Commander in Pips: Before shifting to strategies directly, let’s lay out the rules that have to be applied to the general use of Pivot points:
1. It is preferable to use pivot points 1 time frame higher than that of your trading time frame. If you trade on the daily time frame – use weekly pivots, if you trade on the weekly time frame – monthly. If you trade intraday – you may use daily pivot points as well;
2. Higher time frame pivots are very important for lower time frames. Say if you trade on 30-min charts it does not mean that you should not take into consideration weekly pivots and focus on daily ones only. You have to know where weekly and monthly pivots are even if you trade on 5-min charts.
3. Application of daily pivot points is not spread wide. Some traders use them, but they are much weaker than weekly and monthly. I also very rarely use them. But this is personal – if they work for you – use them!
4. It’s usually assumed that pivot resistance 1 estimates the high for the period and pivot support 1 estimates the low for the period. For example, if we talk about week, then weekly resistance 1 shows the potential high for the week, and weekly pivot support 1 shows the potential low. The same for monthly pivots. But this is just an assumption and not a rule of thumb.
5. Usually the market trades pivot points during the period with a probability around 70-80%. It means that the probability of touching the weekly pivot point by the market during the week is 70-80%. So, if you intend to enter long, but the market stands above the pivot and has not touched it yet – the probability on your side. Possibly you will get much better entry point, when market tends to pivot point. The same is true for downward scenario.
6. When market retraces during a long-term bull trend on the daily chart – it usually retraces to the weekly pivot point or weekly pivot support 1. If market breaks pivot support 1 after a strong up trend – it could be an early notification about breaking of the previous tendency.
7. When market retraces during long-term bear trend on daily chart – it usually retraces to the weekly pivot point or weekly pivot resistance 1. If market breaks pivot resistance 1 after strong down trend – it could be an early notification about breaking of the previous tendency.
8. Pivot point, resistance 1 and support 1 are the most important levels, others have much less importance.
9. Combination of pivots with Fib support/resistance, common support/resistance or overbought/oversold areas makes them stronger.
10. If the market hits some important Fib extension target (usually 1.0 or 1.618) at oversold/overbought area and then moves below/above weekly pivot point – it tells that retracement has started and the move could be very strong;
11. You may understand why does the market take a directional move or retracement move by applying pivot points. If the market does not touch weekly pivot supports 1 in an up move on daily chart or pivot resistance 1 in a down move and weekly pivot point holds market – then the market isin a directional move. If the market reaches support 1 during up move or resistance 1 in a down move – hence, market falls into retracement.
12. If the market stands near the pivot point on Monday – it’s better to wait while it will test it during the US trading session and choose the direction before entering the market.
13. If the market shows a strong bull/bear trend during a number of weeks on the daily chart when price rarely has touched even weekly pivot points and then the market turns to sideways consolidation, forms some bearish/bullish reversal pattern (engulfing for instance) inside this consolidation and close below/above weekly pivot – it could warn about a future strong downside/upside move.
14. If the market shows a strong bull/bear trend during a number of weeks on the daily chart when price rarey has touched even weekly pivot points then market close below/above weekly pivot and during of week after that reaches support2/resistance 2– it could tell trend reversal;
15. If market reaches upward 0.618 Fib extension target at the end of the week and next week’s pivot stands near close price – you may use price action around it as a filter – will market go to 1.0 extension or not. If market will move and hold above weekly pivot on Monday, then probably the next target is 1.0 Fib extension. The same is true for downward move.
16. Pivot point is a market sentiment indicator. If the market flirts with pivot but holds above it, then the market has bullish bias, if it moves below th pivot and holds there – bearish bias. Hence:
17. And the most important rule:
- NEVER STAND AGAINST THE PIVOT! –
If market is above the pivot – do not enter short, if it below it – do not enter long. This rule is applicable to corresponding time frame. If, say, market moves far above Weekly Pivot point and reaches Weekly Pivot resistance 1 or 2 – you could count on and wait for retracement lower to enter Long in terms of daily time frame (i.e. you should not enter short). But you also could do intraday bearish scalp trade – there is no problem with it.
