Pivot points (Educational)

Ok, as promised I’m going to do my best to teach what a pivot point is and why they are so important. I’m going to try to simplify as much as possible, but if you have questions, please post them on my Facebook page so everyone can see the question and answer.

In order to draw a straight line by definition you need a point A and a point B. So where is point A and point B on a stock chart? You need pivot points. In order to see a pivot correctly the price bars on your chart should be OHLC bars. Let me tell you what OHLC stands for and once you hear it, you’ll never forget it. Open, High, Low, and Close. I prefer that all price bars either display all black in color or white depending on the chart background. Why? To keep the emotion out of the picture as much as possible. A normal pivot point looks like or shaped like a V. Some look like an upside down V. An upside down V is a pivot high and normal V is a pivot low. Don’t worry to much about pivot high’s and low’s right now, they will make sense later.

First let’s look at a picture of a pivot and the price bars that make up the pivot.

See the V? See the 3 price bars numbered? Let’s start with number 2, the low must be lower than than the bar directly to the left, or bar 1. Then bar 1 must be higher than the top of bar 2. That is the easy part. The bottom of bar 3 must be higher than the bottom of bar 2 and the closing price of bar 3 must be higher than top of bar 2. Sounds really confusing, but keep looking at the bars and re-read the rules. Now we are not done. This is a perfect pivot. What if the closing price of bar 3 is not higher than the top of bar 2? Then the pivot is not confirmed and you have to wait for day 4, 5, 6, etc.… until it is confirmed. Let me show another pivot.

The first pivot is a perfect pivot. The second pivot is not because it takes a total of 4 days to complete. What is the difference? The difference is to the right of bar 2 on each pivot. On the second pivot the closing price on day 3 did not close above the top of bar 2. on day 4, closing clearly closed above day 2 and finally confirmed the pivot. So no we have two pivots and now you can draw a trend line.

Now you can draw a line from pivot one to pivot two and you have yourself a uptrend. You can also see 6 days later that the uptrend was violated and would be a great indication that your trend was busted.

What is the difference between a pivot low and a pivot high? Pivot lows are created at the low prices and is the reason we call them pivot lows. If you have a series of pivot lows and each one is higher than the last, you have an uptrend. If your pivot lows are always lower than the last, then you have yourself a down trend.

The chart above, all the pivot lows are marked. First thing you want to notice is that all pivots are contained in the trend. So every time a pivot is created in time, you will have to adjust you line. Sometimes it steepens which price is moving uphill faster and sometimes the trend flattens as price slows down. Pivots can go the other way also.

Like a uptrend those same pivots can line in such a way to show a downtrend. Here is a problem with drawing a downtrend is pivot lows. It will be much harder to see a trend reversal because you cannot see price break up through a line or downtrend line because the line has been drawn on the bottom of price. So what we really need to do is this, when pivot low’s keep making higher and higher pivot lows, we draw under price and show an uptrend. When pivot high’s keep getting lower and lower, then we draw on top of price and draw a down trend.

So if we draw our Down trends on top of price bars using pivots, then we can see we the trend is violated. This makes it easier to decide if you enter or exit.