One of the most widely used indicators is the pivot points. Pivots points help determine which levels a particular market can bounce from. It basically “finds” support and resistance levels.
So, do you think price action traders use pivot points in their analysis? Well, Price action traders mostly trade on what the price is trying to tell them. They consider factors like market sentiments and psychology for analysing the market. They typically do not consider mathematics concepts. And, pivot points are entirely derived from mathematical price relations. However, price action trader blend pivot points with market psychology and hence, bring in logic to it. This is what makes them extraordinary and unique.
In this article, we shall be discussing what pivot points are, how to use them in your analysis, and if we really need them or not.
What is a Pivot Point?
A pivot point is a technical analysis indicator, which is derived from mathematically and is used to determine the trend of the market over different timeframes. A pivot point is calculated by considering the average of high, low and closing prices of the previous trading day.
According to technicians, the market trading above the pivot point indicates a bullish sentiment, and the market trading below the pivot point indicates a bearish sentiment. Apart from this, it also shows support and resistance levels.
An example of a pivot point is shown below. The blue lines in the chart are called pivot points. When the price reaches any of the pivot points, the market bounces off from that point. However, sometimes, it does not respect the pivot point and goes past it. Therefore, to master pivot points, you must know which pivot point will hold and which will not.
How Price Action Traders Make Use Of The Pivot Points
As mentioned, price action traders combine pivot points with psychology and then use it as a powerful trading tool.
Before getting into the core of it, let us discuss some psychological concepts which will be implemented in the following topic.
The psychological concept we shall understand is the concept of range. For most traders, a range means the sideways movement of the market. But, have you ever wondered what it means psychologically? Let us understand it with an example.
In the below figure, we can see that the market has been ranging for a while. If we were to interpret the range, the price starts to go up from $1 to $2, and then drops to $1 again. The same process continues for a couple of times. What do you think is in the mind of the public? They see that the market is not able to break above $2, and is also unable to go below the $1.
Thus, these two prices are in the mind of the public. Moving forward, the market manages to break above the $2 resistance and makes a record of $5. And, later when the price comes back to $2, people remember that the previous time when the price was $2, the market had made a massive jump. Therefore, they expect the same move to repeat. Hence, this price ($2) becomes a psychological resistance. And, this psychological resistance is combined with pivot points to trade the markets.
How Do Price Action Traders Fuse Pivot Points With Psychological Support And Resistance
To analyse this indicator, we consider two timeframes. The first timeframe is used to study the direction of the market, and the second timeframe is used to read the fine details of the market. Also, the determination of pivot points is done in the first timeframe.
Consider the below example. Considering this to be the first timeframe, we determine the plot the pivot points and determine the direction of the market. We can see that there are three pivot points, namely, R1, R2, and R1’. These pivot points tell us that there is a possibility that the market might react from these points.
Now, if we consider the most recent market, the price was ranging for a while (rectangle box) before blasting up north. The orange lines represent the top of the range (psychological resistance) and bottom of the range (psychological support).
Also, if you observe carefully, the psychological resistance and R1 pivot point are coinciding, indicating that both psychologically and mathematically this level is pretty strong and holds value. Therefore, the next time the price comes down to this level, we can look to go long.
The magnified image of the above chart is shown below.
Now that we know we must be looking to go long, we switch our timeframe to the second timeframe or the lower timeframe to analyse the market.
Below is the chart of the lower timeframe. When the market breached above the range, the price went up until the R1’ pivot point and started to pullback. The pullback came in strong such that it even dropped below the R1 pivot point.
But, the buyers shot up pretty hard as well. Later, the price dropped again from the R2 pivot point and tried holding below the R1 pivot point, but was unsuccessful as the buyers took over yet again.
Now, the third time the price pulled back from R2, the market started to hold above the R1 pivot point. Also, from point 3, the buyers went above the R2 pivot point. Now, if we read the pullback from R1’, we can see that the price is not effectively able to go below the R2 pivot point.
Also, observe that the buyers are continuously buying at a higher price from point 2 to point 3 to point 4, which indicates that the buyers are getting desperate every step of the way. And also, the sellers are not reacting for R2. Therefore, this clearly tells us that the sellers have been wiped out, and the buyers are all set to take the market higher.
From the below figure, we can see that the buyers broke the R1’ pivot point and went up higher.
Pivot points solely cannot provide trading signals. However, it can be combined and used with other technical tools.
Price action traders too, do not use it as a solo tool. They only determine areas where a trader must be careful about.
Also, if you analyse the above trade deeply, you will realise that pivot points are an optional tool for price action analysis.