Analysts are constantly striving to figure out the patterns within the stock market. Will the stock price continue to go up? Will it plateau? Will we see a crash in the coming days? Looking at trends and attempting to predict the future is the most valuable skill any trader must possess. When the equity price reaches a certain level, known as the support or resistance level, this often indicates that a sudden price shift is about to occur. How do analysts predict this moment and what tools do they use? The answer lies in pivot points.
Pivot points are technical analysis indicators that allow analysts to determine the overall trends in the market. Analysts calculate the pivot point by taking the average of the closing, low and high prices of the previous trading day. When trading occurs above the pivot point, it is a bullish performance. When trading occurs below the pivot point, it has been a bearish day.
This system is most commonly used to calculate the pivot points:
- R2 = P + (H – L) = P + (R1 – S1)
- R1 = (P x 2) – L
- P = (H + L + C) / 3
- S1 = (P x 2) – H
- S2 = P – (H – L) = P – (R1 – S1)
S = support levels. R = resistance levels. P = pivot point. H,L,C represent the high, low and closing marks of the previous day.
So How Do We Use Pivot Points?
Once the pivot point calculations are complete, analysts look for patterns in the results. For example, by comparing pivot points for an extended period, a trader can foresee what might happen in the coming days. Pivot point analysis is most effective when combined with other indicators. An excellent example is combining pivot point analysis with candlestick patterns or MACD crossovers.
There are two uses for pivot points, from an analysis point of view. The first is to determine the market trend. An upward movement in pivot points means a bullish market, and vice-verse for a bearish market.
The second use is to determine when to enter or exit the market. A trader can set a resistance and support level. When the pivot point breaks the resistance level, the trader will buy shares. When the pivot point passes the support level, a trader will sell shares as soon as possible.