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Pivot Points

This tutorial written and reproduced with permission from Peter Ponzo

So I get this e-mail that talks about pivot points and …

And you never heard of them, right?

No. I mean, yes, I never heard of them, but they seemed interesting so I thought I’d investigate. The idea is to look at the variations in today’s stock prices, the Open, High, Low and Close, and construct a so-called PivotPoint price, then generate some resistance and support levels using the PP and the O, H, L and C prices.

Resistance and support?

Resistance and support levels are prices where you expect the stock to have some difficulty in crossing. If they do cross, you might expect some major stock movement as in Figure 1.

Note: In addition to resistance and support levels, there are resistance and supports “trends”.

With pivot points, we just talk about “levels” … as in Figure 1. There may also be several such levels, some weak, some strong. Crossing a strong level may be the start of a major trend, UP or DOWN.

 

Pivot Points
Figure 1

 

And what about pivot points?

Okay. We define, at day’s end, a pivot point:

[1a]       PP = a1O + a2H + a3L + a4C     where a1+a2+a3+a4=1

Then we can define resistance and support levels:

[1b]       R = ß1O + ß2H + ß3L + ß4C      where ß1234=1
[1c]       S = ?1O + ?2H + ?3L + ?4C      where ?1+?2+?3+?4=1

You kidding? Am I supposed to pick all those numbers, a1 and a2 and …

Why not? Or, you can just adopt what others have chosen. For example, here’s one choice:

[2a]       PP = (H + L + C)/3                Note that 1/3 + 1/3 + 1/3 = 1
[2b]       R3 = (5/3)H – (4/3)L + (2/3)C     Note that 5/3 – 4/3 + 2/3 = 1
[2c]       S3 = (-4/3)H + (5/3)L + (2/3)C    Note that -4/3 + 5/3 + 2/3 = 1

Where’s O?

The Open? It ain’t there … for this particular choice.

Example?

I’m glad you asked. See Figure 2? It’s GE, starting on March 10, 2005. The High, Low, Close, Pivot Point, Resistance and Support are shown… for March 10, using magic formulas [2].

So what do I do now?

I guess you wait and see if one of those support levels gets crossed and …

Crossed violently?

Okay, a violent crossing. Then you might consider buying or selling. Of course, you may have several support and/or resistance levels so you watch to see which are crossed. Maybe you have a “weak” level which will attract your attention … then you watch to see if a “stronger” support gets crossed later.

 

Pivot Points
Figure 2

 

Weak? Strong? Are they technical terms?

Yeah … just like violent.

What’s the reason for calling the levels R3 and S3. What happened to R1 and R2 and …?

Patience. I said you can have several levels. Remember?

Yeah. Weak, strong and stronger. I assume there’s a spreadsheet to do all this?

Eventually. In the meantime you can play with the spreadsheet that James sent me.

It looks like this:

 

Pivot Points

 

I assume I just click …

Yeah. As usual, you click on the picture. If you’d like to see what happened in the past, you can play with this guy:

 

Pivot Points

 

I take it R1 is some kind of “weak” Resistance and …

Yes, and R3 is stronger. I’ve used the following magic formulas to calculate R1 and S1:

[3a]       PP = (H + L + C)/3
[3b]       R1 = 2*PP – L = (2/3)H – (1/3)L + (2/3)C
[3c]       S1 = 2*PP – H = -(1/3)H + (2/3)L + (2/3)C

Note that, in early June we crossed the “weak” support level S1. We pay close attention. Then, on about June 22 there was a dramatic crossing of the stronger level, S3.

So we sell?

That’s up to you. Remember we’re looking at the past … and hindsight is 20/20.  Here are a few more (using the same magic formulas as above):

 

Pivot Points

Pivot Points

Pivot Points

Pivot Points

 

 

Here are some pivot point formulas (where particular values are chosen for the parameters a, ß, ? and d

R1 = 2PP – L
R2 = PP + (H – L)
R3 = H + 2(PP – L)

S1 = 2PP- H
S2 = PP – (H – L)
S3 = L – 2(H – PP)

 

Pivot Points
Figure 3

 

The spreadsheet uses these as well as:

PP = (H + L + C)/3

Although none use the Open, the calculation of the Pivot Point might use it. For example:

PP = O + (1/4)(H + L + C)

If the formulas seem strange, we can rewrite them so they give deviations from previous levels, as a percentage of the PP, like so (using the notation in Figure 3).

R1 = PP (1 + b%)
R2 = R1 (1 + a%)
R3 = R2 (1 + b%)

S1 = PP (1 – a%)
S2 = S1 (1 – b%)
S3 = S2 (1 – a%)

Huh?

In place of a = H – PP, we consider a% = a/PP … as a percentage of PP. And instead of b = PP – L, we use b% = b/PP etc.. Then it’s easy to see how we can generate a jillion levels. Of course, in addition to using today’s prices, you might use yesterday’s as well and maybe volume weighting or ..

What’s the best?

I have no idea. As you might expect, there are variations on variations.

I assume these pivot points guys work pretty well, eh?

I have no idea, but here’s an example where, each time the closing price crosses a resistance or support level, we calculate new ones.

New ones? Which ones, since there are variations on variations and …?

I use the magic formulas given above for R3 and S3 and PP = (H+L+C)/3.

 

Pivot Points

 

Uh … could I have made any money there?

I have no idea.

When do you think you might have an idea?

I have no idea … but basing support and resistance upon a single day’s price variations seems a mite simple-minded.