Most traders know pivot points as resistance and support levels they can use to trade swings. There is, however, another prolific way of using pivot points as an early indicator for a weakening trend. Especially trend followers will profit from using pivot points as an enhancement of channel lines, which can help them make better predictions, win more trades, and make more money.
What are pivot points?
Every trend stops moving in its main direction every once in a while. Usually, any change against the main trend direction is only temporary, and the trend will resume its main direction. Sometimes, however, the trend moves sideways for quite some time, and does not create a new high (in an uptrend) or a new low (in a downtrend). Often, the market will remain in its main trend channel during this time of sideways movement.
To a technical analyst, especially a trend follower, this situation poses a dilemma: Is the trend still trustworthy, as the market’s movement inside the channel lines would indicate, or is the trend just waiting to end, as the lack of a new high / low would predict?
Judging whether the sideways movement is temporary or not can be hard. As binary options trader, you need a way to make this decision based on hard facts, not just your feeling. One way is the use of pivot points as support or resistance lines.
There are almost as many definitions on what exactly a pivot point is as there are binary options traders. In all definitions, the pivot point is the average of three relevant price marks. The most common definition uses the median price, the average of the previous day’s high, low, and close.
How to use pivot points for channel evaluation
The logic behind using pivot points as an indicator for whether a trend is still intact or not is that, in order to judge whether the previous trend will resume or not, you need a significant market movement in either direction. If the market moves far enough in the direction of the previous trend, it is likely to keep doing so, and the trend is intact. If it moves far enough away from the previous high / low, however, it is likely too far away to resume the trend again.
To visualize this theory, you start with the median point of the previous day. This is your main pivot line. From there, you add or subtract certain significant market values to get more lines above and underneath the current market price.
To calculate the first (inner) line of resistance, multiply the pivot point value by two and, from that number, subtract the low of the pivot day. This is named R1. To calculate the first (inner) line of support, or S1, multiply the pivot value by two and, from that number, subtract the high of the pivot day. Analogically, you can create a number of pivot lines by using similar equations. In moth cases, your trading software can make this calculation for you, and draw all pivot lines directly into you chart.
Most traders use seven pivot lines: The main line, three lines above the main line, and three lines underneath it. Every line above the main line works as a resistance, every line underneath it works as a support. Once the price breaks a line, however, it switches sides: Support lines become resistance lines, and resistance lines support lines. In short, therefore, any pivot line above the current market price is a resistance line, any pivot line underneath it works as a support.
During a sideways movement, the accumulated effects of all pivot lines can give you a strong indication on where the market is going. If the market is inside the pivot lines, it is still contained by support and resistance lines. Therefore, it could end up moving either up or down. As soon as the market crosses one of the outermost support lines, however, all pivot lines are on one side of the market and push it in the same direction.
During a sideways movement in a trend, this event can give you a strong indication on where the market will move next. If a downtrend has left all pivot points to the upside, it is likely over. The accumulated support lines are too strong to make a continuing downtrend likely. Vice versa, if the market has moved through the lowest support line in an uptrend, the uptrend is likely over, even if the channel is still intact.