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How do I go about identifying pivot points on a chart to help me trade in the short term (say between a couple of days to a couple of weeks, as I don't want to do day trading)?

I understand that a pivot point is basically the intermediary highs and lows on a chart, but the first part of my question is to learn a way of identifying these pivot points and then using them to help me trade in the short term. I already have a brief understanding of Technical Analysis and I am aware of the risks involved in short term trading.

The second part of my question is, once I have identified a pivot point how should I attempt to trade it? What set of rules can I set up so that when I see a pivot point I can act quickly and enter my trade details. Are there alternative setups I could take and how could I decide which is best to use for me? (I am not asking to be spoon fed here, but rather looking for rational of how I could decide for myself).

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    Check out this book: A Complete Guide to Technical Trading Tactics By John Person. He specifically talks about using Pivot Points and how to possibly profit from them. – NuWin Jan 13 '16 at 23:46
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    George, in your question you refer to pivot points but I noticed you refer to them as intermediary highs and lows, are you actually referring to reversal points rather than pivot points? Anyway I have included both in my answer below. – Victor Jan 20 '16 at 5:59
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Pivots Points are significant levels technical analysts can use to determine directional movement, support and resistance. Pivot Points use the prior period's high, low and close to formulate future support and resistance. In this regard, Pivot Points are predictive or leading indicators. There are at least five different versions of Pivot Points. I will focus on Standard Pivot Points here as they are the simplest.

If you are looking to trade off daily charts you would work out your Pivot Points from the prior month's data. For example, Pivot Points for first trading day of February would be based on the high, low and close for January. They remain the same for the entire month of February. New Pivot Points would then be calculated on the first trading day of March using the high, low and close for February.

To work out the Standard Pivot Points you use the High, Low and Close from the previous period (i.e. for daily charts it would be from the previous month) in the following formulas:

  • Pivot Point (P) = (High + Low + Close)/3
  • Support 1 (S1) = (P x 2) - High
  • Support 2 (S2) = P - (High - Low)
  • Resistance 1 (R1) = (P x 2) - Low
  • Resistance 2 (R2) = P + (High - Low)

You will now have 5 horizontal lines: P, R1, R2, S1 and S2 which will set the general tone for price action over the next month. A move above the Pivot Point P suggests strength with a target to the first resistance R1. A break above first resistance shows even more strength with a target to the second resistance level R2.

The converse is true on the downside. A move below the Pivot Point P suggests weakness with a target to the first support level S1. A break below the first support level shows even more weakness with a target to the second support level S2.

The second resistance and support levels (R2 & S2) can also be used to identify potentially overbought and oversold situations. A move above the second resistance level R2 would show strength, but it would also indicate an overbought situation that could give way to a pullback. Similarly, a move below the second support level S2 would show weakness, but would also suggest a short-term oversold condition that could give way to a bounce. This could be used together with a momentum indicator such as RSI or Stochastic to confirm overbought or oversold conditions.

Pivot Points offer a methodology to determine price direction and then set support and resistance levels, however, it is important to confirm Pivot Point signals with other technical analysis indicators, such as candle stick reversal patterns, stochastic and general Support and Resistance Levels in the price action.

These pivot points can be handy but I actually haven’t used them for trade setups and entries myself. I prefer to use candle sticks together with stochastic to determine potential turning points and then take out trades based on these. You can then use the Pivot Points Resistance and Support levels to help you estimate profit targets or areas to start becoming cautious and start tightening your stops. Say, for example, you have gone long from a signal you got a few days ago, you are now in profit and the price is now approaching R2 whilst the Stochastic is approaching overbought, you might want to start tightening your stop loss as you might expect some weakness in the price in the near future. If prices continue up you keep increasing your profits, if prices do reverse then you keep the majority of your existing profits. This would become part of your trade management.

If you are after finding potential market turning points and take out trades based on these, then I would suggest using candlestick charting reversal patterns for your trade setups. The patterns I like to use most in my trading can be described as either the Hammer or One White Soldier for Bullish reversals and Shooting Star or One Black Crow for Bearish reversals. Below are diagrams of where to place your entries and exits on both Bullish and Bearish reversal patterns.

Bullish Reversal Pattern

Bullish reversal

So after some period of weakness in the price you would look for a bullish day where the price closes above the previous day’s high, you place your buy order here just before market close and place your initial stop just below the low of the day. You would apply this either for an uptrending stock where the price has retracted from or near the trendline or Moving Average, or a ranging stock where price is bouncing off the support line. The trade is reinforced if the Stochastic is in or near the oversold and crossing back upwards, volume on the up day is higher than volume on the down days, and the market as a whole is moving up as well. The benefit with this entry is that you are in early so you capture any bullish move up at the open of the next day, such as gaps. The drawbacks are that you need to be in front of your screen before market close to get your price close to the market close and you may get whipsawed if prices reverse at the open of the next day, thus being stopped out with a small loss.

