Pivot Prices
This is Article 20 in a weekly series.
One question traders often ask when they are ready to enter or exit a trade is, “If I get a buy or sell signal, what should my entry (or exit) price be? Should I use a limit order, or a market order?” When trading small cap stocks, it is often very risky to simply place a market order at the morning open. By doing this you are telling the market that you are willing to buy the stock at any price, and have little control over what your actual fill price will be. Prices are usually very volatile in the first 15 minutes of the day.
Many traders use pivot points to find intraday support/resistance levels to help them gauge the current day’s anticipated price movements, and set their target prices. Pivot points are found by a simple calculation which involves the high, low and close for the previous day of any particular stock or index. It is said that when a price hovers below the pivot price and breaks up through it, this triggers a buy signal (or vice versa for a sell signal). Or, if the major price action is above, and stays above, the pivot price, it is considered bullish, and if the action is below the pivot price, this is considered bearish. The most common way to use pivot points are as reference points for entering a trade if other indicators are also giving the same directional signal. Market Makers can use the pivot points to create a market by shifting the price around between levels to entice buyers or sellers of a stock into a trade. This can best be seen on low volume trading days as the prices fluctuate between the calculated points.
Listed below are the most commonly used basic pivot point levels:
R2 Resistance Level 2 – This level often provides strong resistance. Stocks that break above and stay above R2 levels are often in strong trends and many times continue higher the rest of the day.
R1 Resistance Level 1 – Stocks often reverse at or around R1, but if they can get through this level they will usually rally to the R2 level.
Pivot Price (PP) – Average of previous day’s high-low-close. This price level provides the strongest support or resistance for the current day. If the stock price is above this line, wait to buy pullbacks. If the stock price is below this line, wait for a rally to sell short. Stocks often oscillate around this price for awhile before they break out in one direction or the other. It is sometimes best to wait for a few shakeouts and then buy a breakout from the high of the trading range, or sell a breakdown from the low of the range. For short-term trades, your initial entry target might be the pivot price.
S1 Support Level 1 – Stocks often reverse at or around S1, but if they can break down through this level they will usually continue down to the S2 level.
S2 Support Level 2 – This level often provides strong support. Stocks that break below this price most likely spend the rest of the day (and longer) below this level.
The equations for these five levels are:
R2 = P + (H – L)
R1 = (P x 2) – L
P = (H + L + C) / 3
S1 = (P x 2) – H
S2 = P – (H – L)
Where H = Previous day’s high
L = Previous day’s low
C = Previous day’s close
How important is the pivot price in the determination of your entry or exit price? That depends on your anticipated time frame for the trade. For a longer term trade, lasting a few weeks or months, the difference of a few ticks either way in the entry price is pretty insignificant in the whole scheme of things. The Wave Rider system is a good example of a longer term trending system, where I usually don’t worry too much about the exact pivot prices. I sometimes simply place a limit order 1 percent above the previous day’s closing price if I can’t keep a close watch on the morning’s action. I will have most entries filled within the first hour of trading by using this procedure.
However, for shorter term systems such as the Trade 4 Cash system, the actual entry price has a much larger effect on the overall outcome of the trade. In this case I will set my initial limit order at the pivot price. If my order does not get filled in the first 90 minutes of the day, I will adjust my order as needed. I will seldom enter a trade above the R2 level.
The use of pivot points does not guarantee a better outcome to your trade, but it does give a trader one more tool in determining the anticipated movement of a stock, and the determination of the day’s fair market price. And using pivot prices is one way of disciplining yourself against chasing a stock, and buying at inflated prices.
