Pivot Points and Options Trading

Technical indicators are essential tools for trading the markets. One that options traders can find useful is the pivot point. A pivot point is a combination of the average between the intraday high and the previous day’s closing price. The basic use of this indicator is simple. When the following day’s prices are higher than the pivot point this is bullish and when it is lower it is bearish. However, there are support and resistance levels calculated from the pivot point that are also used.

Using Pivot Points in Day Trading

Stock, commodity, futures, and foreign exchange markets always fluctuate throughout the day. How to decide whether movement represents an emerging trend or not is always an issue. Pivot points are useful for helping sort this out. When a pivot point supports an upward movement as bullish it commonly represents a buying opportunity and when it supports a downward movement it typically means a selling opportunity. No matter how certain a trader is of what a pivot point indicates it is always wise to set stop-loss orders in day trading and hedge options trades.

Pivot Points for Short Timeframes

When day trading or otherwise working with short timeframes traders commonly use one, two, and five minutes. As one’s time horizon for trades increases so do the time intervals for the pivot points. As a rule a stronger indication from a pivot point is a more reliable indicator for bullish and bearish trends. These approaches can be applied equally to stock, futures, options, and currency markets. As with all indicators, when the pivot point does not provide any clear direction, it is absolutely OK to sit on the sidelines until the market makes up its mind.

Pivot Point Calculations

The calculation for the pivot point itself is done by adding the session high and low plus the close of the prior day and then dividing by three. The first resistance level is then arrived at by multiplying the pivot point by two and then subtracting the market low. The second resistance level is the pivot point minus the difference between support level one and resistance level one. A third resistance level is found by taking the pivot point and subtracting the difference between support level two and resistance level two. The good part about all of this is that there are programs that do the calculations automatically.

Using Pivot Points in Trading

The reason to use pivot points is to improve one’s assessment of whether or not the market is going to trend up or down. Using a pivot point and the calculated support and resistance levels a trader can more reliably buy or sell based on a more accurate assessment of where the market is going next. However, no single technical indicator is sufficient for all occasions so it is wise to pair a pivot point approach with at least one other indicator, set support and resistance levels for standard trading, and always hedge when trading options. No matter how good a trader is at using technical indicators it is important to have an accurate sense of what fundamentals indicate at all times.

Technical indicators than be used along with pivot points include moving averages, Japan Candlesticks, and simple price action. Although we discuss pivot points in the arena of day trading, the time frame can be expanded to include weeks and months as well. No matter what combination of technical indicators a trader uses with pivot points it is essential to exercise discipline in all trades and hedge every single trade in trading options such as we routinely do at Top Gun Options where we potentially profit in all market conditions.