance identified by pivot points. The first level of support and resistance is calculated using the pivot point and the high or low prices of the previous day. The second level can be calculated based on the pivot point and the range between the high and low prices of the previous day.
Trading Strategies Using Pivot Points
One common strategy used by day traders is to trade in the direction of the overall trend as indicated by the pivot point. If the market opens above the pivot point, this is seen as a bullish signal, and the trader might consider entering long positions. Conversely, if the market opens below the pivot point, this is interpreted as a bearish signal, and the trader might consider entering short positions.
Advantages and Disadvantages of Using Pivot Points
Pivot points have the advantage of being a predictive indicator as opposed to lagging indicators, such as moving averages. This allows traders to anticipate potential price movements rather than just reacting to them.
However, like all technical indicators, pivot points are not infallible and should not be used in isolation. They are best used in conjunction with other indicators and analysis techniques to confirm signals and prevent false alarms.
Conclusion
Pivot points can be a valuable tool for day traders looking to determine potential support and resistance levels in the market. However, as with any trading strategy, it’s important to use pivot points in conjunction with other forms of analysis and to always manage risk effectively.
