Introduction to Pivot Point Trading Strategies
Pivot point trading is a popular method among traders which uses specific points on a chart to determine potential support and resistance levels. It’s a technique mostly used in forex trading, though it can be applied to stocks, commodities, and other financial instruments. The concept hinges on the idea that prices tend to move around a central point, or ‘pivot’, and this pivot point can be used to make predictions about market movement. This strategy can be particularly useful in identifying entry and exit points and setting stop loss and take profit orders.
Calculating Pivot Points
Before diving into pivot point trading strategies, it’s crucial to understand how to calculate a pivot point. The classic pivot point formula takes the high (H), low (L), and closing (C) prices of the previous period to calculate the pivot point (P) for the current period.
Formula:
P = (H + L + C) / 3
To gain a comprehensive insight into market movements, additional support (S1, S2) and resistance (R1, R2) levels are also calculated using the pivot point (P).
Calculating Support and Resistance levels:
R1 = (2 * P) – L
S1 = (2 * P) – H
R2 = P + (H – L)
S2 = P – (H – L)
This basic understanding is essential as the foundation upon which various pivot point trading strategies are built.
Basic Pivot Point Trading Strategy
The most straightforward strategy using pivot points involves trading directly based on the pivot level itself. In this approach, the pivot level serves as the primary indicator for making buy or sell decisions.
Buy Signal:
A trader would consider a buy signal when the price of the asset moves above the pivot point, indicating an upward trend.
Sell Signal:
Conversely, a sell signal is considered when the price falls below the pivot point, hinting at a potential downward trend.
This strategy is most effective in markets with a strong trend, and less so in range-bound markets.
Pivot Point Breakout Strategy
Another popular method is the pivot point breakout strategy, which is especially useful in volatile markets. This tactic involves entering trades as prices break through the pivot point levels.
Buying on a Breakout:
Traders might enter a long position as the price breaks through a resistance level, looking for the upward momentum to continue.
Selling on a Breakout:
Similarly, they might enter a short position as the price breaks below a support level, anticipating further declines.
This strategy requires careful risk management, as false breakouts can lead to significant losses.
Pivot Point Reversal Strategy
The pivot point reversal strategy is based on the idea that once a pivot level is tested and held, the market will reverse direction. This approach seeks to capitalize on these moments of reversal.
Reversal at Support:
If the price approaches a support level and then starts to move upwards, traders might take this as a signal to buy, expecting the upward trend to continue.
Reversal at Resistance:
Conversely, if the price hits a resistance level and then begins to decline, this could be seen as an opportunity to sell, with the anticipation of a downward trend.
Just like any trading strategy, confirmation from other indicators and appropriate risk management should be applied to enhance the trading outcomes.
Conclusion
Pivot point trading strategies offer traders a mathematical-based approach to trading that can be invaluable in identifying potential entry and exit points. By understanding and applying the concepts of pivot points, support and resistance levels, and incorporating other technical indicators for confirmation, traders can develop a robust trading strategy. Nevertheless, it’s critical to remember that no strategy guarantees success and risk management principles should always be in place.
