Pivot points are areas of support and resistance calculated using the high, the low and the close of the previous day. Pit traders pioneered the use of pivots in order to quickly ascertain areas where intraday reversals might occur. Nowadays they are still employed by countless day traders in the same way.
The three most important pivot levels are the central pivot – abbreviated to ‘PP’, the S1 and R1 levels. Prices often touch and rebound off these points offering traders important reversal levels.
It is said that if the open occurs above the central pivot it gives a bullish forecast for the day and if it occurs below it is a bearish sign, however, this isn’t backed up by research carried out on the S&P 500 which showed no discernible correlation.
S1 is the abbreviation for Support 1 and R1 is short for Resistance 1. S1 is derived by multiplying the central pivot by two and then subtracting the High of the previous day. R1 is derived using the same formula but subtracting the Low of the previous day.
The other pivot levels are S2, S3, R2 and R3. These are situated steadily further away from the price as shown on the chart below.
Pivots can be derived from any time period – hourly, 4-hourly, daily, weekly or monthly. The longer the time period the more robust their potential as levels of support and resistance.
The formulas for calculating pivots are below:
R3 = R2 + Range
R2 = PP + (R1-S1)
R1 = (2*PP) – Low
PP = (High + Low + Close)/3
S1 = (2*PP) – High
S2 = PP – (R1 – S1)
S3 = S2 – Range
S1 and R1 are viewed as more important than the other pivots which are wider apart because statistically price activity tends to stay within the limits they mark more often than not.
Pivot Trading Strategies
One common strategy used by intraday traders is to wait for the price to reach the R1 or S1 levels and then enter a trade in the opposite direction.
This strategy is based on research which has shown that most of the time the high and low of the day occur between the R1 and S1 pivot levels.
The research, carried out on EUR/USD, showed that the average daily high occurs 1 pip below the R1 resistance pivot level, whilst the average daily low occurs 1 pip above the S1 support level.
Indeed on 56% of days the low was above S1 whilst on 58% of days the high fell below R1.
One way in which traders exploit these statistics is to wait for the price to touch the pivot and then anticipate a reversal. So for example if the exchange rate was rising and it reached R1, traders might see this as an opportunity to enter a short position expecting the pair to fall, given it is statistically more likely that the day’s high will be below R1.
However, in order to improve their probabilities of success, traders usually combine the use of pivots with other methods such as Japanese candlesticks. So, for example, a trader might look for a pivot touch to coincide with a reversal candlestick pattern such as a hammer or shooting star before anticipating a reversal.
The diagram below shows how this might happen in practice:
In the chart above note the way prices bounce off the daily S1 and R1 pivots, with the exact points of contact circled.
The points where the touch coincided with a candlestick reversal pattern are pointed to by the arrows – there is a hammer and the following day a shooting star, which results in a steep sell-off.
Another strategy traders use in conjunction with pivots is to look for places where the exchange rate has broken decisively above R1 or below S1. Such a sign might indicate the possibility of strong trending day evolving which the trader hopes to ride the back of.
For example, if there was a strong break above R1 the trader might anticipate a continuation higher and enter a long trade to trade the continuation from the breakout.
Other types of Pivots
So far the article has only described the standard pivot but there are other types of pivots also used by traders.
Camarilla Pivots were originally developed by a trader called Nick Scott who drew inspiration for the name from the idea of a secret ‘cabal’ manipulating the market between various levels.
Camarilla can be created using the following equations:
R3 = C + Range* 1.1/4
R2 = C + Range* 1.1/6
R1 = C + Range* 1.1/12
PP = (High + Low + Close)/3
S1 = C – Range*1.1/12
S2 = C – Range*1.1/6
S3 = C – Range*1.1/4
Like normal pivots the most important levels for Camarilla pivots are the R1 and S1 levels and traders use the levels as potential reversal points.
One key difference with Woodie Pivots as opposed to normal pivot levels lies in their calculation. With Woodie pivots the session open is used in the calculation of the pivot point together with the previous session’s high and low.
R3 = H + 2*(PP-L)
R2 = PP + Range
R1 = (2*PP) – L
PP = (High + Low + (Today’s Open*2))/4
S1 = (2*PP) – H
S2 = PP – Range
S3 = L-2*(H-PP)