As the price moves up you would move your stop loss to just below the low of each day.

Alternative Bullish Reversal Entry

Bullish reversal alternative

An alternative, entry would be to wait for after market close and then start your analysis (easier to do after market close than whilst the market is open and less emotions involved). Place a stop buy order to buy at the open of next trading day just above the high of the bullish green candle. Your stop is placed exactly the same, just below the low of the green bullish candle. The benefits of this alternative entry include you avoid the trade if the price reverses at the open of next day, thus avoiding a potential small loss (in other words you wait for further confirmation on the next trading day), and you avoid trading during market open hours where your emotions can get the better of you. I prefer to do my trading after market close so prefer this alternative. The drawback with this alternative is that you may miss out on bullish news prior to and at the next open, so miss out on some potential profits if prices do gap up at the open. This may also increase your loss on the trade if the prices gaps up then reverses and hits your stop on the same day. However, if you choose this method, then you will just need to incorporate this into your trading plan as potential slippage.

Bearish Reversal Pattern

Bearish reversal

So after some short period of strength in the price you would look for a bearish day where the price closes below the previous day’s low, you place your sell short order here just before market close and place your initial stop just above the high of the day. You would apply this either for an downtrending stock where the price has retracted from or near the trendline or Moving Average, or a ranging stock where price is bouncing off the resistance line. The trade is reinforced if the Stochastic is in or near the overbought and crossing back downwards, volume on the up day is higher than volume on the up days, and the market as a whole is moving down as well. The benefit with this entry is that you are in early so you capture any bearish move down at the open of the next day, such as gaps. The drawbacks are that you need to be in front of your screen before market close to get your price close to the market close and you may get whipsawed if prices reverse at the open of the next day, thus being stopped out with a small loss.

As the price moves down you would move your stop loss to just above the high of each day.

Alternative Bearish Reversal Entry

Bearish reversal alternative

An alternative, entry would be to wait for after market close and then start your analysis (easier to do after market close than whilst the market is open and less emotions involved). Place a stop sell short order to sell at the open of next trading day just below the low of the bearish red candle. Your stop is placed exactly the same, just above the high of the red bearish candle. The benefits of this alternative entry include you avoid the trade if the price reverses at the open of next day, thus avoiding a potential small loss (in other words you wait for further confirmation on the next trading day), and you avoid trading during market open hours where your emotions can get the better of you. I prefer to do my trading after market close so prefer this alternative. The drawback with this alternative is that you may miss out on bearish news prior to and at the next open, so miss out on some potential profits if prices do gap down at the open. This may also increase your loss on the trade if the prices gaps down then reverses and hits your stop on the same day. However, if you choose this method, then you will just need to incorporate this into your trading plan as potential slippage.

You could also trade other candle stick patterns is similar ways. And with the long entries you can also use them to get into the market with longer term trend following strategies, you would usually just use a larger stop for longer term trading.

To determine the size of your order you would use the price difference between your entry and your stop. You should not be risking more than 1% of your trading capital on any one trade. So if your trading capital is $20,000 your risk per trade should be $200. If you were looking to place your buy at 5.00 and had your initial stop at $4.60, you would divide $200 by $0.40 to get 500 stocks to buy. Using this form of money management you keep your losses down to a maximum of $200 (some trades may be a bit higher due to some slippage which you should allow for in your trading plan), which becomes your R-multiple. Your aim is to have your average win at 3R or higher (3 x your average loss), which will give you a positive expectancy even with a win ratio under 50%.

Once you have written down your trading rules you can search stock charts for potential setups. When you find one you can backtest the chart for similar setup over the past few years. For each setup in the past jot down the prices you would have entered at, where you would have set your stop, work out your R, and go day by day, moving your stop as you go, and see where you would have been stopped out. Work out your profit or loss in terms of R for each setup and then add them up. If you get a positive R multiple, then this may be a good stock to trade on this setup. If you get a negative R multiple, then maybe give this stock a miss and look for the next setup.

You can setup watch-lists of stocks that perform well for both long setups and short setups, and then trade these stocks when you get a new signal. It can take some time starting off, but once you have got your watch-lists for a particular setup, you just need to keep monitoring those stocks. You can create other watch-lists for other type of setups you have backtested as well.

