What are Pivot Points and Support/Resistance Levels?
They are also called floor pivots and were developed by pit traders. These locals would do these (very simple) calculations and write them down on cards/paper or memorize them before they started trading in the pits each day. It gave them resistance/support areas based on the extremes and close of the previous day. The locals were attempting to get an idea of the day's possible range based on the previous day's action. They were also looking for areas above/below which to be long/short and possible reversal areas. Remember that when pivot points (including the support and resistance numbers calculated from them) where first used there were no computers around to do these calculations. Charts were hand drawn and the pivots were manually calculated - calculators weren't even available.
The key number or midpoint number is the Pivot Point. This is
very simply the average of the high, low and close of the previous
day. A number of variations on the pivot point calculation are
available and use all the permutations that you can think of using
from the previous day's extremes, open and close. Some pivot point
calculations use today's open as one of the inputs when calculating
Once the pivot point for the day is calculated another formula is used to calculate the R1, R2, R3, R4 (resistance) and S1, S2, S3, S4 (support) figures. There is no limit to how many resistance and support numbers you can calculate but these are impractical beyond R4/S4 because the market rarely ever touches R4 or S4.
Trading Strategies with Pivot Points
There are many trading techniques and strategies associated with pivot levels. Here are some:
- Be long above the pivot point and short below it. (directional bias)
- Short at each resistance level and buy at each support level. (entries)
- Take partial profits at each resistance/support level. (targets)
- Place stops above/below resistance/support. (stops)