Commander in Pips: Heh, son, you act like you want FX Warrant Officer Rank. There will not be simple topics ahead anymore.
Pipruit: You always know how to cheer us up, Commander. Thank you.
Commander in Pips: You’re welcome. And now let’s shift to strategies.
Range trading with pivots
This strategy could be applied at relatively calm market and it’s based on points 4, 6 and 16 of our general rules.
We will mostly use weekly pivot points and sometimes monthly. So, here blue line stands for weekly pivot point, red line stands for weekly pivot resistance 1, lime line for weekly pivot support 1 and long gold line for monthly pivot.
Akin situation you can see during the next week. We see a bull trend, but the market stands far above the WPP. According to Rule 5 we can count on retracement till WPP with 70-80 % probability – this is what we want! When market has flirted with WPP, tested WPS1 and returned right back – it tells that we can enter Long (bar with circle). Weekly sentiment is bullish, and potential target is WPR1. As you can see, market has hit it.
The same analysis could be applied to weekly chart with monthly pivots as well.
Another problem with this major approach is that you never know – is it calm market or not, does market in directional move or not etc. So, it’s better to use Pivot points just as support and resistance lines, almost like Fib retracement levels. Yes, Pivots have some additional qualities, but in general they are just another excellent leading indicator.
Pipruit: So, it means that we should use it in some context, do we? And pivots are just a fragment in overall analysis?
Commander in Pips: Absolutely. Will you buy or sell, just because of support or resistance? I think not. We should wait for some confirmation of this level that could come from some pattern, trend or something. Only after that we can pull the trigger and enter the market. So, the same is with Pivots. The only difference is that they could give us some additional clues about the overall situation. Hence you will place your stop-loss order depending on trigger that you follow. If this is candlestick pattern – you will use one rule, trend – second rule, Fib levels – another rule etc.
Trading breakouts of different pivot lines
As you know I’m not the big follower of breakout trading. In fact, all that we’ve discussed in topic dedicated to support/resistance line trading and rectangle trading is applicable to pivot trading. Pivots are just another sort of support and resistance, but they are support and resistance. Professionals rarely trade breakouts as the public does. If they expect some breakout - they prefer to have a position prior the breakout itself or open one on some retracement following the breakout to be a very wise rule – “Buy deeps and Sell rallies”. That’s why they are absolutely calm during the breakout and leave all turmoil to the public. Market makers also like it when the public trade breakouts, because the public open positions right before, at or right after the breakout. Thus lets market makers make some fakes to grab the public’s stops.
So, there are a couple of ways to trade breakouts – aggressive and conservative. The aggressive way assumes that you enter right at the moment of breakout, while conservative way suggests that you enter in the direction of a breakout during the first retracement back towards the broken line.
The aggressive way has only one advantage, compared to the second, conservative way. It allows you to take a position if the market will not show any retracement after breakout.
The second way is safer and closer to what professionals do. Also with the second approach you can place a tight stop. The weak moment is that sometime the market will not show this retracement and continue to move higher.
When you need to make such choice always follow the rule – “Loss of possibility is preferable to loss of capital”. From this standpoint the choice is obvious.
Pipruit: Your explanation is so logical and simple. Thanks.
Commander in Pips: Ok. Now let’s discuss some technical momentum of breakout trading. As we’ve pointed out, the trading of pivots breakout has much similarity with trading rectangles. For that purpose we should look at couple of pivot lines as a rectangle, although not in term of price action but in term of borders placing. Say, WPP and WPS1, or WPP and WPR1 and so on. We need this for better explanation where to place stop loss order.
The second example is a breakout of WPS1. Here, if you apply conservative approach – you’ve gotten a perfect entry during retracement back to WPS1 (here it will act like resistance now) in a calm environment and also you can place tight stop – just above the broken line. Because if the market will return back, it tells that this was a false breakout. Applying the aggressive way here will lead to almost the same entry point, but your stop will be placed two times higher.
