Can Pivot Points Be Used for Trend Trading?

by Walter Johnson

Understanding trends is central to succeeding in the stock market. This means to get in early, and try to sell as close to the "peak" of the trend wave as possible. Pivot points are useful tools for deciding when waves are beginning, but are less useful for deciding when to sell. Since these points are simple to grasp, they are excellent tools for the beginner.

Pivots

Finding a pivot point is easy. For the day, week or month you are analyzing, take the average of the high, medium and low values of the stock. This is the general pivot point. For the high pivot, take this average and double it. Then subtract the low figure. This is the "resistance," or high average. For the "support," or low average, do the same, except subtract the lowest price. What you now have is the basic volatility of the stock in some detail. The longer your period of analysis, the more accurate the pivots will be. Generally speaking, these points are for short term use since shocks to the market may well distort the average.

Stock Volatility

Pivots points give you basic volatility averages. Trends might be deduced from results that exceed the higher averages, while declines can be deduced from the opposite. Pivots have a great deal of use so long as all other variables remain equal. This means that shocks such as lawsuits, new regulations or fuel price hikes cannot be predicted by pivot points, since these have no relation to such independent and rare occurrences.

Trends

Trend trading is a method of investing in stocks that require the pivot points to be broken at their resistance levels. In other words, figuring high pivots are important because when these are broken or exceeded, a trend might well be starting. Pivot points are an excellent way to decide on whether or not a trend is beginning. If you are heavily invested in a specific stock, and your upper pivot calculations for the last quarter are daily being broken, then you are likely seeing a trend.

Limitations

Pivots are excellent and simple tools. They are also merely quantitative variables that only take price movements into account for fairly short time periods. They cannot predict sharp trends or sharp reverses. They are useless in understanding the firm, real stock value or basic qualitative news and ideas about the firm or sector. The concept of a mean or average is itself a problem. Under conditions of extreme volatility, such as the summer of 2011, averages can be greatly distorted since extreme swings can give false figures. This is why median figures make more sense, since a median figure is that which is in the middle of a group of figures, quite different from the average of all those figures taken together. Therefore, pivots become more useful the more stable the market.

References

About the Author

Walter Johnson has more than 20 years experience as a professional writer. After serving in the United Stated Marine Corps for several years, he received his doctorate in history from the University of Nebraska. Focused on economic topics, Johnson reads Russian and has published in journals such as “The Salisbury Review,” "The Constantian" and “The Social Justice Review."

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