The futures markets are fast-paced environments that require discipline and insight to successfully navigate. In order to achieve a winning perspective, traders commonly incorporate aspects of both fundamental and technical analysis into their trading strategy. In particular, Pivot Points are used for trading futures and commodities.
Pivot points (PP) are one of the most popular technical tools among futures traders. Pivot points are frequently used to gauge market sentiment and identify levels where price action is likely to change direction. Because they’re used to identify forthcoming trends, PPs are categorized as a leading indicator.
Support, Resistance and the Pivot Point
Floor and pit traders involved in the futures industry originally developed the pivot point trading style. This approach to short-term trading grew in popularity because of its effectiveness in highly liquid markets, predictive capabilities and applications to risk management.
As a whole, the PP methodology is not overly complex. However, a working knowledge of support and resistance is critical to its comprehension:
- Support: A level below price that typically induces traders to enter buy orders.
- Resistance: A level above price where a large supply of sell orders reside
In practice, price continually rotates between areas of upside resistance and downside support. These levels can be attributed to a wide range of market technicals or fundamentals. Fibonacci retracements, previous session highs or lows, or large institutional market orders can create areas of natural support or resistance.
Calculating Pivot Points
In order to calculate a working PP with associated support and resistance levels, a trader must focus on the previous session’s high, low and closing values.
Using those bits of information, here’s a basic method of deriving a PP with associated support and resistance levels:
- Pivot Point
- PP = (High + Low + Close)/3
- First Resistance
- R(1)= (2 * PP) – Low
- First Support
- >S(1) = (2 * PP) – High
- Second Resistance
- R(2) = PP + (High – Low)
- Second Support
- S(2) = PP – (High – Low)
- Third Resistance
- R(3)= High + 2(PP – Low)
- Third Support
- S(3) = Low – 2(High-PP)
Trading platforms typically perform these calculations automatically and place them upon the chart as an overlay. There is seldom a need to calculate them by hand.
Plus, trades have many ways to derive a PP with various support and resistance levels. Some traders prefer to place emphasis upon a session’s opening price, closing price or Fibonacci numbers. No matter which method is used, PPs can help put the current price of a security into context with previously established price action.
Trading with Pivot Points
Pivot point trading strategies are an all-in-one approach to the market. When used properly, the presence of a trend is easily determined, along with an individual trade’s entry and exit prices.
Applying a PP strategy to any futures market is relatively straightforward:
- Identification of market sentiment:The position of the PP relative to current price action is a key portion of identifying market state. If that price is above the PP, then the market is bullish. If below the PP, then action is bearish.
- Market entry:Entering the market using a PP is not overly complex. Simply go long when price breaks above the PP and short when price falls below.
- Market exit:Each level of support and resistance can be useful when identifying profit targets and stop losses. Pivot traders frequently view S(1) and R(1) as ideal levels for profit or loss. If short, the S(1) level is a great spot to place a profit target, with R(1) acting as a prime level for a stop loss. The opposite is true for a long position.
One major advantage of constructing a trading plan based upon PPs is versatility. Traders may seamlessly integrate additional technicals — such as MACD, RSI or Stochastics — into the approach to validate or deny a potential trade idea.