Amongst stock market trends and graphs exist pivot points. Traders, especially those who do day trading or trade professionally, like to use pivot points to form quick and accurate judgments about a commodity or financial instrument’s price direction.
Professional traders use pivot points. These points are averages of the previous day’s high, low, and closing prices. It works to set a precise price level from where the largest price movements will be made and allow traders to know when to enter and exit a market.
In this article, you will learn what pivot points are all about, how traders apply them, and how they use additional indicators such as support and resistance levels that come with pivot points when buying or selling any security. Additionally, you will also read on to find why traders use pivot points.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Are Pivot Points?
A pivot point has been used as an essential tool over the decades for a trader when approaching day trading at the stock market. It is defined as a technical analysis tool or indicator that reflects the market’s overall trend over various time frames or levels.
Floor traders have used it and market makers alike to predict the next day’s support and resistance level, ultimately allowing them to know when to enter and exit a market and where to place a stop. The pivot point acts as an indicator around which the next day’s stock trading is expected to occur.
The pivot point functions as an average. In calculation, take stock X, for example. To calculate its pivot point, a trader would calculate the average of the previous day’s high, low, and closing price. Of course, a trader does not have to physically perform these calculations as the trading platform will do it for them. However, it still functions as an essential means of measuring a stock’s price levels.
When the trading point essentially works as an average, it predicts different levels above and below the pivot point itself. Trading above the pivot point is a bullish (positive) trading sentiment, whereas trading below the point represents a bearish (negative) trading sentiment.
Another essential thing to know about pivot points is the additional information they provide in four or more additional resistance and support levels.
What Are Support and Resistance Levels?
We will divert for a second to understand the importance of two levels that go hand in hand with pivot points. With the stock market, traders can make use of as much information as possible.
Technical and mathematical analysis and reading different trends on a chart are beneficial skills for traders. It allows them stronger insights into the price level of a stock and the changes it will experience throughout a range of time.
Traders like to use support and resistance levels as a clear indication of stock price levels. They act as barriers or steps of sorts. Resistance levels are placed above a pivot point, whereas support levels are placed below. Supports represent downtrends; it is the point where the price of a stock stops falling and then begins to rise.
These points of halted movements indicated a contraction in demand. From this point onwards, the fall in price gradually enables a rise in demand for the particular stock. The support level, in essence, acts as a price floor. If a stock is unable to fall below the price of, let’s say, $20, that becomes the support level.
Resistance points are the opposite, representing an upward trend. They function as a price ceiling, a point of resistance through which a stock price cannot get through. Hence, a resistance level is the price level a stock reaches, due to a rise in demand, then begins to fall back down from that point.
Of course, stocks are way too complicated to be restricted to one specific level. Just because a pivot point can indicate support and resistance levels does not mean a stock will entirely fall within its barrier.
Once a stock reaches either a support or resistance level, two things can happen. It will either be unable to break through that limit, and the trend will start moving in the other direction, or the stock will pass through that level and continue its movement upward for a period during which a new support or resistance level will be needed.
Due to this unpredictability of a stock’s price trend, traders prefer to have multiple levels of support and resistance levels to draw better conclusions. Support and resistance levels also end up functioning as psychological barriers for traders. Of course, these levels are already drawn up and placed before them on the trading platform.
A trader sits down and observes the stock trend, noticing which level it cannot violate and which level it breaks through. They will set targets based on these trends; for instance, a trader will be willing to buy stock X only if it reaches a specific resistance level, which, according to the trader, will indicate potential profit if invested in.
Pivot Points for Technical Analysis
Pivot points help in smoothing out the fluctuations in price trends. While support and resistance levels will appear alongside this point, it is essential to indicate the level where the largest price movement is expected to occur. Professional traders deem pivot points as a critical tool for technical analysis in two ways:
- Pivot points average and point out a specific area around which price trends will rise and fall. If the price rises from the pivot point and upwards, the trading security is assumed to be more promising in terms of profit (bullish market). If the price falls below the pivot point and charts on different support levels, then the financial investment is said to have lower returns (bearish market).
- A trader needs to know how the market moves to know when to buy a stock if the price is low and to stop a loss. For instance, a trader may decide to place an order of fifty shares only if the price reaches a support level. Similarly, a trader will stop buying shares once the price reaches a specific resistance level.
Why Do Traders Use Pivot Points?
- Accuracy: Pivot points work on historical trends that reflect existing patterns of prices of a commodity. They are considered one of the best indicators to decide on entry and exit points due to their accuracy.
- Recent timeframe: The data used in calculating pivot points is recent, only moving back as far as a day. Other indicators make use of yearly or monthly data, while pivot points work better on a daily time frame, although they can be calculated for longer and shorter durations as well.
- Easy to comprehend: Pivot points aim to simplify the intricate movements of prices. It automatically appears on most trading platforms and gives the additional benefits of resistance and support levels, allowing traders to formulate better approaches.
- Objectivity: Trading the capital markets is filled with subjectivity. Where one trader sees a potential correction, another might prepare for a rally. Between all this subjectivity, Pivot Points truly stand out as one of the very few objective tools in technical analysis. Where one trader sees a pivot point, every trader using this tool as a method of analysis will see the pivot point.
When Not to Use Pivot Points?
While you can benefit from a pivot point strategy, it should not be all that you have in your arsenal. This is especially true if the peaks and valleys in a stock’s history are narrow. In such a case, you’re at the risk of moving with false signals.
You should also avoid pivot points if exponential breakouts are crucial to your success as a trader. Pivot point strategies usually work best for range-bound trading, and you will leave money on the table if you depend solely on pivot points for taking breakout trades.
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Conclusion
Pivot points are popular amongst both beginner and professional traders. They work on the average of the previous day’s prices, making them accurate and objective. Traders understand overall market trends better with support and resistance levels to make entry and exit points easier to mark.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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