Commander in Pips: The reason for that is a growing volatility during breakout, because there are a lot of orders for execution that come around the border and if you place your stop too close – you could be stopped out occasionally and maybe not even stay in once. Here you see that it could be done during WPP breakout (first rectangle) by rearview, but in a real time environment you will not have enough confidence to do it. Also the aggressive way is very sensitive to false breakouts:
Chart #3 | 60-min EUR/USD and Weekly Pivots
See – the same as with any support/resistance or rectangles. Applying here the aggressive entry tactic will lead you to loss. Although, I have no doubts that you’re a very smart guy and possibly will move your stop to breakeven during the second breakout. Also, take a look – the market has shown a breakout just due to accomplishment of 1.0 Fib extension target. I just want to keep you up, so that you do not relax too much. Remember, we’ve discussed this already?
Commander in Pips: Right. Here is the clue, by the way, how you can anticipate the breakout’s nature. If the market has shown breakout, hit the target and continue the move - then possibly this is a real break. If it returns right back – then it just has accomplished a Fib extension target.
Another important note about pivot breakout trading is to watch – does some strong Fib levels or common support/resistance stands near the pivot or not:
Pipruit: Thanks Commander, I’m really forgotten that bit. Looks like I can’t relax even for 1 second during trading. Curious but my attention is sufficient only to current material that we study, and I do not think about other tools and how could I apply them in current situation. I am a bit upset.
Commander in Pips: Don’t worry with that. This is just a lack of practice. When you start to apply all our methods in a calm environment in your trading room – you will be able to do that, and even better.
Pipruit: Commander, can we take a loss even if we apply the conservative entry tactic?
Commander in Pips: Absolutely, because we always can take a loss. This is the market – probability business. It based not on each particular trade, but on probability. If some tool has positive math expectation function – you will make money applying it, although catch losses in a number of trades. But also if you will apply a tool with negative expectation function – you will gradually loss your money, although in some trades make profit.
Here is some additional advice to breakout trading:
1. Before entering the market be sure that beyond the border that you expect will be broken there are no strong areas of support/resistance, targets or oversold/overbought areas. They could lead to fake outs – as on chart #4.
2. Apply all tools that you know to make as safe an entry as possible and place as close of a reasonable stop as possible. This could be trend, oversold/overbought, patterns etc. Say, if the market shows upper breakout but hits overbought – there is great probability that this break will fail. Especially if it has formed a bearish engulfing pattern on the next day after the breakout (in terms of the daily chart).
3. Despite the way of entry you choose – you never know with certainty if the move will continue or not.
4. It’s better to stay aside of breakout trading during news or macro data releases, while this is not your trading strategy. Because this is really doom and gloom environment that leads to multiple spikes, fake outs and volatility increasing. So – always keep an eye on macro data time & date schedule.
Estimation of market sentiment with Pivot points
Well, partially we’ve talked about it already. So let’s shortly repeat the most important thoughts:
1. There is great probability that the market will touch the Pivot point during the trading period – WPP during the week and MPP during the month. We can say, that market tends to pivot’s first touch;
2. In the beginning of the period (week or month) – look how the market will behave around the pivot. If market flirts with it, moves above and holds – sentiment is bullish, otherwise – bearish;
3. Sentiment in the beginning of the period does not mean that it should hold constant during whole period. It could change, for example due to some data release;
4. Keep in mind the overall market environment. Let’s suppose that market’s solid long-term trend on daily chart. It means that usual price action – pivot touch & go. If it has not happened and market moved below pivot during current week – it does not mean that trend has been broken. It just tells us that that possibly the market has turned to deeper retracement to WPS1. The same is true for downtrend and WPR1. Here you should apply our rules 5,6,7, 11 and 14;
5. Don’t make application of Pivot too simple. This is not the rule as “market above the pivot – buy, and below pivot – sell”. Use it as a part of overall analysis.
