In our previous article, we elaborately went over how to use the Open High Low strategy to make consistent profits. Another strategy which gives good returns is the pivot trading strategy. Pivot points are mathematical levels plotted on a security’s graph to mark significant support and resistance levels. The underlying concept in this strategy that, when the stock’s price breaches any of the pivot levels, then it will continue to move in that direction.
How are the Pivot levels calculated?
Before we get into the details of how pivot levels are calculated, let’s talk about how it looks. There are seven lines which are plotted – the middle line is the basic pivot level around which the three resistance and three support levels are plotted. It would look something like this:
This is how the different levels are calculated:
Basic pivot level: This is the middle line and the level based on which further supports and resistances are calculated.
Calculation = [Daily High + Daily Low + Close]/3
Resistance 1: This marks the first level above the basic pivot level.
Calculation = [2 * Pivot Point] – Daily Low
Resistance 2: This is the second pivot level above the basic pivot level.
Calculation = Pivot Point + [Daily High – Low]
Resistance 3: This forms the final upper layer of the pivot points.
Calculation = Daily High + 2 * [Pivot Point – Daily Low]
Support 1: This is the first level below the basic pivot point.
Calculation = [2 * Pivot Point] – Daily High
Support 2: This is the second level of support that the stock will face when it’s price declines.
Calculation = Pivot Point – [Daily High – Daily Low]
Support 3: This is the final level of support in the pivot trading strategy.
Calculation = Daily Low – 2 * [Daily High – Pivot Point]
Calculating these points manually will definitely be cumbersome. For that reason and the accuracy of this trading system, trading platforms like Zebull come with inbuilt indicators which plot these levels for you. To make it easy for you to understand, they will be colour coded to mark the different levels. As and when the price of the stock breaches or bounces off these levels, you can take a call about its trend direction as well as where it can get support or resistance after that.
Pivot Level Breach
If the price of the stock hovers around the resistance of the stock for some time and breaches the R1 level with a good volume, then you can safely assume that it will make its way to the R2 level. And if it breaches even the R2 level, then the price will, in most cases, reach R3. Similarly, if the price breaches S1 with good volume, it will reach S2 and if it breaches S2, it will reach S3.
Pivot Level Bounce
What happens when a stock’s price is around R1 level but instead of breaching it, it bounces off R1 and heads south? This means that a small trend reversal has started and the price will find further support at the pivot point level. The same holds true for prices which turn around at the S2 or S3 levels. This also indicated that the price is consolidating but with sufficient traction and volume, you can definitely expect a breach.
Important points to keep in mind while trading with Pivot levels
- False Breakouts
Like with any other breakout strategy, you need to be wary of false breakouts in this strategy as well. A breakout is considered false if the price is not able to sustain a pivot level breach. There are a few things you can do to eliminate falling for false breakouts. Make sure that the breach happens with sufficient volume. However, always keep in mind that no strategy is perfect and even with a good volume, a breakout might not sustain because of institutional buying or selling in the opposite direction.
While trading with pivot points, it is important to trial your stoploss if the breakout is happening across multiple levels in a single direction. For long calls, the recommended stoploss is the preceding pivot level. For short calls, the stoploss can be placed on the pivot levels preceding the breakout. Please note that the price of a stock generally moves around pivot levels for sometime before breaching it or bouncing off it. So, it is advised to place the stoploss slightly below the supports for long calls and above the resistance for short calls.
- Time Frame
The recommended time frame for this strategy is fifteen minutes. Any time frame lesser than this could lead to multiple false breakouts. Any time frame greater than that will make it a positional or swing trading system which can reduce the returns the system can give.
From this detailed explanation, you can see that the Pivot trading strategy is easy to understand and implement even for novice traders. It is also an accurate system which gives good capital appreciation if it is followed with discipline over several years. Happy trading!