Here's why pivot points are a must for any profitable trading model

Pivot points are the price levels that help traders determine directional movement and potential support/resistance levels of a stock/index. These are calculated considering the open, high, low, and close of the previous sessions. Market participants consider pivot levels as turning points, besides looking at support and resistance.

Avdhut Bagkar | Business Standard
20th November

Market Support

In any charting tool, one would find a minimum of five pivot points, including support and resistance levels. They are calculated as follows:

    S1 (Support 1) = Pivot Point * 2 – Previous High

    S2 ((Support 2) = Pivot Point – (Previous High – Previous Low)

    Pivot Point (P) = (Previous High + Previous Low + Previous Close)/3

    R1 (Resistance 1) = (Pivot Point * 2) – Previous Low

    R2 (Resistance 2) = Pivot Point + (Previous High – Previous Low)

The basic idea is to determine the crucial levels that might trigger major moves in the stock. This could be the support or resistance or even the breaking point. Having such details in advance helps the trader's confidence.

Reversal, on the other hand, shows a complete turnaround in price movement. It depicts the scenario when the price is declining and is an indication that the price is in correction and downside is not capped at any supports. The weakness in price receives added selling pressure when volumes start to surge on a negative close.

Significance of Pivot Points

As the system or the formula brings out the support and resistance levels, the human intervention in this system in determining the outlook is negligible. This helps in taking decisions without any external interference.

The support and resistance levels change with every new session, and while this may not be true for a fortnight strategy, trailing stop loss can help intraday or short term modules. This, in turn, facilitates in building a profitable strike ratio.

Pivot tables may not play as significant a role as candlestick patterns, technical indicators or volume structure in an investment strategy, but they do depict significant levels that can assist in taking an informed decision

How to trade with Pivot Points?

If the stock is trading above the pivot point, it is considered as a bullish sign with S1 and S2 staying as support levels and vice-versa. The targets then would be R1 and R2. Basically, pivot points help frame a stock's outlook before the start of a trading session. They provide pivot levels that help traders determine buy and sell levels. Moreover, these levels do not change during the session.

The efficiency of pivot points increases when combined with moving averages, like the 50-day moving average (DMA), 100-DMA and 200-DMA. One can use pivot points in any of the technical indicators like RSI, MACD, Stochastic, etc. They also assist in Bollinger Band, retracements, Keltner channel.

Market participants study the correlation of short-term pivot levels and medium-term pivot levels for better confirmation of a likely move. These demonstrate the short-term as well as medium-term strength of a stock.

Several studies have invented their own terminology of support and resistance with various modules. Yet, pivot points have kept their accuracy and efficiency high with a simple format, and thus remain a key component in any trading model.

Disclaimer: This information is from a third party—Business Standard—offered through a tie-up to Kotak Securities customers. Click here for complete disclaimer.

The analysis has been done by a Business Standard reporter who is a certified technical analyst. The analysis does not represent the views of Kotak Securities.

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