Thursday, November 19, 2009

Day Trading with Pivot Points

The pivot point (daily pivot or DP) is the level at which the market direction changes for the day. The pivot level, support and resistance levels calculated from the previous day’s range are collectively known as pivot levels. These points can be critical support and resistance levels. The reason pivot points are so popular is that they are predictive as opposed to lagging. You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).

The pivot values are plotted as horizontal levels which, in turn, serve as support and resistance. The daily pivot itself can be thought of as the day’s mid-point, or fulcrum. It’s where the buyers and sellers meet to determine the day’s trend in a stock or futures. The support and resistance levels that are plotted around the pivot point are just that: potential support and resistance.

Trading the Pivots, Support and Resistance

The general idea behind pivots is to go long above the daily pivot and short below the daily pivot. The mode of the market (bull or bear) should be used when deciding whether to go long or short at the pivot point. In addition, the first time the pivot point is violated (to the upside or downside) is the most important crossing of the pivot. Subsequent crossings are less meaningful.

The three most important pivot points are R1, S1 and the DP – Daily Pivot. The general idea behind trading pivot points are to look for a reversal or break of R1 or S1. By the time the market reaches R2 or S2 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

A perfect set would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and ride the trend with the remainder of your position.

Unfortunately life is not that simple and we have to deal with each trading day the best way we can. There are many ways to day trade using pivot points but I shall walk you through a few of them and discuss why some are good in certain situations and why some are bad.

Follow The Intraday Trend

The power of pivot points is unleashed when you follow an unfolding trend during the day, and use the pivot values to measure the magnitude of trend. Additionally, the pivot points can be used to determine entry points into a trade. Applying simple breakout and breakdown entries around pivot points is a powerful way of using the tool

The Breakout Trade

Prices announce their bias for the day. If prices are above DP, then the bias is UP. If prices are below DP then the bias is down. Wait for a consolidation. If price is above DP, buy a breakout from the consolidation with a target of R1. If price is below DP, sell a breakdown from the consolidation with a target of S1. Your stop will be the other side of the consolidation.

Chart Example of Breakout Trade

The Pullback Trade

If the bias is up and price is above DP, then wait for the market to pass through S1 and then pull back. An entry order is placed above resistance, which in this case was the most recent high before the pullback. A stop is then placed below the pullback (the most recent low) and a target set for S2. If the bias is down and price is below DP, the market passes through S1 and then pulls back. An entry order is placed below support, which in this case was the most recent low before the pullback. A stop is then placed above the pullback (the most recent high – peak) and a target set for S2.

Chart Example of Pullback Trade

Pivot Point Tips And Tricks

Trading with pivot points is not a big secret. Floor traders and dealing desks have been applying the methodology for decades in the stock market. But what separates the profitable traders from the losers is the simple act of following the trend of the day, cutting losses short, and letting profits run to the next pivot value. In addition, there are a few observations I’ve made over the years that I can add to the simple truth of following the trend.

The first tip I want to share is that the best trend days usually unfold when the stock begins the trading day near its pivot point. You might have already made this observation. in the two above examples. If you didn’t, then take a second and jump back to the above charts, and note how the Nifty Futures and Reliance Capital Futures began the day at or very near their pivot points. There are usually two or three days out of the week during which the majors such as the Nifty futures, and other momentum stocks begin trading at their daily pivot. These are the days to look for a big trend to unfold.

If the stock that you’re trading begins the day far away from the pivot, either below S2 or above R2, then it’s probably a day that you want to walk away from. When a stock opens the day at one of the daily pivot extremes, it usually spends the rest of the session gyrating around that level. Avoid trying to trade a reversal of the overnight trend. Occasionally it might occur, but more often than not a big overnight trend will stall out at R2 or S2. The temptation is there to try to squeeze out a small profit, or bet on a reversal of the overnight trend. But the reality is that these are the days that can destroy a trader’s equity.

These days are best left to the floor traders. In the long run, you’ll be better off not even trying to trade during days when the futures stage a substantial gap, either high or lower. You’ll be better of by waiting for those days when the futures open near their pivot points.

Markets with wider ranges tend to generate more meaningful numbers than those with narrower ranges. Therefore, use of pivot points, support and resistance levels would most likely work better in markets such as the Nifty futures, High volatility stock futures like Reliance, Reliance Cap, Neyvelli, and would be less meaningful in markets like Hind Lever or ITC, which tend to trade in narrower ranges.


Traders may consider using bigger-picture technical analysis to determine if a market is range-bound or in a longer-term trend.

For example, breakout traders may want to avoid trading until they have a strong market bias (trend) and then use the pivot points, support and resistance as entry and stop points. Likewise, contrarian traders may want to wait until the market is reversing or range-bound before fading the market through support and resistance. In addition, bigger-picture systems, set-ups or patterns can be used as a reason to be long or short a market, and the pivot points, support and resistance can be used to set entry points and protective stops.

A sensible way of keeping the bigger picture in mind is by adding a technical indicator that can pinpoint buy and sell signals. You will still want to use traditional support and resistance techniques around the pivot values. The purpose of adding to the indicator is to help in the timing of an entry into a trade. Above all else, though, you want to trade in the direction of the unfolding trend.

The MACD (12,26,9) is added to the 5-minute RNRL chart below. The MACD generates simple buy and sell signals with the crossing of the fast and slow lines. Quite simply, it’s time to buy when the fast line crosses above the slow. Conversely, it’s time to sell when the fast line crosses below the slow line. Only the buy signals are highlighted on the chart below because the futures was in an upward trend during the day. The sell signals are ignored due to the upward trend in the contract.

Chart for RNRL Pivot with MACD Trade

The RNRL futures began the day at 141 and ended near 134 for a move of roughly 8 points. That’s a lot of potential profit, part of which could have been captured by simply following the trend of the day and taking the sell signals coming from the MACD.

A complete method is given below for trading Pivot Points. This is also an example of how systems should be designed.

Pivot Point Bounce
When the price approaches a pivot point (especially for the first time in each direction), it will have a tendancy to reverse, and it is this reversal that is used by the pivot point bounce trading system

1. Wait for the Price to Move Towards a Pivot Point
Watch the market, and wait until the price is moving toward a pivot point. For a long trade, the price bars should be making new lows as they move towards the pivot point, and for a short trade the price bars should be making new highs as they move towards the pivot point.

2. Wait for the Price to Touch the Pivot Point
Wait for the price to touch the pivot point, which happens when the price trades at the pivot point price.

3. Enter your Trade
Enter your trade when the high (or low) of the first price bar that fails to make a new low (or high) is broken. The following list shows the steps required for both long and short entries :

Long Trade

Price bar touches the pivot point
Subsequent price bar fails to make a new low
Subsequent price bar breaks the high of the previous price bar

Short Trade

Price bar touches the pivot point
Subsequent price bar fails to make a new high
Subsequent price bar breaks the low of the previous price bar
The stop loss can be adjusted to use either the pivot point as the stop loss, or the high (or low) of the entry bar as the stop loss, depending upon the market being traded.

4. Wait for your Trade to Exit
Wait for the price to trade at your target or at your stop loss, and for either your target or stop loss order to get filled. The pivot point bounce trade can take anywhere from a few minutes to a couple of hours to reach your target or stop loss. Depending upon the market being traded, the target could be adjusted to be the next pivot point, and the stop loss could be adjusted to break even at a suitable time.

5. Repeat the Trade
Repeat the trade from step 4, as many times as necessary, until either your daily profit target is reached, or your market is no longer active