Sunday, 19 June 2016

How to use Pivot Points to Trade Profitably

Today, I will be discussing what Pivot Points are and how it can be very useful in trading.

Personally, my style of trading is classified as swing trading or momentum trading. I look for short term reversal in prices and capitalise on that in order to make a profit.

The question remains, where do you close your position and take profit? This largely depends on your risk appetite and trading style. The more aggressive traders would have their take profit further away while the more conservative would have it closer.

However, Pivot Points provide a very good estimate as to where short-term support and resistance are located. Basically, these are areas where prices then to bounce on.

This is helpful to me in 2 ways:

1. It helps me determine if a reversal pattern is valid (aka, if it occurs near a pivot point, the reversal is more valid then if it occurred randomly)

2. It helps me determine my take profit in order to calculate whether my risk-reward ratio is acceptable based on my risk appetite.

Let's look at a recent trade that I made, Skechers USA Inc:

The highlighted candlestick is a reversal pattern known as "Hanging Man". All the yellow lines are known as " Pivot Points".

Pivot Points (Standard) have the following labels and there are calculated as follows:

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)

The source of the high, low and close depends on what time frame you are using to view your charts.

  • Pivots for 1, 5, 10, 15 charts use the prior day's high, low and close. 
  • Pivot Points for 30 and 60 minute charts use the prior week's high, low and close. 
  • Pivot Points for daily charts use the prior month's data.
Click here to read more about Pivot Points as well as different variations on it.

Based on my trading methodology, I will look for reversal candles, like the "hanging man" that occur near a particular pivot point. After which, my take profit would be as follows,

Short Entry

My take profit would either be the higher of the previous swing low, or the next immediate pivot point.

Long Entry

My take profit would either be the lower of the previous swing high, or the next immediate pivot point.

So back to the Skechers example, I shorted the stock based because the reversal candle occurred near a pivot point. The previous swing low was higher than the next pivot point below it. Therefore, I used the swing low as my take profit level.

Using this method to identify swing trading opportunities coupled with the risk management that I mentioned in the previous post, the odds of making a profitable trade are in your favour. 

I will be posting more updates about the indicators that I personally use to identify my trades so stay tuned!

As always, happy trading.



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