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    Thanks, very detailed, and very easy to follow material. Something definately I will be following up on. And it was quite interesting to learn about pivot points, but I think You made a very good point with the turning points and candle stick patterns. Thanks again. – user9722 Jan 20 '16 at 21:51
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What are Pivot Points?

Pivot Points indicate price levels that are of significance in technical analysis of securities. Pivot Points are used to provide clarity for a trader as they are a predictive indicator of where a security might go. There are at least 6 different types of Pivot Points (Woodie Pivot Point, Fibonacci Pivot, Demark etc..) and they are different based on their formulas but generally serve the same concept. I will be answering your question using the Camarilla Pivot Point formula.

Camarilla Pivot Point Formula

Generally any Pivot Point formula uses a combination of the Open, High, Low and Close of the previous timeframe. Since you are technically a swing trader indicated by

say between a couple of days to a couple of weeks, as I don't want to do day trading

you should use a weekly 5 to 30 minute chart but you can also use a daily chart as well. So for example if you use a daily chart, you would use the Open, High, Low and Close of the previous day.

Example of fictitious stock: MOSEX (Money Stack Exchange)

01/14/16: Open: 10.25, High: 12.55, Low: 9.65, Close: 11.50

On 01/15/16: R4 Level: 13.10, R3 Level: 12.30, R2 Level: 12.03, R1 Level: 11.77, Pivot Point: 11.23, S1 Level: 11.23, S2 Level: 10.97, S3 Level: 10.70, S4 Level: 9.91

R = Resistance, S = Support

R4 is calculated by: Close + (HIGH - LOW) * 1.1 / 2
R3 is calculated by: Close + (HIGH - LOW) * 1.1 / 4
R2 is calculated by: Close + (HIGH - LOW) * 1.1 / 6
R1 is calculated by: Close + (HIGH - LOW) * 1.1 / 12
Pivot Point is calculated by: (HIGH + LOW + CLOSE) / 3
S1 is calculated by: Close - (HIGH - LOW) * 1.1 / 12
S2 is calculated by: Close - (HIGH - LOW) * 1.1 / 6
S3 is calculated by: Close - (HIGH - LOW) * 1.1 / 4
S4 is calculated by: Close - (HIGH - LOW) * 1.1 / 2

How to identify these Pivot Points?

Most charting software already have built in overlays that will identify the pivot points for you but you can always find and draw them yourself with an annotation tool.

Since we are using the Camarilla Pivot Point formula, the important Pivot Point levels are the R4 which is considered as the Breakout Pivot, the S4 which is considered as the Breakdown Pivot. R3 and S3 are Reversal Pivot Points.

Once identify the Pivot Points how should you proceed in a trade?

This is the million dollar question and without spoon feeding you requires you to come up with your own strategy. To distinguish yourself from being a novice and pro trader is to have a strategy in a trade.

Now I don't really have the time to look for actual charts to provide examples with but generally this is what you should look for to proceed in a trade:

Potential Buy/Short Signals:

  • A breakout of R4 is considered a strong signal and signals the trader to take long positions in a trade or cover their short positions. This signal is confirmed when a higher high is made from the first candle to break R4 level.
  • I would not buy at the R4 signal but wait for the reversion or pullback to R3 and buy at the bounce back up in which the R3 acts as your support.
  • If a stock breaks the S4 Level which is confirmed with a lower low from the candle that first breaks the S4. This is when you should probably short or sell.
  • If a stock moves below the S3 Level and moves back up the S3, this signals the trader to buy or cover their short position.

Potential Sell Signals:

  • If a stock moves above the R3 Level but then crosses below it, this would be a sell signal. This is confirmed when their is a lower lower then the candle that first crosses below it.

  • Sell a stock when S4 Level is confirmed. See above for the confirmation.

Other Useful Tips:

  • Use the Pivot Point as your support or resistance.

  • The Pivot Point levels can be used for your stop loss. For example, with an S3 reversal buy signal, the S4 should be used as a stop loss.

  • Conversely, the Pivot Point levels can also be used for your target prices. For example, with an S3 reversal buy signal, you should take some profits at R3 level.

  • You should also use a combination of other indicators to give you more information to confirm if a signal is correct. Examples of a good combination is the RSI, MACD and Moving Averages.

  • Read that book in my comment above!!

  • +1, Thanks for your answer and the book link. I did read thriugh both and they were quite interesting. Well I didn't read the whole book yet but skimmed through some interesting parts which I will follow up with. – user9722 Jan 20 '16 at 21:48

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