Most aspiring traders are on the lookout for consistently good indicators that will allow them to obtain an edge in the markets. Pivot Points have been around for a long time and never really fall out of fashion because there were “created by floor traders”.
In this article we shall explore the usefulness of Pivot Points and how you can use them to compliment your own entry and exit methods.
Pivot Points
Pivot points have always been popular tools because they plot static support and resistance levels (valid for the day) which generate a feeling of “comfort” for many traders because they are unambiguous and very evident areas on the chart which allow for clear decision making.
No indicator is perfect, but static levels such as Pivot Points are perhaps more useful than other indicators because they help define risk in a very precise way. Professional traders know that defining risk and having a way to stack the odds in your favour is a key ingredient for consistent trading.
Pivot Points offer an equilibrium starting point based on yesterday’s High, Low and Close. Here is the calculation:
Pivot Point for Today = High (yesterday) + Low (yesterday) + Close (yesterday)/ 3
The pivot point can then be used to calculate estimated support and resistance for the current trading day.
Resistance 1 = (2 x Pivot Point) – Low (yesterday)
Support 1 = (2 x Pivot Point) – High (yesterday)
Resistance 2 = (Pivot Point – Support 1) + Resistance 1
Support 2 = Pivot Point – (Resistance 1 – Support 1)
Resistance 3 = (Pivot Point – Support 2) + Resistance 2
Support 3 = Pivot Point – (Resistance 2 – Support 2)
Obviously you can create the Pivot Points on a Weekly and Monthly basis as well, but in this article we’ll major on Daily Pivot Points, with the objective of building an infrastructure that is useful for intraday trading strategies.
Pivot Point Statistics
Many years ago a study was done by Jamie Saettele on EURUSD. Here is what emerged: since the inception of the euro (January 1, 1999, with the first trading day on January 4, 1999):
- The actual low is, on average, 1 pip below Support 1
- The actual high is, on average, 1 pip below Resistance 1
- The actual low is, on average, 53 pips above Support 2
- The actual high is, on average, 53 pips below Resistance 2
- The actual low is, on average, 158 pips above Support 3
- The actual high is, on average, 159 pips below Resistance 3
Stated otherwise:
- The actual low has been lower than S1 892 times, or 44% of the time
- The actual high has been higher than R1 853 times, or 42% of the time
- The actual low has been lower than S2 342 times, or 17% of the time
- The actual high has been higher than R2 354 times, or 17% of the time
- The actual low has been lower than S3 63 times, or 3% of the time
- The actual high has been higher than R3 52 times, or 3% of the time
Naturally, this kind of work would lure traders to adopt a contrarian approach, looking for shorts at R1/R2 and looking for longs at S1/S2. And while it is possible to benefit from this kind of play (for example, looking for divergences on the 5/15min timeframes around Pivot Points), the risk is that traders get stuck in the contrarian mindset which leads to poor trading habits in the long-term.
A More Useful Approach
Any indicator or strategy that is based on catching tops & bottoms raises more than an eyebrow amongst our traders here at FCI Markets. Traders are much better off learning how to “follow trends” rather than catch turning points.
Many years ago, a trader by the name of Mark Fisher showed a different way of using pivot points. Being a floor trader himself, he greatly appreciated Pivot Points, but he was more concerned about using them to obtain a directional filter.
Enter the 3-day Rolling Pivot.
The rolling 3-day pivot has 1 purpose: to show the balance of power during the past 3 trading days. The kind of information you receive is much more useful now because the pivot is really gauging “micro-trends” in the market which last 2-3 days.
The benefit is self-explanatory: when prices are trading below the pivot, the bias is bearish; when prices are trading above the pivot, the bias is bullish. Compared to the Classic Pivot, the 3-Day Rolling Pivot has more weight because it is based on 3 days’ of trading, not 1.
The Pivot Staircase
One other aspect of the 3-Day rolling pivot (but also of the Classic Pivot) is the fact that it rises or falls in a stair-step manner, and immediately shows traders what direction price has been privileging in the recent past.
As a matter of fact, the directional information offered by the “Pivot Point Staircase” and the “3-Day Rolling Pivot Staircase” can be approximated by a 60 Hour Moving Average!
Now we’re getting somewhere: pivot points can be used as a strong directional indicator. Better yet: we know exactly where the bias changes: on the break of the Pivot!
If you want to learn some simple triggers to help you get into the market in line with the directional indications offered by the Pivot Points, you can find them in our Free Course!
Bonus: Identifying Trend Days with Pivot Points
Last, but not least, I want to share a final benefit of pivot points that I believe has been overlooked by many traders: the fact that Pivot Points allow you to understand when the odds favour a rangebound day vs. when the odds favour a trend day.
In the chart above we have highlighted “inside days”: days when the range between the S1 and R1 are contained within the prior day’s S1 and R1. The kicker is that by today’s close, you already know where the S1 and R1 will be for tomorrow.
When the S1 and R1 are contained within the prior day’s range, it means that volatility has contracted and we should expect a volatility expansion. as such, the rule is clear:
expect a trending day with a volatility expansion when you get a Pivot Point Inside Day.
This little observation offers a great benefit because when you start your trading day you have a clear expectation and your trading strategy will change as a result. Instead of expecting reversals, you will expect breakouts and you will be prepared to play them and follow the market.
Over to You
While there are no magic indicators that offer certainty of results, Pivot Points do have a certain usefulness when it comes to directional bias and volatility considerations.
But the tool is only as good as the trader using it. So now I strongly encourage you to test Pivot Points out for yourself and see whether they can add value to your strategy.
As usual, if you have any questions just get in touch, we’re here to help!