Pivot Point Article:
by: John Person
Editor's note: John Person has been analyzing and trading futures for 32 years and is one of the worlds foremost authority on pivot point analysis. He is the editor of the weekly newsletter, The Bottom Line Financial Report. He also appears regularly on CNBC and is widely quoted in the press. He writes a daily market report on the Chicago Board of Trade web site and speaks at numerous seminars around the country. John Person's first book, A Complete Guide to Technical Trading Tactics, published by John Wiley and Sons, was the first to introduce combining the best of both worlds, candlestick charting and pivot point analysis. His second book Candlestick and Pivot Point Trading Triggers reveals more details about when and how to use pivot point analysis on entry and exits. To read more you can buy the books and courses written by John Person, click here to buy your book or trading courses.
Many traders have probably heard the term pivot points and recognize that they have some bearing on price action. However, most individual traders and even brokers are not familiar with the pivot point formula, perhaps because of the time involved in calculating the numbers. But professional traders including myself look at pivot points, so you should probably be aware of what they are. Some recent chart examples below reflect the validity of the pivot point concept. With pivot point in the name, you might guess that these points are very significant to some traders, especially to those "old school" traders who have been following pivot points for many years. A pivot point is simply a computed number based on the high, low and close of the previous price bar, whether the time period is a day, a week or a month. Using that pivot point number, traders calculate support and resistance levels, which are considered to be price brackets for the current time period.
To determine current support/resistance levels, the first step is to find the pivot point number:
PP = (H + L + C)/3
The first resistance level(R1)=(PPx2)-L
The second resistance level (R2)=PP+H-L
The fist support level (s1)=(PPx2)-H
The second support level (S2)=PP-H+L
All right, now that we have that established you can see it is a detailed formula. So let’s try to simplify it. Consider the pivot point as the average of the previous sessions trading range combined with the closing price. The numbers of support and resistance that are calculated indicate the potential ranges for the next time frame based on the past weight of the markets strength or weakness derived from the calculations of the high, low and distance from the close of those points. Pivot point analysis is also used for identifying breakout points from the support and resistance numbers. The previous sessions trading range could be based and calculated for an hour, a day, a week or a month. Most trading software includes these numbers on a daily basis so that you do not have the tedious chore of doing it the old fashion way, by hand using a calculator. The really old fashion way doesn’t use a calculator. Don’t make your job harder try the easy way.
If you wish to read more about pivot point analysis John Person's book was the first ever to introduce candle stick patterns and pivot point analysis. Click here to learn more. In addition, here is an excerpt from that first book... Since most technical analysis is derived from mathematical calculations the common denominators that are used are the high, low, close and the open. This is what is used for plotting a bar chart. More notarized techniques like Moving averages, Relative Strength Index, Stochastics, and Fibonacci numbers are all calculated using mathematics based on those points of interest. It is also what is published in the Newspapers. It is there for a reason. The concept is this, as technical analysts we are trying to use past price behavior to help us indicate future price direction. This sounds absurd because no one can predict the future, right? Well I am not trying to predict the future I just want an Idea of where prices can go in a given time period based on where they have been. After all isn’t that similar to the concept of drawing trend lines? If the professional traders are looking at these pivot point numbers why wouldn’t I want to look at them as well? Anything that can help me make better decision by determining a game plan that integrates a better level of risk and a potential profit objective can’t be bad. Remember, I won’t know where I am going if I don’t know where I have been. That is what this method helps you to do, navigate future price moves based on the previous time frames data. Before going any further let me further explain who uses the pivot point numbers, mainly floor traders, hedge funds, prop traders and large speculators all use them. However, the popularity is growing as investors quest for education increases. I picked up on the method back in 1984 as a colleague was showing me how to day trade the foreign currencies, namely the Swiss Franc and the German Deutsche Mark. This was way before forex was popular. In fact trading currencies at the CME has been around since the 1970's. Pivot Point analysis and using a pivot point calculator worked fairly well in those days so I incorporated it for the market I had a passion for, which was Bonds. After using them for some time as a “crutch” I was losing interest as a day trader. I experimented with them using this concept of a longer time period namely on a weekly basis. Wow what a discovery! Then I came to the conclusion to try to use them on a Monthly basis after all I was a believer in Daily, Weekly and Monthly Charts. In fact the Chicago Board Of Trade use to give out a monthly Bond Chart and another friend of mine on the floor use to get together with me for “homework” sessions. We would do longer term chart studies using Moving Averages. I figured why not look at the monthly pivot point price targets too. WOW again! I discovered that I could look at a potential price range target in the future based on price action in the past. The longer the time frames the more power or market move would happen. I also discovered the power and leverage of options as they were introduced in to the futures market with the first market being … you guessed it Bonds. I hit a grand slam home run that lasted through most of 1986. You see I was bullish and the era of Reaganomics was happening! Interest rates were declining from 14% and Bond prices were exploding (bonds have an inverted relationship between yield and price). That was a great time. I made a lot of money and I made other people a lot of money too.