Pivot Points 101 

Pivot point  is a price level of significance in technical analysis of a financial market that is used by traders as a predictive indicator of market movement. Pivot points  are used to identify potential spots of support and resistance. Can we use pivot points to help us identify trading opportunities in S&P/ASX 200 index ( ASX trading symbol XJO ) ?

How to Calculate Pivot Points

The prices used to calculate the pivot point are the previous trading day’s high, low and closing prices for a security. The textbook calculation for a pivot point is as follows:

Pivot Point (P) = (High + Low + Close) / 3

Support and resistance levels are then calculated using the below formula

• The first resistance level (R1) = (Pivot Point x 2) – Yesterday’s Low.
• The second resistance level (R2) = Pivot  Point + (Yesterday’s High – Yesterday’s Low).
• The third resistance level ( R3) =  R2 +  (Yesterday’s High – Yesterday’s Low).
• The  first support level (S1) = (Pivot Point x 2) – Yesterday’s High.
• The second support level  (S2)=  Pivot Point  – (Yesterday’s High – Yesterday’s Low).
• The third support level  (S3)=  S2  - (Yesterday’s High – Yesterday’s Low).

Pivot Point Probabilities on XJO 

We studied the number of days when  the low was lower than each S1, S2 and S3 and the number of days that the high was higher than the each R1, R2 and R3 since  Jan 2,  2008 till Nov 22 , 2011 period. Here are the results

• There have been a total 987 trading days.
• The actual low has been lower than S1  435 times, or about 44% of the time
• The actual high has been higher than R1 444  times, or about  45% of the time
  
• The actual low has been lower than S2 267 times, or about 27% of the time
• The actual high has been higher than R2 243times, or about 25% of the time
  
• The actual low has been lower than S3 76 times, or about 8% of the time
• The actual high has been higher than R3 53 times, or about 5% of the time

The above information can be useful to a trader; if you observe that the XJO  slips below S1 44% of the time, you can place a stop loss order ( if are holding on to longs ) below S1 zone with confidence, understanding that probability is on your side. Additionally, you may want consider taking  profits  ( again under the assumption that you are holding on to longs) around R1 zone  because you know that the high for the day exceeds R1 only 45% of the time. It is important to understand, however, that theses are probabilities and not certainties.