Technical analysis is a very broad subject that includes many great tools to analyze and trade the financial markets. Successful technical analysis requires one to analyze securities and cross-check their findings using many different market indicators. One such indicator is the Woodie pivot point.
A pivot point is a price level at which market support “pivots” to market resistance. Woodie pivot points are used to determine support and resistance levels in a given market using 3 data points from the previous day: High, Low, and Close. The support and resistance lines are then used to manage trades.
In the article below, we share how you can add Woodie pivot points to your technical analysis toolbox where it can be used to verify continuation or reversal indicators.
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Table of Contents
What Are Woodie Pivot Points?
When considering a pivot point, it helps to think of it in terms of a baseline price level for the day. The actual price of a stock will fluctuate relative to this baseline.
It is basically the average of 3 prices from the previous day:
- The previous day’s high
- The previous day’s low
- The previous day’s closing price
As the price increases above the pivot point, it will approach resistance, and as it drops below the pivot point it approaches to support. The pivot point itself can be either a support line or a resistance line.
Remember, a support line indicates a price level at which buying pressure can influence prices; based on the previous days’ trading history.
Similarly, a resistance line indicates the opposite: selling pressure.
So, if the price is trending downwards towards the pivot point, you can consider the pivot point a support line. Conversely, if it is trending upwards towards the pivot point, it may act as a resistance line.
Woodie pivot points are but one type of pivot point among a few others.
- Standard Pivot Point (“Floor-traded”)
- Camarilla Pivot Point
- Fibonacci Pivot Point
In each of these methods, the pivot point is the average of the previous day’s high, low, and close. The only difference lies in how the projected support and resistance lines are calculated, and how many of these are there. Woodie pivots, as with the rest, are used to indicate one of two things:
- A price trend reversal
- Or a price trend continuation
The support lines calculated by the Woodie pivot method can be used to verify other technical analysis indicators. And because the pivot point is calculated based on the previous day’s trading data, it makes them a good tool for short term traders.
Before we get into trading with them, let’s first discuss how to calculate them.
Calculating Woodie Pivot Points
The formulas to calculate a Woodie pivot point and its support/resistance lines are quite simple. Before we get to the “how” though, let’s talk about “what” we’re calculating.
Composition of Woodie Pivot Points
A Woodie pivot point indicator is made up of the following:
- The pivot point itself
- Two to three support lines
- Two to three resistance lines
The support lines are at some price level above the pivot point, and the resistance lines are at some price level below it.
Woodie Pivot Point Setup Calculations
The pivot point and its support/resistance lines are calculated using the formulas below:
- PP = (H + L + 2*C) / 4
- R1 = (2*PP) – L
- R2 = PP + H – L
- R3 = H + 2*(PP-L)
- S1 = (2*PP) – H
- S2 = PP – R1 -S1
- S3 = L – 2*(H – PP)
Where,
- H is the previous day’s price high
- L is the previous day’s price low
- C is the previous day’s closing price
- PP is the pivot point
- R1, R2, R3 are resistance lines 1, 2, and 3, respectively
- S1, S2, S3 are support lines 1, 2, and 3, respectively
Once these lines are calculated and plotted onto a price chart, the support and resistance lines can be put into context and interpreted.
Interpreting Woodie Pivot Points
The first thing you’ll want to do is identify the price trend. This can be done just by looking at the price chart, but the actual pivot point itself can be a bit more telling. The amount of trading happening above or below the pivot point will indicate either bullish or bearish behavior.
Investopedia puts it simply:
- “When the price of an asset is trading above the pivot point, it indicates the day is bullish or positive.
- When the price of an asset is trading below the pivot point, it indicates the day is bearish or negative.”
Volume can be used to confirm the bullish or bearish tendency your pivot point is indicating, more on that later when we discuss the reliability of Woodie pivot points.
Now that you’ve identified the trend, your support and resistance lines exist within a context. Support and resistance lines can only exist relative to the existing price and the current trend. Calculating these lines with data from the previous day is what puts them into context.
So How Do I Read the Support and Resistance Lines?
Great question. You read it as indicators of a price trend reversal or continuation.
Let me explain. As the day goes on, the price of the asset you’re watching will fluctuate, bounce up and down, if you will. What you are looking for are “bounces” off of the support and resistance lines. A bounce at a support/resistance line is the reversal you’re looking for. Simply put:
- When observing a reversal at a support line, buy.
- When observing a reversal at a resistance line, sell or short.
It’s also worth noting that each support and resistance line carries a different “weight.” The farther the support line is from the pivot, the more bearish the market environment. The same goes for resistance lines that include:
- Resistance Level 3: Extreme bullish market condition
- Resistance Level 2: Bullish market condition
- Resistance Level 1: Mild bullish turning bearish market condition
Each support and resistance line is an indicator of the intensity of buying/selling pressure at a given price. The higher the pressure, the more likely the price is to “bounce” off the line.