How to use pivot points in trading?To effectively use pivots in trading you need to follow a few very simple rules:
Rule #1. Use Pivot levels of higher time frames – weekly and monthly pivots on the daily chart, weekly and daily pivots on the intraday charts, etc.
Rule #2. Watch where price stands in relation to the pivot fulcrum and do not open positions against the pivot. If the rice is above the pivot fulcrum – do not go short, if the price is below – stay away from longs.
Rule#3 Pivot point levels are just the same support and resistance lines, so use them in the same manner. General rules of application suggest:
- Sell at Pivot resistance with placing stop loss slightly above it
- Buy at Pivot support with stop loss slightly below it
How do pivot points work?There are two major applications of pivot points in trading:
Pivot points are a very valuable tool in trading, because they are a real leading indicator. Traders know the value of the pivot points in advance as they are calculated on the previous time period. For example, on Monday we already know the values of the pivot points for the entire week ahead. It means that we already know where support and resistance will be in advance of the actual price action.
The classic Pivots are used most often. They are calculated based on High, Low and Close price of previous time frame as follows:
There are different type of Pivot points calculations, such as Fibonacci pivots, Woodie Pivots, DeMark pivots and some others. But they are rare used in practice.
Pivot point sentiment analysis is very simple. The rule of thumb is “Just don’t trade against the pivot”. Pivot point level works like a barrier between bullish (above the pivot) and bearish (below the pivot) sentiment. Once price breaks above the pivot level, it means that the sentiment is mostly bullish and one should not consider taking the short position. The same is true for the downside pivot point breakout. In this case sentiment stands bearish and it is better not to go long. This explains why the first thing that experienced traders do – they watch how the market reacts to the pivot point at the first touch.
In trading Pivot points or Pivot levels are primarily used as leading indicators. Since levels are calculated on the price data of the previous time frame – they show in advance where support and resistance are going to be. There are few major features of the pivot points:
- Pivot fulcrum point when first touched by the price should be treated as support/resistance area, depending the direction of price action;
- Market direction after testing of the Pivot fulcrum shows market’s sentiment;
- Pivot fulcrum works as a magnet and price tends to touch it, at least once through the time period. Thus, if we have weekly pivot fulcrum – price tends to test it during the week;
- Upside pivot fulcrum breakout suggests that market moves to Pivot Resistance 1 while downside breakout suggests action to Pivot Support 1;
- Using pivot levels as trend validity indicator. When market is in the upside retracement during the downtrend then Pivot resistance 1 should hold this retracement. Otherwise, breakout of pivot resistance 1 becomes the first sign of the trend changing into bullish;
- When market is in the downside retracement during the uptrend, then Pivot Support 1 should hold it. Otherwise, breakout of pivot support 1 becomes the first sign of the trend changing into bearish.
- Most common application – Pivot support 1, 2 and 3 levels work like support where trader could consider entering the long position with stop loss slightly below the level. While pivot resistance 1, 2 and 3 levels work like resistance where trader could enter the short position with stop just above the level.
- Traders are rarely using pivot levels as a single tool for the decision making. Usually they combine pivots with other tools of technical analysis to increase performance and reduce the number of losing trades.
Combine pivot levels with other technical tools – Fibonacci levels, trend lines, Candlestick patterns and others to make them more efficient.
How do you calculate a pivot point?Classic Pivot points are the ones most often used in trading. Pivot point (PP) is calculated as follows:
Pivot t = (High t-1 + Low t-1 + Close t-1)/3
(t-1) suffix means the High Low and Close price of previous trading period.
PR1 = 2xPP – Low
PS1 = 2xPP – High
PR2 = PP + (High – Low)
PS2 =PP – (High – Low)
PR3 = High + 2x(PP – Low)
PS3 = Low – 2x(High –PP)
When can you buy with pivot point?
