Pivot points are the oldest form of technical indicator in the financial market. However, being old doesn't mean its relevance is bygone.
Pivot points remain the most widely used indicator to identify market trends and spot profitable entry and exit points.
As it's tightly knitted with the market's support and resistance levels, pivot points are integral to trading a ranging market.
In this TradeGeek lesson, you'll walk through the use of pivot points and their huge role in your range trading journey.
Pivot points are the oldest form of technical indicator in the financial markets. In the past, it was used by floor traders to identify the day of an asset's entry into the market.
Today, technological advancement makes pivot point analysis more sophisticated. It doesn't only identify market trends; it becomes valuable to understand the prevailing market sentiment and spot potential reversals.
At its core, pivot points measure the underlying asset's previous closing, high, and low prices. This allows traders to understand the key historical turning points of the market, which are necessary to form the market's support and resistance levels.
These key levels are the commonly used indicators for potential market reversal. Its popularity even resulted in a herd behavior phenomenon among the market participants.
Making everyone believe and act upon the signal, this indicator became self-confirming due to herding behavior.
If someone asks you to imagine a forex market environment, you'll probably think of a trending market.
That's understandable, as they carry the volatility and fluctuation needed to profit from trading. Many traders deem a trending environment as the most profitable market.
But did you know that you can also profit from a ranging or range-bound market?
Briefly, a ranging market is a market phenomenon wherein the price trades within an established range. Thus, it's called a ranging market.
How can a trader tell the range that the market trades? They identify the key support and resistance levels.
Again, support and resistance levels are the basis of a ranging market.
These key levels act as the floor and ceiling of the market – the threshold levels that reverse the price direction once touched.
A trader should be familiar with pivot point calculation to identify the key support and resistance levels.
Here is the formula to get the pivot point values and identify the potential support and resistance levels.
Pivot point formula:
(High + Low + Close) / 3
Here are the pivot point formulas for the market's support and resistance levels.
| Resistance 1 | (P X 2) - Low |
| Resistance 2 | P + (High – Low) |
| Support 1 | (P x 2) - High |
| Support 2 | P - (High – Low) |
Effectively getting these necessary values allows you to identify the market points in which the market participants expect the price to reverse.
Pivot points should be a staple in traders' range trading strategies. These technical indicators provide a reliable framework for identifying key support and resistance levels, enabling traders to anticipate potential price movements effectively.
Here's a comprehensive guide on how to use pivot points for range trading:
Pivot points are a predictive indicator, helping traders pinpoint significant support and resistance levels.
The main pivot point (PP) acts as a central reference, while additional resistance levels (R1, R2) and support levels (S1, S2) help traders to understand price boundaries better.
By plotting these levels on your trading chart, you can better identify the range within which an asset is likely to trade.
Since a range market is considered less profitable due to a short trend, traders must capture reversals to maximize potential profits.
Pivot points make this process easier by highlighting the levels at which reversals are bound to happen.
Tools like candlestick patterns (e.g., hammers, shooting stars) or price action confirmation can refine your entries and exits further.
Related: What Is a Hammer Candlestick and How Traders Use It?
Despite its wide usage, pivot points are susceptible to providing false signals.
That's why it's essential to never treat pivot points (or any technical indicators) as an ultimate indicator.
Combine pivot points with momentum indicators for more reliable trading signals. This adds an extra layer of confirmation and reduces false signals.
The Relative Strength Index (RSI) indicator is commonly used to supplement the pivot point analysis.
As it measures the speed and momentum of the trend, RSI is useful to understand the potential change in the market trend.
When effectively interpreted, RSI tells you about the underlying market conditions – overbought or oversold conditions.
Ultimately, when the market is in these conditions, a reversal is bound to happen as the price will naturally correct itself.
This is called price correction. It suggests that an overbought asset will experience a price decline to go back to its usual price points. Conversely, an oversold asset must have a significant price increase to correct its valuation.
As its name suggests, a stochastic oscillator is an indicator that oscillates within the chart. By oscillating, the indicator follows the trend's momentum.
The price interaction from the oscillating indicator represents the trading signals from this indicator.
It functions similarly to RSI as both suggest an overbought or oversold market.
Again, an oversold market carries an asset priced too cheap. When this market happens, market participants expect a potential price reversal as the price is bound to correct itself.
Meanwhile, an overbought market represents an asset that's priced too expensive. As these markets follow a specific intrinsic value, their respective prices will likely correct themselves.
Price correction during an oversold market would push the price up. This is typically an entry opportunity for buyers and an exit point for sellers to lock in their profits.
When used with pivot points, you have a more reliable signal for the potential market reversal.
Here are the values of stochastic oscillators and their respective values:
Finally, looking for the interaction of the two oscillators (%K and %D) helps you spot a profitable entry or exit signal.
When the two oscillators cross, it signals a strong uptrend. However, the potential for a downtrend is imminent when the two oscillators diverge.
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