Trend trading is an investment strategy using direction, momentum and a degree of predictability to help you realize gains. Based on Newton’s Law of Physics, it assumes the direction a stock is currently taking – whether upward or downward -- will continue into the future until or unless an event or outside influence disrupts and changes its current movement. Pivot points not only can be used to help you implement a trend-trading strategy, but also are a fundamental tool for helping you identify short-term price patterns and for deciding when to buy and when to sell.
Using pivot points in trend trading requires that you first become familiar with their definition and associated terms. By definition, a pivot point is an average of the high, low and closing price of a security, usually for the previous day, although a longer time frame -- the previous week or month – may also be used. Two important terms are “support” and “resistance.” Some identify these as levels, and some call them lines, but both predict movement, and their meaning is the same. Support is a point-of-entry indicator and refers to a price level that a stock has shown historically it will most likely not fall below. Resistance is the price point at which a stock will most likely not rise above and indicates that it’s time to sell.
Standard pivot point charts use a five-line system consisting of a primary pivot point and two supporting and resistance points. The first set of supporting and resistance points assume the current trading day will trend identical to the last. The second set establishes new supporting and resistance points if volatility or another outside influence causes stock prices to break through and rise above or below the first set of points. Pivot point charts most often use color – such as green, red and blue -- to identify the three sets of points.
Calculate pivot points manually or by using an online calculator. To calculate a five-line pivot point system manually, start with the equation “High + Low + Close / 3” to get a base pivot point. Multiply the base pivot point by two and subtract the high price of the stock in question to get Supporting Line 1. Get Supporting Line 2 by subtracting the difference of the high and low prices of the stock from the base pivot point. Calculating resistance works much the same. Multiply the base pivot point by two and subtract the low price of the stock in question to get Resistance Line 1. To get Resistance Line 2, add the difference of the high and low prices of the stock to the base pivot point. Although this formula is not complex, you may nevertheless find using a calculator simpler and more accurate. Plot pivot points on a chart or compare your results with current stock prices.
Use pivot points to analyze price patterns and identify changing short-term trends that signal it’s time to buy, sell or hold. One of the most effective and simplest ways to do this is by paying close attention to reversals. Watch stocks closing in on their resistance line and take any reversal downward as a sell indicator. Do the same for stocks closing in on their supporting line, and if you see any reversal upward – called a bounce -- consider this a time to buy. Consider holding – at least in the short term -- if stocks break through the first set of supporting or resistance points as prices historically tend to trade back to their base pivot point and resume their primary trend.
Video of the Day
- Comstock Images/Comstock/Getty Images