With all other things being equal, trader could consider “Buy” opportunity around Pivot Support levels with placing stop-loss order slightly below it.
Note, Pivot points are rarely used as the only tool for decision making and almost always combined with other tools of technical analysis. This is done to reduce the number of losing trades. Please remember, as with any other support/resistance levels, pivot levels could be broken and using the single single analysis tool for decision making is too risky.
Together pivot pints and these other tools are becoming the part of the trading system.
Do pivot points work?
Actually they do. Pivot points are not just the tool of technical analysis but also have relation to statistics. Pivot fulcrum level is a kind of a mean value of the previous session while pivot resistance 1 and pivot support 1 work in the same way as a standard deviation from the mean value.
Pivot support and resistance levels form specific range, a kind of confidence interval around the pivot fulcrum. Inside this range prices should remain with the higher probability than on the outside. That’s why when price hits pivot support or resistance – it feels like a barrier and reacts on it. Pivot levels have the same feature as the Bollinger bands indicator around the moving average and market meets real resistance and support at pivot levels.
How are Fibonacci pivot point calculated?
Fibonacci Pivot levels is a mix of the classical pivot approach and the camarilla approach. Classical calculation meets with specific multiplier ratios (similar to the camarilla multipliers use), but in this case they are the Fibonacci ratios.
Below are the formulas for Pivot Resistance levels around Pivot Fulcrum (R1, R2 and R3) and Pivot Support levels (S1, S2 and S3). High, Low and Close prices stand for previous time period as with the classic pivot points.
R3 = PP + RANGE * 1.0
R2 = + RANGE * 0.618
R1 = PP + RANGE * 0.382
PP = (High + Low + Close) / 3 RANGE = HIGH – LOW
S1 = PP – RANGE * 0.382
S2 = PP – RANGE * x 0.618
S3 = PP – RANGE * 1.0
How do you use weekly pivot points?
Pivot points are the great technical analysis tool and one of the real leading technical indicators. Pivot levels have a few of the little known interesting specific features beyond the widely used support and resistance. So, here is how I use them:
- I use higher time frame pivots, ignoring pivots of the same time frame. Thus, on the daily chart I use weekly, monthly and yearly pivots; on the intraday charts – daily and the higher time frame pivots;
- Pivot fulcrum works as a magnet and price tends to touch it, at least once through the time period. Thus, if we have a weekly pivot fulcrum – price tends to test it during the week;
- At the first touch of pivot fulcrum it works like support or resistance, depending on the side price touches it;
- Market direction after testing of Pivot fulcrum shows market’s sentiment. The rule of thumb – do not stay against the pivot. If price breaks above the pivot – don’t be short, if it breaks pivot fulcrum down – don’t take long position;
- Upside pivot fulcrum breakout suggests that market moves to Pivot Resistance 1 while downside breakout suggests the price movement to Pivot Support 1;
- Use pivot levels as trend validity indicator. When market stands in the upside retracement during the downtrend then Pivot resistance 1 should hold this retracement. Otherwise, breakout of the pivot resistance 1 becomes the first sign of trend changing into bullish;
- When market stands in the downside retracement during uptrend then Pivot Support 1 should hold it. Otherwise, breakout of the pivot support 1 becomes the first sign of trend changing into bearish.
- Finally, despite all virtues of the pivot levels are, do not rely exceptionally on them. Use them together with other technical analysis tools in your trading arsenal. This should reduce number of losing trades and increase your performance
What is a daily pivot point?
A daily pivot point is a Pivot fulcrum level that is calculated based on High, Low and Close prices of previous trading day.
Daily Pivot (t) = (High t-1 + Low t-1 + Close t-1)/3
Where (t-1) suffix means the High Low and Close price for the previous trading session
For example, if during the yesterday’s trading session we had High = 1.0896; Low = 1.0811 and the Close price = 1.0818 for EUR/USD, then today’s daily Pivot fulcrum is: (1.0896+1.0811+1.0818)/3 = 1.0842