Pivot point is a price level that is calculated for a stock based on its previous days open, close, high and low price. It is basically an average of these prices and helps to predict where the price will more likely be for the day, given no other factors of involvement. If the market, or if the stock itself is bearish, the prices are more likely to be below the pivot point and if the prices are bullish, they are more likely to be above the pivot point.
Pivot points have associated price levels as well, that are referred to as support and resistance levels. On a bullish day, a stock price is highly capable of reaching these support levels or even cross them, depending on the volume and the bulls. On a bearish day, to the contrary, the prices are likely to reach these resistance levels, and once a resistance level is broken, it signals bearish movement.
Support levels are S1, S2, S3 and resistance levels are at R1, R2, R3. Online pivot calculators are available that help calculate the pivot point for a particular stock based on the previous days prices.
I am providing a link below of the 5-day intra-day chart of the SPDR Gold Trust in Wikipedia, that illustrates how pivot points might be helpful in determining entry and exit points for inter-day as well as intra-day trades. http://en.wikipedia.org/wiki/Pivot_point (see the Trading Tool section)
If you analyse the chart more carefully, you will observe the following:
On the first day, the market is directionless, and hence the prices fluctuate more or less around the pivot point. Even though the price tries to reach the first resistance level, it is immediately pulled back, and keeps hovering near the pivot point for the rest of the day. This indicates that the support is not strong enough.
On the second day, it starts near the second support level, indicating, that it is going to remain bearish for the rest of the day.
Note on the fourth day, that even though the stock price falls very close to the pivot point, it is not able to break it and go below it or reach it, indicating a bullish trend ahead. When it crosses the first resistance level, this is further confirmed. If the point at which this happens is used in conjunction with candlestick patterns, it will be even easier to identify the entry and exit points during the five day chart referred to here.
In my next post I will try to illustrate how pivot points when used in conjunction with Fibonacci numbers can act as a helpful tool to determine entry and exit point for trades.