How Reliable Are Woodie Pivot Points in Trading?
This is pretty tricky when the only thing you are paying attention to is price relative to the support/resistance lines, though.
On their own, the pivot point and support/resistance lines are not very reliable. They do not guarantee a price reversal.
Improving Reliability of Woodie Pivot Points in Trading
A resistance line by itself is not a hard barrier that guarantees the price will stop rising and start falling on a dime. Similarly, a support line alone does not guarantee the falling price that you just bought will instantly turn around.
To improve the reliability of Woodie pivot points, they must be used in conjunction with other technical analysis indicators.
John L. Person writes about this in Candlestick and Pivot Point Trading Triggers:
“…when you apply more layers of analysis, such as candle patterns and a moving average approach of the pivot point, that is where you will improve on your trading decisions….”
The reliability also depends highly on the trader themselves. This means try it out. Add pivot points to your analysis algorithm and test it with simulations. Measure the reliability of your existing analysis method. Do this
- Woodie Pivots vs. without Woodie pivot points and support/resistance lines
- Woodie Pivots vs. other means of projecting support/resistance lines
The reliability of Woodie pivot points will improve when they are fit into your existing trading method, tested, and calibrated.
How to Trade Using Woodie Pivot Points?
Now that we understand the fundamentals of what a Woodie pivot point is, and how to interpret one, let’s get into how to use one to inform trades.
Basic Strategy
As with any trade, you’ll want to follow similar steps:
- Understand the current market environment
- Identify an area of value in the market
- Determine trade entry and exit price points
- Execute trade
Woodie pivot point lines can be used to help you identify the criteria above. Here’s how.
Market Environment
Successful traders are always aware of the current market trend. Uptrend (bullish) or downtrend (bearish)… how can you tell?
There are tons of ways, the simplest of which is just observing the chart over time. However, this is a bit more difficult when the trading window we are working with is only a day or two. This is where woodie pivot points help.
If the price is approaching the pivot point from above, the trend is bearish. If the price is approaching it from below, the trend is bullish.
It was mentioned earlier, but it’s worth mentioning again. The farther the price gets from the pivot point, the more intense the opposing pressure becomes. A bullish run will experience the most bearish pressure as it approaches Resistance Level 3.
Identify and Confirm Trade Opportunity
With Woodie pivot points on your chart, your trade opportunities will exist at or near the support and resistance lines.
Use other patterns such as candlestick patterns or chart patterns to identify price reversals or continuations. If a reversal or continuation exists at a support or resistance line, chances are you’ve identified an area of value at which to make a trade.
Determine Trade Entry and Exit
The area of value above is considered your trade entry point. Depending on the trend and the direction of the reversal, you would choose to buy or short a security.
Similarly, use the support and resistance lines to determine your exit point (take profit and stop-loss levels). For example, if the price is trending up when you buy, a sensible take profit level could be the next resistance line up. Similarly, set a stop-loss in relation to the nearest support or resistance line below your entry point.
Execute and Manage Trade
When placing your order, be sure to include the stop-loss level. Most trading platforms will allow for an automated take-profit level as well.
Once you’ve entered the trade, continue to monitor price levels in relation to the support/resistance lines.
A good example is to watch as the price approaches your take profit level. If you see a continuation pattern where you were expecting a reversal, it may be an opportunity to adjust your initial take-profit and let it ride.
Advantages and Limitations of Trading Using Woodie Pivot Points
Just like any other tool in technical analysis, Woodie Pivot Points come with their own set of advantages and limitations. When leveraging these levels to inform trading decisions, it is critical that you account for these pros and cons of Woodie Pivot Points.
Therefore, in the following sections, let us discuss some of the most critical advantages and limitations of this analysis tool.
Advantages of Trading Using Woodie Pivot Points
Listed below are the primary advantages of trading with Woodie Pivot Points –
- In calculating these levels, higher weightage is given to the most recent price changes. Hence, on relative terms, these pivot points are more suitable in volatile markets.
- These pivot points react quicker to changes in price direction and are thus favorable for short term trading.
- These levels are easy to implement and integrate into an existing trading strategy, and thus great at improving the reliability of your trading decisions.
Limitations of Trading Using Woodie Pivot Points
Listed below are the primary advantages of trading with Woodie Pivot Points –
- On relative terms, Woodie Pivot Points are not as suitable for long-term investors and traders.
- These levels work great in combination with other analysis tools, but will rarely result in profitable trading as a stand-alone assessment tool.
- To successfully trade using these levels, one needs to have a basic understanding and strategy around trading support and resistance levels.
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Conclusion
Support and resistance lines are key terms when speaking the language of technical analysis. A Woodie pivot point is one of many methods to derive these lines and is particularly well suited for short-term day trading.
Hopefully, in addition to teaching you how to calculate them, this article has shed some light on their meaning as well.
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