BarroMetrics Views: The Pivot Point Formula
The Pivot Point Formula arose in the days when Pit Trading was in full swing and computers were still to be invented. The locals used it to provide some idea of resistance and support for the next day’s trading.
Many think there is only formula, the Classic (using the range of the pit session)
PP = (HIGH + LOW + CLOSE) / 3
S1 = (2 * PP) - HIGH
S2 = PP - RANGE
S3 = S2 - RANGE
R1 = (2 * PP) - LOW
R2 = PP + RANGE
R3 = R2 + RANGE
But actually, there are quite a few:
- The Standard 24hr (same as above but using Globex and pit session i.e. 24hr session)
- Camarilla (http://www.mypivots.com/investopedia/42/camarilla-pivot-points)
- Woodie (http://www.mataf.net/en/tools/pivot-points-woodie)
- Fibonacci (http://www.mataf.net/en/tools/pivot-points-fibonacci)
- DeMark (http://www.mypivots.com/investopedia/57/demark-pivot-points)
All the formulas use the previous day’s bar in their calculations. Except for the DeMark formula, they all use the same calculation, ignoring the location of the day’s open to its close. DeMark’s formula is dependent on whether the close is above, below or equal to the previous day’s.
I tried the Classic formula (pit session only) when I first started trading, abandoned it and returned to test it about 5/6 years ago. On the second occasion I backtested the classic (pit and 24 hour session) and found that the results produced were no better than random.
If you think about it, the problem lies with using the previous day’s range. The assumption behind the pivot formula is this: today’s range will be about the same as yesterday’s.
But this is not always the case. In fact, in the appropriate context, a small range today may mean a larger than normal range tomorrow; and a large range today may mean a smaller than normal range tomorrow.
Armed with this idea, I had the same pivot formula tested using the Average True Range for the pit session. But I made one change: this time I assessed whether the day’s Average True Range was to be normal, above normal or below normal. I then used mean for normal, mean +1 stdev for above normal, and mean -1stdev for below normal and I used this figure to assess the ‘PP” value in the formula.
The results obtained were superior to using yesterday’s range. This means of course the trader has to have some skills at assessing the likely strength day’s range.
In the way I use it, the formula’s of R1 and S1 tend to identify the high and low for the day. R2 and S2 tend to identify stronger or weaker than anticipated day and suggest I substitute the appropriate value (e.g. mean +1 rather than mean for the PP’s calculation). A market’s acceptance below R2 or above S2, (where PP is normal), suggests a trend day (i.e. a strong directional day).
While I would not use this idea as a stand-alone tool, it does play a part in helping me identify support and resistance for the various timeframes.
By the way, there is a site (free) that calculates in the traditional way most of the different types of Pivot areas and combines them with moving averages, Market Profile areas, and Fibo zones and gaps to produce a cluster of support and resistance zones. You can find it at: www.pivotfarm.com