We have discussed the concept of Support and Resistance in a different section. As a continuation of that, we introduce the concept of Pivot Point. Let PP be the Pivot Point. It is defined as

PP = (H + L + C) / 3

where H is High, L is Low and C is Close of prices of a stock or of any instrument. With the help of the PP, 3 levels of Resistance (R) and Support (S) are calculated as follows;

R1 = (2*PP) – L

R2 = PP + (H – L)

R3 = PP + 2*(H-L)

S1 = (2*PP) – H

S2 = PP – (H – L)

S3 = PP – 2*(H – L)

In terms of actual numbers, on 25.3.2010 the following numbers for Sensex were observed:

O = 18480

H = 18858

L = 18480

C = 18815

This would imply the following pivot points:

R3 = 19473

R2 = 19095

R1 = 18955

PP = 18717

S1 = 18577

S2 = 18339

S3 = 17961

The above levels provide indicators of taking long and short positions in the market. If the Sensex crosses the first and the second resistance, the market has turned bullish. If it goes below the second support, the market has turned bearish. Pivot points are useful in intra day trading. If the market opens nears the PP and goes up, long the stock and exit once it crosses 2R. Similarly, if it falls below S, short the stock and exit once it crosses 2S. It provides a basis for entry and exit.   However, for volatility trading in options, the use of pivot points is different, and we will discuss it later. Figure 1 shows the various levels using pivot points for Monday, 28.3.2011, using the data for 25.3.2011.

Figure 1

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