I am frequently asked how to use pivot points in day trading. They can certainly be useful tools, but, by themselves, they are not a real trading system or strategy. If you know how to calculate pivot points, however, they can be a helpful source of information.
Pivot points are most commonly used to determine support and resistance levels, which are the prices at which trends will tend to reverse direction. The support level indicates where the price will likely find “support” as it goes down and start to turn back up again. The resistance level is the opposite: the price where a trend tends to stop rising and start dropping.
When it comes to actually using pivot points, most traders refer to the "5-point-system." This system uses the previous day's high (H), low (L) and close (C), along with two support levels (S1 and S2) and two resistance levels (R1 and R2). The pivot points are calculated as follows:
R2 = P + (H - L) = P + (R1 - S1)?R1 = (P x 2) - L?P = (H + L + C) / 3?S1 = (P x 2) - H?S2 = P - (H - L) = P - (R1 - S1)
If it has been some time since you’ve used formulas, however, don’t worry. Fortunately, there are many free pivot point calculators available, such as http://www.pivotpointcalculator.com, and you do not have to calculate them yourself. Once you have calculated the pivot points based on the previous day data, you simply plot them on your chart.
I have never heard of any professional trader who uses pivot points exclusively in their day trading. They should not be seen by themselves as a trading system since, in fact, you will find pivot points at many different places on a trend line. In other words, if the price falls below a certain support level, for example, you will be able to calculate another pivot point, or support level, below that one. Pivot points are not absolute numbers, but are relative to the price’s current position. Consequently, most traders use them in conjunction with other indicators, and some even use them as profit targets or stop loss levels.
Deciding whether or not to use pivot points depends entirely on your current trading strategy. Experiment with them first. Plot the pivot points on your chart, and determine whether they give you any additional information. Can you use them as a filter? Could you use them to narrow your stop loss? Would they keep you out of losing trades and therefore increase your trading performance? If the answer to any of these questions is yes, then you should update your trading plan and use them. Otherwise, delete them and keep your charts clean. Your charts should only ever contain information that you actively use, and you should never feel compelled to use an indicator just because others use it. Pivot points are no exception, no matter how widely used they are.