Lessons from the Pros

Pivot Point Analysis

Pivot Point analysis originated many years ago in the grain pits. Before the Pivots, all that the pit traders had to trade off of in reference to yesterday’s range was the sacred High, Low and Close. Pivot Point analysis was designed to give the trader a reference of where today’s prices are in relation to yesterday’s prices. Since traders were not allowed to have electronic devices in the pits during trading hours, this was a big help. Of course, back then, even the smallest electronic device took a table to rest on. The were nothing like today’s micro electronics technology. These numbers were static and would be effective for most of the trading day if not all of it.

The numbers worked so well when they first came out. Then like many trading ideas in the markets, everybody started using them and they lost some of their strength. Also, people started using them thinking that they were going to be the "exact" projected High or Low of the day and the study was used improperly. This just caused more opportunities for the floor traders to fade these levels where the public would Buy or Sell blindly on these numbers. You see, back then we only had a handful of technical studies to look at and a lot of traders. Today, we literally have hundreds of studies to look at. For this reason I believe that some of the more traditional studies are starting to work well again. With much more variety to trade from, the idea of too many people using one tool is not as likely.

Let’s look at the formula for calculating these levels:

By adding these extra Levels to your trading arsenal you will have 8 key Levels for the next trading day. You can actually sort them in this manner so you can see the Levels as price approaches them.

There are many variations on this model. Now some people calculate the Pivot by adding in the days Opening price. So the formula looks like this:

Daily Pivot = (Prev. High + Prev. Low + Today’s Open + Today’s Open) / 4

This variation puts more weight on the day’s opening price. If you get a gap up or down, your R1 level and S1 level can be skewed – meaning that R1 is actually under the Pivot or that S1 is actually above the Pivot. By using the previous day’s High, Low and Close only, you can create a more static set of numbers that the markets will better respect and not be as distorted by gaps.

Another variation people use is taking the Support and Resistance Levels out to 5 or 6 levels. After you exceed the R2 or S2 Level you are basically just multiplying the previous day’s range and adding or subtracting from the Daily Pivot. For example,

R3 = (Daily Pivot + Previous Day’s Range * 2)

R4 = (Daily Pivot + Previous Day’s Range * 3)

This can go on forever. For Support you would just subtract the multiples of the daily range from the Daily Pivot.

Now let’s look at some rules for using these numbers.

• The Regular Trading Hours (RTH) is still the most liquid of all hours traded. This is the time in which the pits are trading simultaneously with the electronic platforms. You want to calculate your Daily Pivots using only the RTH session High, Low and Close. Why? Much like any Support or Resistance level created, the more volume behind the High or Low, the more significant. A Support or Resistance level created at night on maybe 30 – 40 contracts is not going to be as significant as one created during higher volume periods.
• Do not get caught up in the title of the Level. For example, just because a Level says "S1" does not mean it cannot be Resistance at a later point. Just like traditional Support and Resistance price Levels, the Pivot Levels can reverse roles also. One of my favorite setups is old Resistance becoming new Support once it is violated. The same holds true with Pivot levels.
• When using Daily Pivot Levels, look to the left of your chart for price Support and/or Resistance levels to confirm a Level you are looking at.
• You can also use Indicators (Bollinger Bands, Stochastics, RSI, Commodity Channel Index etc.) to time your entries around these Levels.
• These Levels are calculated off of a Daily chart so the larger timeframe Support or Resistance Levels have more impact than just intra-day price levels.
• The Daily Pivot Level acts as a price magnet for the next day’s trading. There is a very high percentage of times that the market comes back to the Daily Pivot and touches it the next day. The Daily Pivot is actually a weighted average of the average price of where most people bought and sold at the previous day.
• Watch the R2 and S2 Levels. The later in the day that these Levels are violated, the better the chances of a market move into the close in that direction.
• Daily Pivots can also be used on Weekly charts to help give you a perspective of where you are trading in reference to last week’s price range.
• If for some reason your charting package does not calculate the RTH Daily Pivot Levels for you, try this website: www.pivotpointcalculator.com

The above chart of the E-Mini S&P shows a typical day of using the Daily Pivot Levels. Notice how the market opened and found good Support at the Daily Pivot. Market then rallied to the R1 level and met Resistance. Later in the day, the market broke the R1 Level and later that R1 Level became good Support for the market to bounce off of. Then a rally to R2 came late in the afternoon.

This is just one tool you can use to help with determining Support and Resistance levels in the markets you trade. As with all tools and strategies, always use stops and good money management. In my trading, I like to keep the Daily and Weekly Pivot Levels handy for the market I am trading. Give these Daily Pivot Levels a try and see if they don’t help give you that little extra edge in trading.

Until next time, I wish you the best in your trading endeavors.

- Don Dawson