Pivots, support and resistance are based on the prior day’s high, low, and close. These values suggest where the commodity will pivot up or down and hit levels of support or resistance. Below we will show you how to calculate pivots, support and resistance and suggest ways to use them in your trading.

Before we get into how the levels are calculated, let’s briefly discuss support and resistance. These can best be understood using the analogy of jumping up and down in a high-rise building. The floor beneath your feet is your “support” and the ceiling above is the “resistance.” You would encounter resistance as you hit the ceiling and support as you landed back on the floor. If the floor gave way, the next lower floor would be the next support level. If you continued jumping, the ceiling above you, which used to be the old floor (prior support), would now be resistance.

For instance, suppose a market trades between 90 and 100 for some time. At 90 buyers would be expected to come into the market as prices are perceived to be cheap. By the same token, at 100, sellers would be expected to come into the market as prices are perceived to be expensive. Once the support (90) is broken decisively, the target for the commodity then becomes the next level of support. Also, the former support level becomes resistance (and vice versa). This is only natural because those who bought the commodity at the original support level (90) may be looking to get out at breakeven.

Support and resistance levels are normally found through chart analysis. If a market trades at a certain level for some time (i.e., bases) and then begins to rally, that level will provide support, should the market come back in. On a smaller scale, pivots, support and resistance levels attempt to project where intraday support and resistance will likely occur based on the prior day’s range and close.

The math

To calculate the pivot point, support and resistance levels for the next trading day, you need today’s high, low and close. The pivot point is simply the average of the high plus low plus close, or (H + L + C)/3. Support level 1 is calculated by multiplying the Pivot by 2 and then subtracting the day’s high. Resistance level 1 is calculated by multiplying the Pivot by 2 and then subtracting the day’s low. Finally, the secondary support (S2) and resistance (R2) levels are calculated by using the numbers (P, S1 and R1) created in step one. These are the calculations:

 Pivot (P) = (H + L + C)/3 Resistance level 1 (R1) = (2*P) – L Support level 1 (S1) = (2*P) – H Resistance level 2 (R2) = (P – S1) + R1 Support level 2 (S2) = P – (R1 – S1)

For example, On April 8, 1999, the June S&P futures traded as follows:

 High = 1357.00 Low = 1331.00 Close = 1355.60

The pivot, support and resistance levels would be:

 Pivot (P) = (1357 + 1331 + 1355.60)/3 = 1347.87 Support 1 (S1) = (2 * 1347.87) – 1357 = 1338.74 Resistance 1 (R1) = (2 * 1347.87) – 1331 = 1364.74 Resistance 2 (R2) = (1347.87 – 1338.74) + 1364.74 = 1373.87 Support 2 (S2) = 1347.87 – (1364.74 – 1338.74) = 1321.87

These levels are illustrated in Figure 1.

Figure 1. Source: Omega Research

Trading the Pivots, Support and Resistance

Based on an article written by William Greenspan,1 the general idea behind pivots is to go long above the pivot and short below the pivot. Greenspan also notes the mode of the market (bull or bear) should be used when deciding whether to go long or short at the pivot point. In addition, the first time the pivot point is violated (to the upside or downside) is the most important crossing of the pivot. Subsequent crossings are less meaningful.

The interpretation of the support and resistance levels can be used for profit targets and setting stops. If you trade off the pivot point, then you might look to begin taking profits on the long side at R1 and profits on the short side at S1. The secondary profit targets would then be R2 and S2.

Breakout traders may look to go long if a market can break through R1 with a target of R2 (or short the market if it falls through S1 with a target of S2). Because resistance becomes support once it is violated, and vice versa, you also could place stops near the breakout level (R1) for longs and near breakdown levels (S1) for shorts. Countertrend traders may look to fade (go against) the market by buying at support levels (S1, S2) and sell (or take profits) as the market approaches resistance levels (R1, R2).

Referring to Figure 2, those who go long or short at the pivot point (P) may look to begin taking profits at support one (S1) for shorts or resistance one (R1) for longs. Countertrend traders may look to go long as S1 is approached and look to go short (and/or take profits) as R1 is approached. Breakout traders may look to go short below the violation of S1 (A) with an initial profit target of S2. By the same token, they would look to go long as R1 is broken (B) with a profit target of R2.

Figure 2. Source: Omega Research

Because pivot points can potentially generate numerous trade signals on any given day, they should only be considered by the most active traders. (This is why they are popular among floor traders, where execution is fast and transaction costs are small.) Less active traders may consider using bigger-picture technical analysis to determine if a market is range-bound or in a longer-term trend.

For example, breakout traders may want to avoid trading until they have a strong market bias (trend) and then use the pivot points, support and resistance as entry and stop points. Likewise, contrarian traders may want to wait until the market is reversing or range-bound before fading the market through support and resistance. In addition, bigger-picture systems, set-ups or patterns can be used as a reason to be long or short a market, and the pivot points, support and resistance can be used to set entry points and protective stops.

Other considerations

Markets with wider ranges tend to generate more meaningful numbers than those with narrower ranges. Therefore, use of pivot points, support and resistance levels would most likely work better in markets such as the S&P futures, Dow Jones Futures or T-bond futures, and would be less meaningful in markets like corn or sugar, which tend to trade in narrower ranges.

Summary

Pivots, support and resistance are calculated based on the prior day’s high, low and closing price. Active traders look to go long above the pivot point and short below the pivot point. The support and resistance levels can be use for profit taking or initiating trades. Less active traders can use bigger-picture technical analysis to help establish a market bias and then use the pivot points, support and resistance to help them enter and manage a trade. Finally, markets with wider ranges tend to provide more meaningful numbers than those with narrower ranges.