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: October 31, 2021
: Prashant Shah
Trading based on Pivot levels is one of the popular approaches. Both short-term and intraday traders track Pivot levels to identify support and resistance levels in any instrument. Let’s discuss how these levels are calculated.
The pivot calculation method considers the previous day prices to calculate the important price reference levels for trading the next day. The price levels are known as support and resistance levels. Support is a demand level and a resistance is the supply level.
There are seven levels marked on the chart when we plot Pivot as a tool. There is a Pivot level, three support levels (S1, S2 and S3) and three resistance levels (R1, R2 and R3).
We have four prices for any trading session - Open, High, Low, Close. They give us important information about what happened during that session. The Pivot is calculated using the High, Low and Closing price of the previous day.
Let’s understand Pivot calculation with an example. Assume that below are the OHLC prices of a session.
The difference between high and low is a range of the day.
High – Low = Range
In our example, range of the session is 10 points.
105 – 95 = 10
Mid-price of the session is average of high and low price. The Mid-price in this case would be 100. ((105 + 95) / 2).
Mid-price is the average of the range of the session. How about including the closing price to this calculation?
If we calculate the average of High, Low and Closing prices - we get the Pivot point. (105 + 95 + 103) = 101 is the Pivot level in our example.
Take a pause and spend some time thinking about this method. What would be a Pivot point had the close would be exactly at the mid-price of the session?
The mid-price is 100. Had closing price also be at 100, the pivot price would have been equal to the mid-price of the session.
The Pivot point in this example was 101 when the closing price was 103 i.e., closer to the high. What if the closing price was at 97? The Pivot level in this instance would be 99. (105 + 95 + 99) / 3.
The key point is that the pivot level captures the relationship of the closing price to the range of the session. Pivot would be above mid-price if the close is towards the high and below mid-price if the close is more towards the low.
The pivot price is an important reference level for the next day session.
Let’s say this:
Pivot price above mid-price = bullish pivot
Pivot price below mid-price = bearish pivot
Understand that the closing price to the range is important. This calculation doesn’t consider whether the candle was bullish or bearish. It also doesn’t consider whether the closing price was higher or lower than the earlier session. Wide range Doji kind of candle or bullish Marubozu kind of candle with the same length and closing price towards high will have same bullish pivot.
The range of the session is an important ingredient in Pivot calculation. The range of the current session would determine the support and resistance level for the next session. Have a look at the image below and we shall revert to this discussion in a little while.
We have calculated the pivot price and range of the day. Pivot levels revolved around these two. Let’s discuss how support and resistance levels are calculated. If we deduct the range of the session from the pivot price, we get a support price for the next day.
In this case, if the pivot price is bullish, the support level for next session will be nearer. If the pivot price is bearish, the support level will be deep.
Pivot level in our example is 101. Support level would be 101 – 10 = 91
This level is known as S2 support level in Pivot calculation.
Similarly, we can add range price to pivot price and calculate the resistance level. This is known as R2 level.
The R2 in this example will be 101 + 10 = 111.
We now have the formula to calculate S2 and R2, Let’s discuss S1 and R1.
The difference from high or low price of the day to the pivot point would also be an important clue. The calculation is a bit tricky. Let’s understand it in two steps.
Step 1 is to double the pivot level.
101 x 2 = 202. Let’s call it A.
Let’s call the low price of the session as B. Second step to get R1 is to deduct the low price from A.
A – B = R1.
202 – 95 = 107.
This is R1 resistance level for the next session. This level will always be below R2.
If the previous high is deducted from A, it becomes S1.
202 – 105 = 97.
This level will be always above the S2.
Usually, the price is expected to remain between the R2 and S2 levels.
What if the price crosses above R2?
It is a sign of a strong trend.
What can be the expected level to refer to next?
The previous session range above R1 could be enough for bulls.
So, R1 + Range would be R3. 107 + 10 = 117.
The same logic is used for calculating S3.The formula for calculating S3 = S1 – Range.
In this example, S3 = 97- 10 = 87.
Below are the images capturing the calculation of all three resistances (R1, R2 and R3) that we have discussed.
Below are the images capturing the calculation of all three support (S1, S2 and S3) levels that we have discussed.
The calculation method is such that the sequence would always be R1 -> R2-> R3 above pivot level and S1-> S2-> S3 below pivot level for any session.
Have a look at below chart showing pivot levels for different sessions on a fifteen-minute candlestick chart. Observe Pivot ranges on day A and B.
Session A and B marked in the above chart is enlarged below. Note how the distance between Pivot levels depends on the range of the prior day session.
It should be apparent that the placement of the pivot levels depends on the range of the previous session. The range of the session and its close are important metrics in the pivot calculation. Pivot is an important reference point for the next session.
If the previous session was narrow, it could be a narrow range market and the trading range shown by pivot could be helpful. If price trades away far from pivot level, it is a range expansion day.
Buying at support and selling at resistance would work well in a range-bound market. When the trend is bullish, buying at support and when the trend is bearish, selling at resistance strategy would a logical course of action.
R2 and S2 are strong reference levels and work well in range-bound scenario. I would recommend the resistance level to exit in an uptrend instead of initiating shorts. Similarly, consider profit taking at supports in short trades and avoid buying at supports in a downtrend.
There are many methods to determine trends using these pivot levels.
Consider this simple definition. the price sustaining above pivot level is bullish and sustaining below pivot level is bearish. If price > Pivot and Current session pivot > previous session pivot = strong bullish trend.
If price < Pivot and current session pivot < previous session pivot = strong bullish
Else, it is a range day session. Does these levels work? You’ll not know unless you try it. The price does not always turn from the exact level, and you would not know which level will work. Moreover, these are mathematical calculations based on the previous day levels. Do you buy that idea? Then explore it. You will have to deal with scenarios when the narrow range is followed by the wide range and vice versa.
I think it can be a good method for confirmation. Trade action should be performed based on the price pattern. A strong bullish candle or price pattern near support provide confirmation of demand. A strong bullish pattern near the resistance area is a sign of a breakout. Pivot levels can be beautifully combined with the Breadth zone. There are many possibilities here.
We can also plot pivot levels on P&F or Renko charts. The calculation is performed on the previous day candle range and levels are plotted on these charts. The objective price patterns of these charts can help in taking trades at these levels. For me, this is a fascinating idea.
The intention behind this post was to dig deeper into the calculation and understand the tool better. There is more to discuss about the Pivot tables. CPR, Camarilla, and there are other such tools to calculate support & resistance. We will discuss this in subsequent newsletters.