You are going to love this lesson. Using pivot points as a trading strategy
has been around for a long time and was originally used by floor traders. This
was a nice simple way for floor traders to have some idea of where the market
was heading during the course of the day with only a few simple calculations.

The pivot point is the level at which the market direction changes
for the day. Using some simple arithmetic and the previous days high, low and
close, a series of points are derived. These points can be critical support and
resistance levels.

The pivot level and levels calculated from that are
collectively known as pivot levels.

Every day the market you are
following has an open, high, low and a close for the day (some markets like
forex are 24 hours but generally use 5pm EST as the open and close). This
information basically contains all the data you need to calculate the pivot
levels.

The reason pivot points are so popular is that they are
predictive as opposed to lagging. You use the information of the previous day to
calculate potential turning points for the day you are about to trade (present
day).

Because so many traders follow pivot points you will often find
that the market reacts at these levels. This give you an opportunity to trade.

If you would rather work the pivot points out by yourself, the
formula I use is below:

Resistance 3 = High + 2*(Pivot – Low)

Resistance 2 = Pivot + (R1 – S1)
Resistance 1 = 2 * Pivot – Low

Pivot Point = ( High + Close + Low )/3
Support 1 = 2 * Pivot – High

Support 2 = Pivot – (R1 – S1)
Support 3 = Low – 2*(High – Pivot)

As you can see from the above formula, just by having the previous days
high, low and close you eventually finish up with 7 points, 3 resistance levels,
3 support levels and the actual pivot point.

If the market opens above
the pivot point then the bias for the day is for long trades as long as price
remains above the pivot point. If the market opens below the pivot point then
the bias for the day is for short trades as long as the market remains below the
pivot point.

The three most important pivot points are R1, S1 and the
actual pivot point.

The general idea behind trading pivot points is to
look for a reversal or break of R1 or S1. By the time the market reaches R2,R3
or S2,S3 the market will already be overbought or oversold and these levels
should be used for exits rather than entries.

A perfect set up would be
for the market to open above the pivot level and then stall slightly at R1 then
go on to R2. You would enter on a break of R1 with a target of R2 and if the
market was really strong close half at R2 and target R3 with the remainder of
your position.

Source : theindianstocks.com