Pivot Points & Trendlines

Pivot Points and Trendlines are foundational tools in technical analysis, widely used by traders to identify support and resistance levels, as well as trend direction. Both indicators provide insights into potential price movements, helping traders make informed decisions about when to enter or exit a trade. In this article, we’ll explain how Pivot Points and Trendlines work, how traders interpret them, and how they can be combined to develop effective trading strategies.

What Are Pivot Points?

Pivot Points are a widely used technical indicator that helps traders identify key levels of support and resistance. These levels are derived from the previous day’s high, low, and closing prices. Pivot Points are used in a variety of trading strategies, particularly for day traders who aim to capitalise on short-term price movements.

The main pivot point (P) is calculated as the average of the high, low, and close from the previous trading day:

P = (High + Low + Close) ÷ 3

From this central pivot point, several support and resistance levels are calculated:

• Resistance 1 (R1) = (2 × P) – Low
• Resistance 2 (R2) = P + (High – Low)
• Support 1 (S1) = (2 × P) – High
• Support 2 (S2) = P – (High – Low)

These levels act as price boundaries, with R1 and R2 acting as resistance and S1 and S2 acting as support.

Image Courtesy: Tradingview

How to Interpret Pivot Points

Pivot Points are primarily used to determine support and resistance levels. Traders can use these levels to anticipate potential price reversals or breakouts.

1. Identifying Support and Resistance

• Support Levels: S1, S2, and S3 represent levels where the price may find support and potentially rebound.
  

• Resistance Levels: R1, R2, and R3 are levels where the price may encounter resistance and potentially reverse downward.
  

2. Price Breakouts

If the price breaks above R1 or below S1, it suggests the market has enough momentum to break out from the previous range, potentially signalling the beginning of a new trend. Traders often wait for confirmation before acting on these breakouts.

3. Pivot Points as Targets

Pivot Points can also be used as profit targets. For example, if a trader enters a long position, they might set their exit target at R1 or R2, depending on the strength of the trend.

What Are Trendlines?

Trendlines are one of the simplest yet most effective tools in technical analysis for identifying trend direction. A trendline is drawn by connecting two or more significant highs (in a downtrend) or lows (in an uptrend). By extending these lines, traders can project potential future price movements.

Trendlines help traders visualise the overall direction of the market—whether it's moving upward, downward, or sideways.

Image Courtesy: Tradingview

How to Interpret Trendlines

1. Identifying the Direction of the Trend

• Uptrend: In an uptrend, a trendline is drawn by connecting two or more significant lows. The price generally respects this line as support, bouncing off it multiple times.

• Downtrend: In a downtrend, a trendline is drawn by connecting two or more significant highs. The price often respects this line as resistance, falling back after touching it.

2. Trendline Breaks

A break of a trendline often signals a potential reversal in the trend direction. For example, if the price breaks below an uptrend line, it could indicate that the bullish trend is losing momentum, and a reversal to the downside may follow. Similarly, a break above a downtrend line could signal a new bullish phase.

3. Confirming Trends

Trendlines can also be used to confirm the strength of a trend. A steep trendline indicates a strong trend, while a shallow trendline suggests that the trend is weakening. Traders may also look for multiple touches of the trendline as confirmation of its significance.

How Traders Use Pivot Points and Trendlines Together

Pivot Points and Trendlines complement each other, helping traders confirm support, resistance, and trend direction. Here’s how traders can combine them for more effective strategies:

1. Confirming Breakouts

• If the price breaks above a trendline and also crosses above a pivot resistance level (R1 or R2), it provides stronger confirmation that the breakout is genuine and likely to continue.

• Conversely, if the price breaks below a trendline and also crosses below pivot support (S1 or S2), it confirms the strength of the downtrend.

2. Identifying Reversals

• When the price approaches a trendline while also hitting a pivot level, traders may anticipate a reversal. For example, if the price touches a support trendline and also hits S1, it may bounce upward, indicating a reversal from a downtrend to an uptrend.

3. Using Trendlines to Project Price Movements

Trendlines can help traders project where future support and resistance may occur based on previous price action, while pivot points provide short-term levels to guide daily or intraday trades. Together, they give a more complete picture of where the price might be headed.

Example: Using Pivot Points and Trendlines in Infosys

Image Courtesy: Tradingview

Suppose the price of Infosys has been on an uptrend for several days. A trendline is drawn connecting the lows of the price movement. On a particular day, the price hits the S1 pivot support and also touches the upward trendline. This convergence of the trendline and pivot support suggests a strong support level, and traders might consider entering a long position, anticipating that the price will bounce off this level.

If the price then breaks through R1, it confirms that the uptrend is still intact and may continue further, with R2 as the next target.

Adjusting Pivot Points and Trendlines for Different Strategies

Both Pivot Points and Trendlines are highly flexible tools, and traders can adjust them to suit different trading styles:

Pivot Points

• Day traders: Typically use daily pivot points to guide intraday trading decisions. These levels are recalculated every day based on the previous day’s price action.
• Swing traders: May use weekly or monthly pivot points for longer-term trades, providing broader levels of support and resistance.
  

Trendlines

• Short-term traders: Draw short-term trendlines on hourly or 15-minute charts to guide intraday trading decisions.
• Long-term traders: Rely on long-term trendlines drawn from daily or weekly charts to confirm major trends and make longer-term trading decisions.
  

Common Mistakes to Avoid

1. Drawing Trendlines Incorrectly

One of the most common mistakes traders make is drawing trendlines incorrectly. It’s important to connect at least two significant highs or lows for the trendline to be valid. Additionally, forcing trendlines to fit the price action can lead to false signals.

2. Ignoring Pivot Point Breakouts

Pivot point breakouts often signal strong price moves, but traders sometimes ignore them in favour of other indicators. It’s important to watch for breakouts above or below pivot levels, as they can signal major market movements.

3. Overreliance on One Indicator

While both Pivot Points and Trendlines are powerful tools, they work best when used in combination with other indicators like RSI or MACD to confirm signals.

Conclusion

Pivot Points and Trendlines are essential tools for traders looking to identify support, resistance, and trend direction. By combining these two indicators, traders can gain a deeper understanding of the market, allowing them to anticipate price movements more accurately and make more informed trading decisions.

In the next chapter, we will explore another critical tool in technical analysis: Fibonacci Retracements, which help traders identify key levels of support and resistance based on the Fibonacci sequence.