Professional traders and market makers use pivot points to identify important support and resistance levels. It is a simple calculations based on yesterday’s price action to help them anticipate today’s price action.
Pivot points are especially useful to short-term traders who are looking to take advantage of small price movements. Pivot points can be used by both range-bound traders and breakout traders. Range-bound traders use pivot points to identify reversal points. Breakout traders use pivot points to recognize key levels that need to broken for a move to be classified as a real deal breakout.
The use of pivot points has become universal that they have become a major influence on market sentiment and expectations, affecting trader behaviour as price approaches them. With computerized trading now there are many automated trading systems that engage pivot points as well. So pivot points have become self-fulfilling predictions. Therefore it is essential that you plot them on your charts so that you will understand what is happening when price approaches these milestones.
Example of pivot points are shown below.
where PP is the central pivot point, R1 and R2 are first and second level of resistance, and S1 and S2 are first and second level of support. Pivot points work very well because they are always based n the most recent time period, and because they are a concept shared by a great majority of traders.