Pivot points were introduced in the first half of the 20th century by trader Jesse Livermore, who called them “pivotal points.” Livermore defined pivotal points as exact psychological moments when a move of importance begins. Buying stocks at exact pivotal points allows you to maximize profit while minimizing risks.
Importance of Pivotal Points
Stocks move in trends. Pivot points mark the beginning and end of a trend. Recognizing pivot points and acting on them by buying or selling helps maximize profits while minimizing risk. When a stock moves through a buy pivot point, its chances of continuing to move higher are greater than the chances of reversing lower.
Reversal and Continuation Pivots
There are reversal and continuation pivots. A reversal pivot marks a change in direction – from up to down or from down to up. A continuation pivot occurs when a stock has completed a consolidation and resumes an advance. Reversal pivots are much less common and, therefore, much more significant than continuation pivots, because major trend reversals in stocks do not occur often.
Using Charts to Recognize Pivots
Livermore had his own method of recognizing pivots based on his stock price records. In 2011, most traders use stock charts to identify pivots. Stocks form recurring chart patterns that help anticipate the next moves of significance. When a chart pattern is complete, a trader may anticipate the next move by making a “mental bet”: If the stock moves through point A, I will buy. To calculate a pivot, traders usually add 10 cents to the price. For example, if a stock has consolidated between $22.50 and $26.18 for some time, a move above $26.18 will constitute a breakout, so the correct pivot will be $26.28.
A stock moving out of a consolidation area is said to have a breakout – that is, it is breaking out of that consolidation area. A valid breakout occurs when a stock moves through a pivot point on an unusually high volume.
Pivots are not fail-proof. A stock that moves through a pivot may still fail and fall back below it. When that happens, the trader should sell the stock to prevent further losses and wait for a more opportune moment to buy or look for a different stock.