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Pivot points have a long history in trading, and are a commonly used technique to this day. They can help determine the direction of movement for a market within the context of a broader trend. Essentially, they are another form of support and resistance, with traders attempting to identify where prices may find support after falling, or run into resistance after rising.
How are pivot points calculated?
Pivot points are calculated based on the high, low and closing price of the previous day, and help to identify potential areas of support and resistance.
The usual system used is the five-point system. This uses the previous high, low and close, and then also employs two extra support levels and two additional resistance levels to provide five pivot points. This is calculated in the following way:
Pivot point (P) = (previous high + previous low + previous close)/3
Support 1 (S1) = (pivot point x 2) - previous high
Support 2 (S2) = pivot point - (previous high — previous low)
Resistance 1 (R1) = (pivot point x 2) — previous low
Resistance 2 (R2) = pivot point + (previous high — previous low)
Like all other indicators, there are other ways of calculating pivot points, but the above is the standard method.
Using pivot points to identify trends
Pivot points can be used to identify the overall trend, since a move through pivot points to the upside indicates an uptrend. Meanwhile the opposite, where a price continues to fall below pivot points during a session, is indicative of a downtrend. It is not a foolproof system, but like the use of basic support and resistance, the system tries to use previous important levels to derive others that may be worth watching. Some sessions will see the price adhere to pivot points in an impressive way, while other days the price will simply disregard these levels.
Pivot Points can be added on to a chart in the IG platform in the usual way, by selecting the indicator drop down menu and choosing ‘pivot points’ or by right-clicking to select them. Instead of using daily pivot points, a trader can also use weekly data, useful for longer-term trading.
Candlestick and pivot point trading strategy
Pivot points can be used with any type of chart, but it is most useful with candlestick charts. This allows you to see price action more effectively. An example can be seen below. In this hourly chart of AUD/USD, the price moved above the central pivot point, but then fell back below it and posted an hourly close below it. This could provide a possible short position, indicating that the price cannot hold support around the daily pivot.