Pivots are a reference point where there was a shift between the forces of supply and demand. This is sometimes referred to as peak and trough analysis. It is a very objective way to manage your positions within an ongoing trend. Pivots tell you where there are potential buyers (demand) and sellers (supply).
In this Wiki we will take an in-depth look at Pivots and how they can be applies to trading the financial markets.
This Wiki is part of the larger Price Action Analysis Wiki. You can access the Price Action Analysis Wiki HERE.
This Wiki is also a part of our Essential Forex Trading Guide. Be sure to check that out HERE.
Pivots are a reference point where there was a shift between the forces of supply and demand. This is sometimes referred to as peak and trough analysis. It is a very objective way to manage your positions within an ongoing trend. Pivots tell you where there are potential buyers (demand) and sellers (supply).
Pivots can be used as an effective tool to jump on board a stock or market that has momentum but not all pivots are created as equals. Different pivots will have varying degrees of significance in the context of the overall trend.
The type of pivot seen will often suggest the level of certainty within a trend. For example, if minor pivots are holding any retracements in an uptrend then it will be clear that the market participants are certain the trend will continue higher because minor pivots have little power and if they are holding on retracements the power is with the momentum higher.
You will know that a pivot of significance has formed when the next candlestick after the pivot candlestick is completed.
A cluster of pivots in a trend that forms a support or resistance area makes that area very significant. There has been a buildup of supply or demand over time. Many trades have taken place in that area and that represents a lot of commitment from the traders involved. If that area is broken this is very significant because many traders will be trapped on the wrong side of that trade and can create a very explosive move in the opposite direction of the trend as traders liquidate their inventory.
In most cases, the candlesticks adjacent to each side of the pivot high or pivot low candle do not need to be unidirectional. They can have varying degrees of higher highs, higher lows, lower lows or lower highs adjacent to the pivot candlestick.
Pivots are a great trading tool when using multiple timeframe analysis. Find a major pivot in a higher timeframe then trade it in the lower timeframe.
Price voids are created between pivot highs and lows and understanding when a pivot has significance gives the trader the best opportunity to trade within a predictable price void. Pivot analysis can help keep traders trading on the right side of price voids.
Technical Characteristics of Pivots
Each pivot low has a higher low adjacent to each side of the pivot low candle or the lowest candle in the series of candlesticks (see figure 10.1). This is telling you that demand is increasing. Buying is starting to overwhelm selling. Once the higher lows have formed on both sides of the pivot candle there is no doubt that demand has increased and there may be some good trading opportunities especially if the pivot has formed in an uptrend confirming the strength.
Each pivot high has a lower high adjacent to each side of the pivot high candle or the highest candle in the series of candlesticks]. This is telling you that supply is increasing. Selling is starting to overwhelm buying. Once the lower highs have formed on both sides of the pivot candle there is no doubt that supply has increased and there may be some good trading opportunities especially if the pivot has formed in a downtrend confirming the weakness.
A pivot forming does not mean that there will be a change in the trend or that you should place a trade based on this information. It simply helps to give you an objective method to determine where the momentum is the strongest and the odds of a successful trade exist. Understanding supply and demand guidelines are essential when reading pivots.
Figure 10.1: Pivot High and Pivot Low.
Level 1 Minor Pivots
Level 1 Minor Pivot Low: Has 2 or more higher high or higher low candles to the left OR right of the pivot low candle (sometimes called a V) as compared to the pivot candle. There should only be one higher high or higher low candle on the opposite side of the pivot low candle with 2 higher highs or higher lows (see figure 10.2).
The level 1 minor pivot low is telling you that upward or downward momentum has stalled forming a minor pivot low.
Figure 10.2: Level 1 Minor Pivot Low.'
Level 1 Minor Pivot High: Has 2 or more lower low or lower high candles to the left OR right of the pivot high candle (sometimes called a V) as compared to the pivot candle (see figure 10.3). There should only be one lower low or lower high candle on the opposite side of the pivot high candle with 2 lower lows or lower highs.
The level 1 minor pivot high is telling you that upward or downward momentum has stalled forming a minor pivot high.
Figure 10.3: Level 1 Minor Pivot High.
Level 2 Minor Pivots
Level 2 Minor Pivot Low: Has 2 higher low candles than the pivot candle adjacent to each side of the pivot candle low (see figure 10.4).
Figure 10.4: Level 2 Minor Pivot Low.
Level 2 Minor Pivot High: Has 2 Lower high candles than the pivot candle adjacent to each side of the pivot candle high (see figure 10.5).
Figure 10.5: Level 2 Minor Pivot High.
Level 3 Major Pivots
Level 3 Major Pivot Low: Has 3 or more higher low candles than the pivot candle adjacent to each side of the pivot candle low. They do not have to be consecutive higher low candles (see figure 10.6).
Figure 10.6: Level 3 Major Pivot Low.
Level 3 Major Pivot High: Has 3 or more lower high candles than the pivot candle adjacent to each side of the pivot candle high. They do not have to be consecutive lower high candles (see figure 10.7).
Figure 10.7: Level 3 Major Pivot High:
Level 4 Major Pivots
Level 4 Major Pivot Low: Has 2 or more higher highs and higher lows to both sides of the pivot low candle. They must be consecutive higher highs and higher lows to be a level 4 major pivot low (see figure 10.8).
Figure 10.8: Level 4 Major Pivot Low.
Level 4 Major Pivot High: Has 2 or more lower highs and lower lows to both sides of the pivot high candle. They must be consecutive lower highs and lower lows to be a level 4 major pivot high.
