Catch Breakouts With Pivot Points

Breakout trading is among the most popular strategies thanks to their volatility and momentum which often provide better reward opportunities over a short-term time frame compared to trend trading.  While there are numerous ways to spot a potential breakout setup including the identification of consolidations, triangle patterns, or horizontal ranges, another common tactic involves the use of pivot points.  Besides providing useful information about the state of price momentum in an instrument, pivot points give a good indication of the strength of the breakout, enabling investors to go ahead and be more or less aggressive in their risk-reward settings depending on risk tolerance.

Pivot Point Basics

Pivot points are a popular intraday trading tool that identifies horizontal levels similar to support and resistance based on the average of the low, high, and closing prices during a defined period.  Typically, a pivot point is based on the prior sessions trading activity which is why it is normally regarded as a more short-term indicator.  Once the pivot point is established by the average prices, the first levels of support and resistance, referred to commonly as S1 and R1, are determined based on the highs and lows recorded during the prior trading period.  Besides the levels of first resistance and support, levels typically included in pivot points include S2 and R2, with some traders opting to include an additional two levels of support and resistance.

Beside their obvious use as ways to assess the strength of a trend, pivot points are commonly employed in binary options trading strategies to define areas to enter and exit potential trades.  The initial price action during a session is very important in this respect, considering that an opening price that is higher than the pivot is considered bullish for sentiment whereas an opening price that is below the pivot is regarded as bearish for sentiment.  Once the bias in price action has been established, either bullish or bearish, the next step is to wait for a break of either first support or first resistance.  Once broken, the next step is to wait for a pullback which sees the broken level hold, providing further evidence of a breakout emerging.

Two Breakout Strategies for More or Less Risk

When using candlestick charts, the easiest way to spot a breakout early is identifying a candlestick close above or below the first resistance or support level.  Generally, higher volatility or volume will serve as further confirmation that a breakout is underway.  Once a level is broken, there are two directions that traders can potentially take depending on their level of risk tolerance and aggressiveness of their tactics.  The first, more risky strategy, is to get involved once the R1 or S1 level is broken, with exits set for R2 or S2 depending on whether it is an upside or downside breakout.  The downside to this strategy is that by getting involved in a momentum trade, if risk-reward is set to narrowly, it might be easy to get stopped out of this type of position.  However, if caught early, a breakout can provide higher rewards.

The second strategy, which is significantly less risky, but may provide more limited reward, is waiting for a pullback from the breakout momentum back to the broken S1 or R1 level to establish a position targeting the subsequent support or resistance level.  The value in waiting for a pullback is determining direction with greater confirmation instead of trying to get involved in momentum that may or may not last.  In the case of a bullish breakout that sees an asset’s price rise above R1, the key is to wait for a correction to R1 without a break back to the downside as an entry point.  Depending on the pace of upward momentum, targets may be set at either R2 or R3 depending on reward conditions set at the outset of the trade.  However, if R1 is broken to the downside, the trade should normally be abandoned.

Final Notes

It is always important to bear in mind that similar to normal support and resistance levels, once broken, support turns into resistance and resistance turns into support.  Additionally, when trading breakouts, some of the strongest signal confirmation comes from heightened volume and volatility.  However, whenever it comes down to using pivot points in a breakout strategy, it is wise to use the horizontal levels as entry and exit points considering their usefulness in identifying pockets of buying and selling pressure.