An Introduction to Pivot Points

In technical analysis the terms support and resistance are often spoken about. Some techniques used to identify support and resistance lines include past highs and lows, and others use the Fibonacci retracements. Today we will be talking about another technique called the pivot points.

Pivot Point analysis is used by some because it is a predictive, as opposed to lagging, indicator. It therefore uses the price from the previous day to calculate the probable support and resistance lines of the current day. Although it is mainly used in forex trading there are good reasons to be aware of it for indices and equities trading. The calculation involved in pivot point analysis is fairly rudimentary, and because of the widespread popularity of support and resistance regions you tend to find that prices will adhere to them.

Calculation

There are several ways to calculate pivot points and luckily many software programs are able to calculate the levels for you, but in today's lesson we will be looking at a more 'traditional' way.

Pivot Point = (previous days high + previous days low + previous days close)/3
1st Support Line = (2*Pivot Point) – previous days high
1st Resistance Line = (2*Pivot Point) – previous days low
2nd Support Line = Pivot Point – (previous days high – previous days low)
2nd Resistance line = Pivot Point + (previous days high – previous days low)

Example

Today we will be using Zinifex (ZFX) in our practical example, this is one of the most favourite stocks amongst investors and traders alike. We will be calculating the relevant information from yesterday's chart movements (16/11/06). The three pieces on information needed are yesterday's high, low and close prices. They are $15.46 (H), $14.62 (L) and $14.73 (C).

The calculation of the relevant lines are as follows:

Pivot Point = ($15.46+ $14.62+ $14.73)/3 = $14.94
1st Support Line = (2*$14.94) – $15.46 = $14.42
1st Resistance Line = (2*$14.94) -$14.62 = $15.26
2nd Support Line = $14.94 – ($15.46-$14.62) = $14.10
2nd Resistance line = $14.94 + ($15.46-$14.62) = $15.78

The first thing you will notice is that in the intra day 5 minute chart above there are three lines instead of five. The reason for this is because today (17/11/06) the share price of ZFX didn't trade outside the 1st support (very briefly upon market opening) and 1st resistance lines.

Interpretation

In the yellow rectangle area notice that the ZFX opened below the 1st support line. This line was early resistance and then support before it rocketed to the Pivot Point Line (Red Line)

In the aqua rectangle again notice how the pivot point line (red line) acts initially as resistance and then support.

Finally, when the share price approached the 1st Resistance Line - the theoretical line drawn from the calculations - shown here in grey, the share price lost momentum.

As descibed by one subscriber, "for the speculative short-term trader, this analysis tool provides a prospective "trading" road map for the day ahead.