Figure 10.9: Level 4 Major Pivot High
To be a level 4 pivot the preceding price move should have been a unidirectional or a fluid price move and not a congestion area or basing pattern. This is the kind of pivot that you will likely see in very strong trends that have a good directional bias. These strong trending characteristics tell us that there is a high degree of certainty amongst traders for the trend to continue.
Figure 10.10: 15 Minute EURUSD showing many different levels of pivots. Try printing a chart and marking off the different types of pivots for practice.
Using Pivots
If you are trading against the established trend then the odds of a successful trade will be against you the vast majority of the time. However, the odds of a successful trade against the established trend increase once a major level 3 or 4 pivot has been overcome. For example, if you are in an uptrend and the market retraces lower than the last major level 3 or 4 pivot then the odds increase for the prior high to hold, at least for the short term.
Bullish moves against a strong downtrend typically produce little to no follow through higher. Major pivot lows are more easily overcome in a downtrend than they would be in an uptrend. Downtrends also are more likely to produce many minor pivots that hold as highs. Minor bearish moves will tend to produce more follow through than minor bullish signals in an uptrend.
A stock or market moving with extreme momentum may not create a pivot at all in the timeframe that you are watching. This pattern will appear as a series of consecutive candlesticks without any pause and will make it hard to jump on this momentum. If your position has momentum it should not violate any pivot once it’s moving with extreme momentum.
When using a higher timeframe look to a lower timeframe to give you a better zoomed-in look at what is happening in the higher timeframe. Looking at the lower timeframe can help you refine your entries and exits and help you determine potential shifts in trend sooner. For example, when watching a 60 minute chart look at the 5 minute chart to see how the stock or market is pivoting on the lower timeframe (see figure 10.11).
Figure 10.11: The 5 minute chart shows a nice trending market and there with definable areas where a trader can place a trade. The 60 minute chart shows a momentum move that would be very difficult to trade. This highlights the need to use multiple timeframes. Find your trend in the larger timeframe and trade it in the shorter timeframe.
For climactic setups find the climactic setup in the higher timeframe and trade it in the shorter timeframe. A reference point of a potential trend change may not have been established in the higher timeframe but the lower timeframe may be showing signs that the trend reversal is coming by way of pivot analysis.
M and W patterns are distribution and accumulation patterns. When you see the M or W in a lower timeframe it may be confirming the reversal in a higher timeframe (see figure 10.12).
Figure 10.12: EURJPY nice W pattern on the 60 minute chart. The red box on the 60 minute chart is the same area as shown on the 5 minute chart. There were many areas that the trader could have jumped in a buy trade after the pattern had confirmed to be a W. Find the pattern in the higher timeframe and trade it in the lower.
When a trend of pivots becomes a base or congestion area (multiple opposing pivot points), it reflects complete indecision and a total lack of directional bias (see figure 10.13). This is the kind of market that can lead to many false breakouts/breakdowns and trading losses. At these times it is best to stand aside or find something else to trade until that indecision has been resolved. The conflict has likely been resolved after a closing price above or below the last major pivot.
Figure 10.13: A picture of uncertainty. This hourly chart of GBP/USD has no directional bias and is very choppy. It would be very hard to make money in this type of environment. Move on to something that has characteristics of a trend.
Pivots for Exits
Once you are in an already profitable position, if you want to attain a larger gain, you will have to sit in the inevitable corrections and tolerate short term losses for long term gains. There will never be a way to know when the correction will stop or if it won’t turn into a full-blown reversal.
Your first reference point of demand in a long position is the prior candle’s low. The second reference point would be the last pivot to have formed. If a long position is being traded within a price void you might want to consider holding all or part of that position even if it violates the prior bars low. You can adjust your stops to be below the prior pivot low until a break of the prior pivot low as this will represent a strong indication that the trend may be changing.
As the market moves closer to a supply point in an uptrend, where there is a possibility that the market will stall or reverse, stop losses should be brought under the prior candle’s low instead of the prior pivot low. Vice versa for a short trade.
Pivot Turning Point Types
Turning Point Type 1: Prices are trending and a deep pullback into supply and demand occurs (see figure 10.14).
- The deep pullback or retracement suggests that there may be a potential trend change. Something has changed, traders are becoming emotional by panicking or greed is becoming extreme.
- The area above/below from which the pullback occurred is now a new area of supply/demand.
- The distance between the pullback into supply and demand and the prior area that is now supply/demand should be considered.
- The move into the prior area of supply or demand and the candles that occurred off the high/low should be considered.
- The distance between the current candles and the newly formed area of supply/demand from the prior high/low should be considered.
- If the supply/demand area above/below is larger than the demand/supply that is below/above, and the distance between the two is great enough (a nice price void to trade in), there is an opportunity to trade.
Figure 10.14: Prices are trending and there is a deep pullback past prior support. This trend is in question.
Turning Point Type 2: Prices are trending and momentum increases.
- Prices accelerate in the direction of the trend creating a void.
- A retracement occurs but does not move close to the prior area of supply or demand.
- Once a retracement from that move occurs, there is a new point of supply or demand.
- This is a new reference point from which a trend change can begin.
- Once overcome, the old reference point of supply/demand will become the point or interest again.
- If the supply/demand area above/below is larger than the demand/supply that is below/above, and the distance between the two is great enough (a nice price void to trade in), there is an opportunity to trade.
Figure 10.15: Prices are trending lower and the momentum increases.
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