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## Understanding the Pivot Points

*Pivot Points*, *Floor Trader Pivots*, *Support / Resistance Levels*, etc. are all names for the same set of *price levels* derived from the previous day, week, or month. They are heavily publicized by financial news channels since the late 1990s as the stock market indices seem to react to these prices magically. I am going to discuss the general usage of this technical analysis technique, and some interesting characteristics that has never been discussed publicly.

**The Formulas**

To calculate the *pivot points *for the current trading session, you need the high, low and close prices from the previous trading session. Sometimes, if you are using a particular variation of the concept, the open price will be used in the calculation too.

For example, if you are interested in the pivots points for the current trading day, you need the high, low, and close prices from the previous trading day.

The calculation is very simple, just plug the numbers into the formulas below and you will get your pivot point values.

`P = ( H + L + C) / 3`

H1 = 2 P - L

L1 = 2 P - H

H2 = P + (H1 - L1)

L2 = P - (H1 - L1)

Once you have done the calculation, it is obvious that the *price levels* you have generated is always in the following order, from largest to smallest,

H2 – the upper resistance level

H1 – the lower resistance level

P – the pivot point

L1 – the upper support level

L2 – the lower support level

In NeoTicker, these values can be obtained through using the built-in indicator sets based on the time frame you are interested in.

To plot the pivot points for the current trading day, use the indicators starting with the prefix *PrevDay*.

To plot the pivot points for the current trading week, use the ones prefix with *PrevWeek*.

I have also written an article on hourly pivot points, you can read about that here.

Power indicators are provided to draw the complete set of pivot points for you so that you do not need to add them one by one. The daily version is called *PivotPoints Daily *and the weekly version is called *PivotPoints Weekly*.

Each indicator set gives you,

`H2 = PrevPeriod Resistance (with parameter set to Upper)`

H1 = PrevPeriod Resistance (with parameter set to Lower)

P = PrevPeriod Average

L1 = PrevPeriod Support (with parameter set to Upper)

L2 = PrevPeriod Support (with parameter set to Lower)

The previous period data information are also retained through the following indicators, so that you can construct your own set of pivot points easily,

*PrevPeriod Open* provides you the previous trading period opening price.

*PrevPeriod High* provides you the previous trading period highest price.

*PrevPeriod Low* provides you the previous trading period lowest price.

*PrevPeriod Close* provides you the previous trading period closing price.

Example indicators are PrevWeekOpen, PrevMonthOpen, etc.

There are also the current period open, high, low indicators for constructing your price projection for the next trading period. We will discuss about that later in the article.

**Magical Results**

Take a look at this chart of Emini S&P with daily pivots,

The various pivot price levels indeed provide *support* or act as *resistance* that the prices just cannot violate easily.

Knowing that the pivot points are calculated one trading period (i.e. in this case, one trading day) beforehand, it makes the pivot points even more interesting.

General usage of the pivot points – support / resistance analysis.

When a market sell off and lands onto a particular pivot price level, it is considered as the *support price level*.

If the market rally upto a pivot price level, it is considered as the *resistance price level*.

In case the market decidedly penetrated a price level and then *retraced *back to that, it will then assume the opposite role. i.e. suppport price level will turn into resistance price level, and vice versa.

**The Mathematics Behind**

Many readers who have read my previous articles on the use of average range, would know that the actual range covered in a trading period is pretty much statistically fall into the possible range (or, technically the expected range) based on the price distribution.

The use of previous trading period range (i.e. high minus low) is an estimate of the *expected average range*. The *pivot point* (i.e. average of high, low and close) is an estimate of the *mean* of the price distribution. Combining the two, we get the various price levels that simply represents the expected one and two deviations out from the estimated mean. That, of course, will mark the important price levels easily because they are very good estimate for the significant price levels based on *normal distribution*.

That implies the possibility to make a better pivot points system. But can we really create a better system?

**A Better Pivot Point System**

To make the pivot point concept more mathematical, we can use true *average range *as oppose to just the range of the previous trading period.

We can also provide a better estimate for the *mean *using the *average mid-point *over certain period of time.

Here is the same chart with the alternative pivot point system at work,

Notice how good it is at capturing the extremes of these trading days.

Feel free to experiment with other possible combinations, like changing the pivot point from the average midpoint to something else. A well known variation of the original pivot point system use the opening price of the current trading period as the average, and another model use the average of the open, high, low and close as the pivot point. Try them out yourself to see how they fair against the original model.

**Anticipation Technique**

You probably notice that the alternative pivot point system I have provided does not really deviate from the original system a lot.

The original system is easier to use (i.e. not even a computer is needed) and produces reasonable results. That is the reason why professional traders keep using the same system, or, at least as a reference, due to its popularity.

There is a trick to utilize the pivot point system **one trading period earlier**.

Based on the original formulas, there are scenarios that we can project the pivot points for the next trading period.

Reversal from a low and traded higher, where the high and close will probably be set by the end of the current trading period. We can then project H1 to be landing at approximately,

`H1 = 2 C - L`

This price level is the one that traders will be watching in the next price period, thus is likely a good price level where traders will sell into. It is obvious then this price level can be used as a target price to lighten up positions, or, if you are bearish, good price level to establish your bearish position by taking advantage of the current buying action.

Vice versa, if the market is selling off, then we can estimate the price level of L1,

`L1 = 2 C - H`

In short, you can *act *on the estimated price levels as oppose to *react *on them after they are established.

**Complete Indicators**

**Summary**

There is nothing magically about the pivot point trading concept. It is simply one of the easiest way to trade in a more discipline, and consistent manner based on sound assumptions of the underlying data.

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PAUL CHERNEY(veritgo3)Says:L. C. I can’t thank you enough for all the comments you make on ET and ss forums. right now I’m struggling, but some day I will have to buy one of your programs.