Ric has 2 decades trading experience and is a syndicated finance writer, having appeared on CNBC, NASDAQ, Economy Watch, Motley Fool, and Wired Magazine.
The first question is what is a pivot? A pivot point is a technical analysis indicator, or calculations, used to determine the overall trend of the market over multiple time frames. The pivot point itself is simply the average of the high, low and closing prices from previous trading sessions. Once a pivot point has been determined, going forward trading above the pivot point is thought to indicate ongoing bullish sentiment, while trading below the pivot point indicates bearish sentiment.
The pivot point is the basis for the indicator, but it also includes other support and resistance levels that are projected based on the pivot point calculation. All these levels help traders see where the price could experience support or resistance. If the price moves through these levels it lets traders know that price is trending in a specific direction.
I know what you are thinking? That is a whole lot of words give me the anchor. Pivots are where computer algorithms (which we will refer to as algos in this article) have bought and sold in the past. The majority of the buying and selling in the market these days are done by algos. Just like determining intraday trades on lower time frames and swing trades on higher time frames. The higher the time frame of the pivot the stronger it is.
There is a saying that history does not repeat itself but sometimes it rhymes. In trading history does repeat itself and if as a trader you do not understand history and its relation to price action you have not reached your full potential as a trader. In fact the foundation for many of the principles in trading is based on that as an immutable truth. Every trading day is unique but every trading day is a replica of a prior trading day in the past. I know your eyes may have just crossed reading that, but it is a universal truth understood by the most successful traders. Each day in the markets some of the players change, the names change, but the thing that never changes is human psychology. That is why pivots work so well.
Now Pivots alone are not a magic bullet that will guarantee that your trading is a success. You have to know how to use them effectively. That is why being able to determine what kind of market you are in is extremely important. If you are in a bullish trend day, that means the market opens at session lows and closes at session highs. The ticker that you are trading should move upward and assuming there is enough momentum should move from one pivot to another:
Once we broke above and held the pivot around the 290 area we enter a long position. We remain in our long position placing our stop loss below the pivot. When we are in a trending market in an equity with range we usually trade from pivot to pivot. So once we enter and have lift-off we can enter a trailing stop or manually watch for signs of a reversal to exit prior to our target. In the trade referenced in the image we don’t hit resistance until we reach the next pivot near the 292.75 area where we can choose to scale out a percentage of our shares or contracts and holding the rest for continuation. In this case after a brief pull back and multiple attempts we managed to break above the pivot and continue to climb headed into the close.
If it is a bearish trend day the open usually marks the session highs and the close the day’s lows. You will usually see an increase in volume on trend days to provide continuation in one direction. Example of using pivots in a bearish trend see next picture. We see a push up at the open then a struggle to hold the pivot above the 292 price point. Once we fall below the pivot and the back test fails we enter our short position. Our stop is set at the break of the high of day price set during the cash session. We continued to trend down pivot to pivot. We can choose to scale out some of our position size at near the pivot around the 289 area. We can choose to set a stop on the break above the 289 price point. The remaining position we can choose to exit as we push down through the 285 pivot or choose to hold our position setting stops at the break above any of the higher pivots.
If the market was always trending up or down we would always have crystal clear entries, exits, with range. But, sometimes the market move sideways for a period of time, where neither the buyers nor sellers are in control. This is usually termed a range bound day. On a range bound day the price is pushed back and forth by both buyers and sellers but it is unable to break out of the set range with conviction. This is almost like a game of table tennis. Both players volleying the ball back and forth, as a ball is in flight each player is trying to position themselves for the best opportunity to return the ball to the other player. Buyers will position themselves at the bottom of the range and attempt to push price back to the high of the range. Meanwhile, sellers position themselves at the high of the range and attempt to push price back to the low of the range.
Sometimes it may be a little challenging to figure where the day’s range may be; in this case the pivots make it incredibly simple see the picture below. We opened gapped down below $3007.50 then bought back up above the pivot. Price was pushed to $3015 area then pushed down to $3009. The buyers tried to push the price back to the top pivot but the sellers took control and pushed price back down to the lower pivot. At the lower pivot the buyers stepped in again and this time they managed to push the price not just back to the upper pivot but above before it curled back down back under the upper pivot, and sellers forced price back down near the lower pivot.
In closing why are pivots so important? They give us clear areas of supply and demand pre-populated into our charts. They are used by algorithms as areas where they enter and exit positions. They are also signs for retail traders to look for potential reversals.