How to Calculate Pivot Points

04/26/2011 5:00 am EST

Focus: STRATEGIES

Charting pivot points is a popular method among traders, and while there are many variations, all traders can benefit from the proper application of this analysis.

Let me say from the onset that there are a great number of individuals who rely heavily on daily pivot points in their trading. I am not one of those individuals, but I do chart daily pivots as a frame of reference in my trading to see where other traders may be placing their orders.

On some days, the market pays especially close attention to pivots, and on other days, they are completely irrelevant, as if they did not exist. I have yet to find a system that can tell me which day pivot points are going to be relevant, and on which days they are going to be irrelevant.

Pivot points are a function of the high, low, and close of the previous trading session where:

H = high price of the day
L = low price of the day
C = closing price

The basic formula for calculating pivots is:

Pivot point = P = (H + L + C)/3

First area of resistance = R1 = 2P – L

First area of support = S1 = 2P – H

Second area of resistance = R2 = (P - S1) + R1

Second area of support = S2 = P – (R2 – S1)

There are, however, a number of variations on the standard pivot point system of which you should be aware. These systems include:

  • Floor Pivot Points: These calculations are referenced above. They have been popular with traders for years and calculate up to three support/resistance levels. You can actually get more support and resistance levels by continuing the formula, but it is generally not necessary.

  • Woodie’s Pivot Points: This pivot point system is similar to the floor formula but uses a different calculation method. In this system, more weight is given to the close of the previous period. I personally use this particular pivot system.

  • Camarilla Pivot Points: While not explicitly defined as pivot points, the system identifies eight levels which resemble support/resistance level for a given period. The origin and methodology of this system is unclear, and they enjoy limited popularity.

  • Tom DeMark’s Pivot Points: This system is another hybrid pivot point system designed to predict the highs and lows in a selected trading time frame.

NEXT: Know Which Pivot Strategy Is Right for You

|pagebreak|

As you can see, there are a number of systems that traders use to calculate pivots. In the truest sense, pivots are a leading indicator (though hypothetical) for market performance and directionality.

In my experience, most traders use floor pivots and Woodie’s pivots, while a minority uses the other two pivot systems. Regardless of their effectiveness, it is a daily ritual for me to draw in specific pivots on my chart. It should be a habit you also develop. There are variations of pivot points that incorporate the opening price of the previous session as well.

When calculating pivot points, the pivot point itself is the primary support/resistance. This means that the largest price movement is expected to occur at this price. The other support and resistance levels are less influential, but may still generate significant price movements.

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.

In summary, we have pointed out that pivots can be very important on certain days, but on other days, they can be of lesser importance. I have even seen days when, during the morning session, the market ignores pivot points, yet in the afternoon session, it adheres to them strictly.

For that reason alone, pivots should be on your daily chart. We have also identified several different pivot calculation methods and pointed out the most popular systems in use. For most people, floor pivots will be a logical starting point, and experimentation with other systems may improve your trading.

By David Adams of The E-Mini Trading Professor

See related video: Power Up Your Pivot Points

Related Articles on STRATEGIES