Pivot trading

Hi Dear Readers,

I happen to answers many query's about the 'Technical Analysis' . There are many new comers to our site who is also new to stock trading and keen in learning the basics..So i have posted here the most basics "Pivot Trading" and hope it may help the new comers to learn and initiate spark in further learning .

Pivot trading is very popular in floor trading; it gives us the fair value of financial instruments. Emotional trading will always move the price from its fair value but when traders realize the price is overbought or oversold, they will sell the overbought currency and buy oversold currency.

That’s why pivot point and the associated support and resistance levels often are turning points for the direction of price movement in a market. In an up-trending market, the pivot point and the resistance levels may represent a ceiling level (overbought) in price above which the uptrend is no longer sustainable and a reversal may occur. In a declining market, a pivot point and the support levels may represent a low price level of stability (oversold) or a resistance to further decline.

Calculation:

Several methods exist for calculating the pivot point (P) of a market. Most commonly, it is the arithmetic average of the high (H), low (L), and closing (C) prices of the market in the prior trading period:

P = (H + L + C) / 3.

Sometimes, the average also includes the previous periods or the current period's opening price (O):
P = (O + H + L + C) / 4.

In other cases, traders like to emphasize the closing price,
P = (H + L + C + C) / 4,

(Or) the current periods opening price,

P = (H + L + O + O) / 4.


Support and resistance levels

Price support and resistance levels are key trading tools in any market. Their roles may be interchangeable, depending on whether the price level is approached in an up-trending or a down-trending market. These price levels may be derived from many market assumptions and conventions. In pivot point analysis, several levels, usually three, are commonly recognized below and above the pivot point. These are calculated from the range of price movement in the previous trading period, added to the pivot point for resistances and subtracted from it forsupport levels.


The first and most significant level of support (S1) and resistance (R1) is obtained by recognition of the upper and the lower halves of the prior trading range, defined by the trading above the pivot point (H − P), and below it (P − L). The first resistance on the up-side of the market is given by the lower width of prior trading added to the pivot point price and the first support on the down-side is the width of the upper part of the prior trading range below the pivot point.


• R1 = P + (P − L) = 2×P − L
• S1 = P − (H − P) = 2×P − H

Thus, these level may simply be calculated by subtracting the previous low (L) and high (H) price, respectively, from twice the pivot point value:The second set of resistance (R2) and support (S2) levels are above and below, respectively, the first set. They are simply determined from the full width of the prior trading range (H −L), added to and subtracted from the pivot point, respectively:

• R2 = P + (H − L)
• S2 = P − (H − L)

Commonly a third set is also calculated; again representing another higher resistance level (R3) and a yet lower support level (S3). The method of the second set is continued by doubling the range added and subtracted from the pivot point:

• R3 = P + 2× (H − L)
• S3 = P − 2×(H − L)


This concept is sometimes, albeit rarely, extended to a fourth set in which the tripled value of the trading range is used in the calculation. Qualitatively, the second and higher support and resistance levels are always located symmetrically around the pivot point, whereas this is not the case for the first levels, unless the pivot point happens to divide the prior trading range exactly in half.