9# Pivot levels Trading System

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For any market, there is an equilibrium point around which

trading activity occurs. In the absence of large numbers of

new buyers or sellers, this point serves as the pivot or focal

point for market makers as they adjust their bids and

offers. When prices move away from the pivot, there are

zones of support and resistance that can be derived from

the established value area in the market. Penetration of

these zones leads to perceived changes in valuation and the

entry of new players into the market.

The pivot point and its support and resistance pairs are

defined as follows:

Pivot Point (P) = (H+L+C)/3

First resistance level (R1) = (2*P)-L

First support level (S1) = (2*P)-H

Second resistance level (R2) = P+(R1-S1)

Second support level (S2) = P-(R1-S1)

where H, L, C are the previous day’s high, low and close, respectively.

If either of these first levels is penetrated, off-floor traders are attracted into the market.


These breakout levels then usually reverse their function and serve as test points, i.e.,

previous resistance becomes support or previous support becomes resistance. The range of trading has expanded and if a second support or resistance level is breached then longer term trades will be attracted.


The valuation parameters used by market makers can be

calculated with the simple formulas above. Knowledge of

the levels at which different types of traders enter the

market can help in determining when a shift in valuation by

the locals has occurred.

As with traditional technical analysis, should these levels

fail then the second levels will come into play. If this next

support and resistance band fails then a new influx of

players will come in and likely start a trend in motion.

Market makers regularly take the market up and down

within their value range so orders placed within it are likely

to be executed. This can cause a problem as whipsaws can

occur. However, by placing stop orders outside this range it

is more likely that a trend emerging from the local “noise”

of the market can be captured.

Some charting packages, like Intellichart, allow you to draw

pivots automatically; although, in other charting packages,

pivots aren’t included. If that’s the case, you can easily

build a simple pivots calculator on Excel (using the formulas

provided above), or search on Google for a free one.

Let’s take a look at some practical examples.

As you can see in this GBP/USD 5 minutes chart, the blue

lines represent the support lines, and the red line

represents the resistance area.

The line at 1.9063 is the first support level (S1); the one at

1.9077 is the first resistance level (R1); and the other one

at 1.9038 is the second support level (S2). The points 1, 2

and 3 show us clearly that prices are facing some

congestion area. Notice that only the shadows of the

candlesticks have penetrated the S1 line. At point 1, the

prices are going down from R1 to S1, but they remain

above this last line, so S1 is acting as a strong support.

Then, they try to cross it down and they do that but not

without two different retracements to the points 2 and 3. It is easy to see that S1 is now acting as a resistance, so you

can expect prices to fall to S2. Again, only the shadows

surpass the line. At point 3, sellers gain strength and the

price goes down to the S2 area.

You can clearly see that these lines represent strong

support and resistance areas. This is why they give you a

great assistance in order to choose the best stop losses and

targets.

 

In this GBP/USD 5 minutes chart, you can see three lines:

one at 1.8975 (the blue one) which represents the first

level of support (S1), another one at 1.9025 which

represents the first level of resistance (R1), and the last

one at 1.9055 which represents the second level of

resistance (R2).

As you can see, the prices were moving up from the S1

area until they touch the R1 line. At this point, GBP/USD

faced a resistance, and retraced. After that, GBP/USD

started to go up again; this time it passed the R1, retraced

again to the area below R1 but above the price reached on

the first retracement, and started to go up again. This time,

the prices went to the R2 area and then came back to the

R1 again.

As you can see, at first, R1 acted as a resistance and then,

when the prices reached R2, it acted as a support. This is

how pivots usually act.

 

In this GBP/USD 5 minutes chart, you can see three

different lines: the first one is the first support level (S1) at

1.8070, the second one is the first level of resistance (R1)

at 1.8152, and the third one is the second level of

resistance (R2) at 1.8204. As you can see in this chart, prices were oscillating around

the S1 area. Prices were facing a strong support, until they

managed to reach R1. They have crossed above the line

but retraced back. At this moment, R1 is acting as a

support, pointing for higher prices and a good target at R2.

As expected, prices gained strength and jumped until they

reached R2. As you can see, R1 started to act as a

resistance area and then began to act as a support area.

This gives you an idea of what should happen and where

the trend may face a strong resistance.

 

 

Pivot Indicator   

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