In recent lessons we focused on the concepts of Support and Resistance and we saw what factors increase or decrease their significance or effectiveness. These two concepts are preparatory to the topic we are about to discuss in this lesson: the Pivot Point. In fact, what factor is always open to interpretation when dealing with supports and resistances? How to draw the line that identifies them. Now, taking up the simplest concepts in general, what is needed to mark a line? A point. In this case it is the Pivot Point.
To better mark the support and resistance line, practice and experience are needed, but it certainly represents an exciting moment in trading. Let’s call it with its technical name: Pivot Point or PP.
What is Pivot Point?
The Pivot Point is a price level calculated on the maximum price (high), on the minimum (low) price, and on the closing price (close) of the last complete session. For example, if we want to calculate the last Pivot Point, we should take the yesterday’s data and graphs to mark the highest price recorded, the lowest price recorded and the price with which a given currency pair has closed. We need these three elements to calculate the Pivot Point.
The Pivot Point will serve to set up the operation for the next session. Once a session is closed, we can immediately set up the operation of the session on which we will work with other supports and resistances, with other strategies. PPs are therefore also used intra-day and can also be applied to indices and titles.
How to set up the operation with the Pivot Point
Sometimes some terminology can get out of hand, so we specify what was said in the paragraph above. We have specified that once we obtained the Pivot Points, we can use them to set up the operation for the following session: but what does this mean exactly? To give you an example, let’s set up the following:
S1 = Support 1
S2 = Support 2
R1 = Resistance 1
R2 = Resistance 2
AP = Average Price (Average Price)
In an example of setting up an “operation” let’s suppose:
– Buy when you exceed the R1 level with the R2 target
– Buy on the S1 Support with AP lens
– Sell when S1 breaks with S2 lens
– Sell on Resistance R1 with AP target
These are examples, because there are trading systems that work in reverse and therefore reverse the positions shown here. This happens because the possible “congestion” is taken into consideration. The area between S1 and R1 indicates congestion, while the one between S2 and R2 could indicate a fall (in the case of S2) or a rise (in the case of R2) well marked.
How to calculate the Pivot Point?
Now let’s see how the Pivot Point is calculated.
First of all, we need the following data:
- Maximum Price (H);
- Minimum Price (L);
- Closing Price (C)
- The average price (Average Price = AP)
To obtain the Average Price, proceed as follows: AP = (H + L + C) / 3
So if the maximum price (High) is 15, the minimum price is 12 (Low), the closing price (Close) is 14, the average AP price will be given by (15 + 10 + 14) / 3 or 39/3 that is 13.
Now, to calculate the different PIVOT POINT we’ll proceed as follows:
1st Support Pivot: S1 = (2 * AP) – H That is double the average price, minus the highest price recorded in session
1st Pivot of Resistance: R1 = (2 * AP) – L That is twice the price average, minus the lowest price recorded in session
2nd Support Pivot: S2 = AP – (R1 – S1) That is the average price minus the difference between Resistance 1 and Support 1
2 ° Resistance Pivot: R2 = (AP – S1 ) + R1 Or the difference between the average price and S1, added to R1
3rd Support Pivot: S3 = S2 – (H – L) Or S2 minus the difference between maximum and minimum recorded in session
3rd Resistance Pivot: R3 = R2 + (H – L) Or R2 plus the difference between maximum and minimum recorded in session
How to use Pivot Point values
Now that we have seen how to calculate Pivot Points, let’s see how to use them. Let’s take an example with a very used methodology that provides the following rules:
- With the price at the Pivot Point you can expect a move back to R1 or S1
- With the price at R1, you can expect an upward movement up to R2 or down to the Pivot Point
- With the price at S1, you can expect a downward movement up to S2 or upward to Pivot Point
- With the price at R2, you can expect an upward movement up to R3 or down to R1
- With the price at S2, you can expect a downward movement up to S3 or upward to S1
Although it may seem difficult when reading it, you can imagine a chart and understand how in reality it is logical. If I’m at 1, I can go up to 2 or go down to 0. If I’m 2 I can go up to 3 or go down to 1. If I’m at 0 I can go up to 1 or go down to -1.
Understand that in the absence of major changes, prices will move from S1 and R1, to increase in “value” when the markets move with more intensity. Therefore, if talking about R3 and S3 we are talking about a situation or a very volatile market, in which there will be a great potential for gain, but also for loss.
Go to the next lesson – Inflation, Deflation, Recession