Using 'Pivot points' in Day-trading

Who uses? Originally used by floor traders.

What it indicates? Some idea of where the market was heading during the course of the day.

Definition: The pivot point is the level at which the market direction changes for the day.

Using some simple arithmetic and the previous day’s high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels

Why so popular? The reason pivot points are so popular is that they are predictive in nature.

As one said that history repeats itself (sometimes rather).You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).

Calculations:

Resistance 3 = High + 2*(Pivot - Low)
Resistance 2 = Pivot + (R1 - S1)
Resistance 1 = 2 * Pivot - Low
Pivot Point = ( High + Close + Low )/3
Support 1 = 2 * Pivot - High
Support 2 = Pivot - (R1 - S1)
Support 3 = Low - 2*(High - Pivot)

If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to look for a reversal or break of R1 or S1. By the time the market reaches R2, R3 or S2, S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

For example,

On the 12th August 09 the Euro/Dollar (EUR/USD) had the following:
High - 1.2297
Low - 1.2213
Close - 1.2249

This gave us:

Resistance 3 = 1.2377
Resistance 2 = 1.2337
Resistance 1 = 1.2293
Pivot Point = 1.2253
Support 1 = 1.2209
Support 2 = 1.2169
Support 3 = 1.2125

Pivot points can be used in two ways.

The first way is for determining overall market trend: If the pivot point price is broken in an upward movement, then the market is Bullish, and vice versa. Keep in mind, however, that pivot points are short-term trend indicators, useful for only one day until they need to be recalculated.

The second method is to use pivot point price levels to enter and exit the markets. For example, a trader might put in a limit order to buy 100 shares if the price breaks a resistance level. Alternatively, a trader might set a stop-loss for his active trade if a support level is broken.