Price Pivots Circle Big Profits

A pivot is a turning point in the price of an asset and often coincides with key levels of support and resistance. When a trader understands and uses pivots effectively, this can increase their potential profit.

There are two basic types of pivots:

• Calculated pivots, which are determined by using a mathematical formula
• Price pivots, which are determined by looking at the price action on a chart

Using price pivots can be successfully implemented as part of an active trading strategy.

Types of Pivots

There are two main types of pivots: a calculated pivot and a price pivot.

Calculated Pivot

A calculated pivot, often called a floor trader pivot, is derived from a formula using the previous day's high, low, and closing prices. The result is a focal price level about which price action is likely to turn, either up or down.

Price Pivot

Price pivots are not calculated. The pivot is defined by the structural relationship between price bars. Price pivots form on all time frames, are building blocks of trend, and provide objective entry and exit points for trading.

Price pivots are best conceptualized with three bars, as shown in Figure 1. A three-bar pivot low represents support and is formed when buying pressure turns the price from down to up. It is designated by a price bar with a higher low that closes above the previous bar's high, where the previous bar's low is lower than the bar that preceded it. This is true in every time frame.

A three-bar pivot high represents resistance and is formed when sellers turn the price from up to down. It is seen where a price bar with a lower high closes below the previous bar's low, where the previous bar's high is higher than the bar that preceded it. Structural pivots are more easily recognized and understood when seen in a diagram or on a price chart. This is true in every time frame.

Figure 1: Three-Bar Formations

Price pivots represent reversals and are the building blocks of a trend. A series of lower pivot highs and lower pivot lows is a downtrend, and the pivot highs are connected to form a downtrend line. A series of higher pivot lows and higher pivot highs is an uptrend, and the pivot lows are connected to form an uptrend line, as shown in Figure 2.

Figure 2: Series of Pivot Lows Create an Uptrend

Source: TradeStation

Strategic Uses for Price Pivots

The ability to read structural pivots provides a major edge in trading. Pivots show the presence of a trend, as well as when the trend changes into a reversal, consolidation, or a breakout from consolidation. Structural pivots help outline important price patterns and give real-time signals for entry, exit, and stop-loss placement.

Pivots are essential for seeing when the trend changes in the opposite direction. A trend reversal is seen by a change in the sequence of pivots. A downtrend will have a series of lower highs and lower lows, and a downtrend line is drawn on the pivot highs.

Once there is a higher high and higher low, there is presumptive evidence of a trend reversal to the upside. You can see this in Figure 3, where the higher pivot low triggers a reversal in the uptrend. This signal is strengthened when the higher pivot low closes above a descending trend line.

The strength of the signal is increased when the higher pivot low forms above the downtrend line. Aggressive traders can enter at the closing price on the same day the higher low completes the pivot formation.

Figure 3: Downtrend Reversal in Nasdaq Futures

Source: TradeStation

Pivots also help in the management of risk. In the example in Figure 3, the stop-loss order is placed under the previous pivot low. Confirmation of the trend reversal from down to up is seen when the price makes another higher pivot high and low.

If the price cannot make a higher high, then a trend reversal has not occurred, and the trader will exit the trade. If the price does make a higher high and higher low, then the stop-loss is moved to the next higher pivot low, and the stop is trailed under subsequent pivots as the trend progresses.

An uptrend reverses to the downside with the opposite pivot sequence. An uptrend will have a series of higher lows and higher highs, and an uptrend line is drawn on the pivot lows. Once there is a lower low and lower high, there is presumptive evidence of a trend reversal to the downside, as seen in Figure 4.

Again, the strength of the signal is increased when the lower pivot high forms below the uptrend line. Traders can enter at the closing price on the same day the higher low completes the pivot formation. An initial stop is placed at the previous pivot high and trailed by the trend.

Figure 4: Uptrend Reversal in Goldman Sachs

Source: Telecharts, Worden Brothers Inc.

Pivots frame out price, allowing us to see when the trend enters a period of change. Price normally cycles between trend and range conditions. When pivots form a series of variable highs and lows, price enters range consolidation, or a sideways trend. In a range, the pivots are not moving consistently up or down. Price moves back and forth between support and resistance, testing for levels of buying and selling pressure.

During these periods of price consolidation, trend lines can be drawn on the boundaries of the pivot highs (resistance line) and lows (support line) to show price patterns.

Using Patterns As Confirmation

A rectangle, or channel pattern, appears when both support and resistance lines are horizontal, as seen in both Figures 3 and Figure 5. A triangle pattern is seen when one or both of the lines are slanted, as seen in Figures 4 and 5. Small penetrations of these lines can be faded in the opposite direction. The lines also help identify when range conditions change back into trend.

A new pivot high with a price that remains above the resistance line suggests a breakout into an uptrend. A new pivot low with a price that remains below the support line suggests a breakout into a downtrend.

Figure 5: Weekly Trends

Source: TDAmeritrade Strategy Desk

Benefit of Using Pivots

One of the major benefits of using pivots for trade signals is that they are objective price points and can make trading less emotional. Either price has reversed or not, based on the structure of the price bars. Stops are placed according to specific pivot points. There is no need to guess where to put a stop or make predictions on the future direction of price.

Pivots show investors what is really happening as opposed to what they hope will happen. Traders who understand pivot structure will no longer have to wonder what price is doing. They will have an objective way to find out and make their decisions based on that knowledge.

The Bottom Line

Pivots are turning points in an asset's price. They can indicate the presence of a new trend, the reversal of a trend, or consolidation in an asset's price. This information provides objective information on price changes that can be used as part of an informed trading strategy.

There are two types of pivots. Calculated pivots are found using the previous day's high, low, and closing prices. They are potential turning points in price. Price pivots, by contrast, are historic turning points in price. They are defined by the relationship between price bars.