Pivot points explained simply
Pivot points are horizontal lines calculated from the previous day's or week's high, low and close. Many day traders use them as possible turning points.
Pivot points date back to floor traders who had no computers. They needed simple levels they could work out with a calculator in the morning. Today every charting tool draws them automatically. They work much like support and resistance.
What it's about
The middle line P is the pivot point. Above it are the resistance levels R1 and R2, below it the support levels S1 and S2. When the price is above P, the mood counts as fairly positive, below it as fairly weak.
An example: today's pivot is at €100, R1 at €104, S1 at €97. If the price falls to €97 in the morning and bounces there, many day traders see S1 as confirmed.
How it's calculated
You take the high, low and close of the previous period, usually the previous day. P is their average. R1 is two times P minus the low, S1 is two times P minus the high. R2 sits the whole range above P, S2 the whole range below.
With numbers: high €103, low €97, close €100. P is €100. R1 is 200 minus 97, so €103. S1 is 200 minus 103, so €97. R2 is at €106, S2 at €94.
What signals traders read from it
- Bounce: When the price reaches S1 and turns up, some buy with P as the target.
- Breakout: When the price rises clearly above R1, some expect a move on to R2.
- Mood: Trading above P counts as positive, below it as weak.
Where it misleads you
Pivot points are pure arithmetic from three numbers of the previous day. They know nothing about news, events or the state of the company. That prices sometimes turn at them is partly because a lot of day traders watch the same lines.
There are also several methods, such as classic, Fibonacci, Woodie or Camarilla. Each gives different lines. One of them is almost always close to the price.
An example trade with made up numbers
Ben has €10,000 in his account and risks at most €150 per trade. A stock falls to S1 at €97 in the morning and edges back up. Ben buys at €97.20 and sets his stop loss at €95.20. With that distance, he buys 75 shares for €7,290. Costs: €1 each to buy and sell, plus about 2 cents of spread per share on each order.
If it works: The price rises to the pivot at €100, where Ben sells. Ben is €210 ahead. After €2 in fees and €3 in spread, €205 is left.
If it goes wrong: S1 doesn't hold and the price falls towards S2. The stop fills at €95.10. That's a €157.50 loss, €162.50 with costs.
A possible €205 gain against a possible €162.50 loss isn't a good ratio. For this to pay off, Ben would need to be right much more often than wrong.
The classic formula is P = (H + L + C) / 3, R1 = 2P − L, S1 = 2P − H, R2 = P + (H − L), S2 = P − (H − L). For daily lines you use the previous day's values, for weekly lines the previous week's.
With cryptocurrencies, which trade around the clock, there's no natural daily close. The lines then depend on which time your charting tool treats as the end of the day, usually midnight UTC.
The ratio of possible gain to possible loss, the reward to risk ratio, is often tight on pivot trades because the lines sit close together. That makes it all the more important to measure your hit rate honestly over many trades.
Summary
- Pivot points are calculated from the previous day's high, low and close.
- They also work because many people watch the same lines.
- The gaps are often small, so the reward to risk ratio is tight.
Did you get it?
High €103, low €97, close €100. Where is the pivot point?
At €100, the average of the three values.
How is S1 calculated?
Two times the pivot point minus the previous day's high.
Why are pivot points harder with cryptocurrencies?
Because there's no natural daily close and the lines depend on the chosen time.
Sources and further reading
- StockCharts ChartSchool, Pivot Points. View source ↗
- ESMA, investor information on trading risks. View source ↗
Related
- Support and resistanceLesson
- FibonacciIndicator
- Reward to risk ratioLesson