Basically, there are three major forms of support and resistance which can be represented specifically by way of horizontal lines drawn from left to right, all of which serve the same basic functions. They include: Old Highs & Lows, Fibonacci retracements and extensions, and pivots.
While it may seem to be a minor technical detail, it may be worth knowing how pivots are actually calculated. Firstly, we input the High/Low/Close (HLC) numbers for the last completed trading session into the calculation of the Central Pivot (CP) value for the following session. Ideally, the calculation is automated, but such is not always the case. This is why it might be handy to know how to do the calculation yourself.
The formula for the Central Pivot is as follows:
Central Pivot (CP) = (High + Low + Close)/3
As you can see from the formula above, the Central Pivot is in effect a simple average of these three parameters of the prior trading range. While you might find some variation among analysts (and charting packages) as to what constitutes a standard pivot set, my approach provides for
four Resistance (or 'R') pivots, and
four Support (or 'S') pivots, each sequentially numbered outwards from the Central Pivot (CP).
These S and R pivots are calculated with reference to the Central Pivot, as follows:
In addition to these major intervals, we can also plot both half and quarter pivots. A convenient method for labelling these levels is to simply add to the respective 'R' or 'S' pivot name, a suffix for '25' corresponding to the first quarter pivot beyond the major interval (again, in the outwards direction from the Central Pivot), '50' for the half pivot (or M level) and '75' for the third quarter pivot. Therefore, as illustrated below, the third quarter pivot up between RI and R2, for example, would be labelled R175; the third quarter pivot down between S1 and S2 would be labelled S175, and so on. This scheme is then repeated through all the remaining whole pivot levels in the set. Once you take a moment to get used to it, this labelling system makes it spontaneously obvious exactly where you are in the spectrum of pivot values from S4 to R4.
The calculation for quarter-pivot levels is straightforward: the half-pivot labelled 150 simply splits the difference between the adjacent whole pivot levels (e.g. Rl and R2); the smaller quarter pivots labelled 125 and 175 split the difference again between the half and two adjacent whole pivots. While the market is less likely to make a major turn on a quarter than on a whole pivot, these levels can be useful and should be watched within a potential confluence of events.
So now that we have figured out how to calculate pivots for different degrees of trend, and plotted them on our charts, what do we do with them? With all three varieties of horizontal support and resistance mentioned above, what we are most interested in is finding a confluence of events suggesting that price should either:
- Provide an interim take profit opportunity prior to a retracement of some kind; or
- Conclude the retracement (either at resistance in the downtrend, or support in the uptrend) and continue in the direction of the higher level trend; or
- Reverse outright at or near the horizontal line, changing higher level trend direction from down to up, or vice versa.
In other words, we plot horizontal support and resistance lines on our charts to identify potential levels where price could possibly change direction.
Example 1In this chart, which plots Daily pivots on a H1 chart, let's say we have a valid reason to go long following a Swing Point Low completing a pullback in the uptrend. The open price for this trade was 1.6628. We see that the trade might have carried through to the next Daily session, as indicated by a second set of pivots painting in to the right. While the Daily Rl pivot (the lowest red line on the right-hand side of the chart) provided a minor take-profit objective, the next higher resistance level at R2 did a better job, in real time underscored by a still bullish confluence of oscillator readings higher up.
Realistically, it would have been prudent to trim a few pips off that target for the sake of safety (i.e. not missing a fill on the exit limit), but putting that issue aside for a moment, we can see price ran up precisely to the R2 pivot, before hitting resistance and commencing a relatively steep retracement. From the open price to the close on this level at 1.6752, the run up was worth 124 pips as a day trade. Holding the trade open beyond that level would have resulted in a disappointing drawdown of 116 pips as price fell almost all the way back down to entry, which would have triggered a stop loss if previously trailed to breakeven. This serves as an excellent example of why booking profit on anticipated support or resistance levels can be a useful tactic.
Example 2
In the above chart, which plots Weekly pivots on a H4 chart over a span of 10 weeks, we see a total of seven instances where retracements in the downtrend ended - sometimes literally to the pip - on either a whole- or half-pivot level. (As denoted by the green arrows underneath price action on this chart, there were also a few instances when a retracement started on a bounce off a support pivot; however, trading with the trend, we would have more likely used these as take-profit targets rather than opportunities to go long against the trend).
If we were poised throughout this downtrend to sell the rallies, these pivot resistance events would have provided an important part of the confluence of events desired to execute a trade to the short side (and bear in mind, this is only one pivot set; it would be interesting to see what kinds of resistance events were confirmed on the Daily and Monthly time frames as well).
With reference to the chart above, from the open of each candle following the confirmed pivot resistance, and carrying the trade open through to the lowest low on the right-hand side of the chart, this 10-week span offered the possibility of the following gross profit potential:
Example 3Finally, in this chart, which plots Monthly pivots on the Daily chart over a period of roughly 13 months, we see from left to right that there had been a long uptrend covering a distance of at least 2,242 pips. The final leg of this larger move sub-divided perfectly into a smaller 5-wave impulse pattern, the fifth and final leg of which ended with a high degree of precision at the Monthly R3 pivot (solid red line). As is typical of major reversals, we can recognise a Swing Point High in the area of this resistance pivot, which was followed several weeks later by a so-called Death Cross of the Moving Average pair plotted in blue, which helped to confirm the new downtrend underway.
From this top reversal to the lowest low on the right-hand side of the chart, the resulting down move covered a distance of 1,469 pips. Whether viewed as an important take-profit target on the preceding long move, or a signal to position trade to the short side (or both), this high level pivot event correctly foretold a reversal of major importance.
