If only trading was as simple as buying support and selling resistance.
Daily support and resistance levels can provide traders with potential entry and exit points. The real question then becomes, how can someone calculate where to find support and resistance?
The incredible thing about traders is that they have all sorts of methods for computing essential levels. From a good old fashioned pen and paper to supercomputers, there is no shortage of ways traders can use to figure out low risk/high reward levels to buy and sell.
One method used to calculate fundamental areas of potential support and resistance revolves around the daily pivot point. The pivot point is essentially the level at which trends can change for the day, or that buying gives way to selling and vice versa.
You may want to be long above the daily pivot, but short below the daily pivot. I’ll show you how to calculate the daily pivot and put it into practice.
How to Calculate the Daily Pivot
To calculate the daily pivot, you will need the previous day’s high, low and closing prices.
With this information, the pivot point is measured using the following equation:
PP=(H+L+(0*2))/4
From the pivot point, multiple levels of potential support and resistance may be calculated. To calculate the first area of support and resistance, use the following equation:
R1=(2*PP)-L
S1=(2*PP)-H
The second potential level of support and resistance is calculated using the following equation:
R2=PP+(H-L)
S2=PP-(H-L)
The third potential area of support and resistance is calculated as:
R3=H+2*(PP-L)
S3=L-2*(H-PP)
While the above formulas may seem complicated, they’re fairly straightforward with a little practice.
Putting It Into Practice
Since the pivot point gives an indication of the day’s bias, it makes sense that a trader would want to be long if a price is above the daily pivot, and short if a price is below daily pivot.
For example, let’s say a stock is currently trading at $40 per share.
That means:
Daily PP is $39.80
R1=$40.40
R2=$40.80
R3=$41.15
S1=$39.20
S2=$38.80
S3=$38.45
Because the price is currently above the daily pivot of $39.80, a trader may look to enter into long positions only. The R1 and R2 levels may be used as potential points to scale out or take profits.
If the price declines below the pivot of $39.80, a trader may look to enter only short positions using the S1 and S2 levels as possible levels to scale out or take profits.
Moves to the R3 and S3 levels are far more uncommon and can potentially mark the high or low and can be faded.
The daily pivot and corresponding levels may also be used for risk management. For example, if a long position is taken just above the daily pivot, a stop loss order can be placed just below the PP.
While this relatively simple method of calculating the daily pivot point isn’t rocket science, it can help keep traders on the right side of the day’s price action, while providing a clear road map for potential entry and exit points.
