You hear and read market analysts and traders talking about support and resistance levels a lot. Often support for a stock is assumed to lie at a prior low and resistance at a prior high. When the major indexes and many stocks are at 52-week highs as is currently the case, you might wonder how so-called 'resistance' (an area of potential selling interest) is determined. The same is true in a bear market regarding 'support' when the indexes and many stocks are making new 52-week lows.

A question is how analysts and traders come up with what might be a key or pivotal resistance level on a day to day or week to week basis for the major indexes or individual stocks. A common method is the use of a pivot point formula. There are several pivot point methods.

The most common pivot point calculation is a five-point system and is based on use of the current day's High (H), Low (L) and Close (C) to project a price 'pivot point' for the following trading day along with two higher resistance points (above the pivot) and two lower support points below the pivot. This of course totals 5 points that are calculated.

The 5-point pivot point formula seen below is where "P" is the Pivot point; "H" is the High for the trading period; "L" is the Low; "C" is the Close; S1 and S2 are first and second Supports; R1 + R2 are first and second Resistances:

R2 = P + (H - L) = P + (R1 - S1)

R1 = (P x 2) - L

P = (H + L + C) / 3

S1 = (P x 2) - H

S2 = P - (H - L) = P - (R1 - S1)

Ok, this isn't so complicated. First we calculate the P or Pivot Point, which is the middle value above. This is the most important and starting number as the other values above (R1 and R2)) and below (S1 and S2) are calculated from this price.

Yesterday (10/21/09)'s HLC in the S&P 500 Index (SPX) was 1101.36 (H), 1080.77 (L) and 1081.4 (C). I'll round SPX's HLC to 1101.4, 1080.8 and 1081.4 respectively.

The Pivot Point is 1101.4 + 1080.8 + 1081.4 = 3263.6 divided (/) by 3 to equal 1087.9. I'll round our 10/22 SPX pivot to 1088.

From a chart perspective in SPX, yesterday I was considering 1100 as a first area of resistance, the powerful round number near the cluster of prior highs, then 1110 at the top end of the upper channel line to be a next key resistance (per the red down arrow in the chart below). Also from a 'chart' perspective, I would consider key near support to lie at the prior 1080 intraday high, as noted at the green up arrow, with next likely chart support in the 1060 area at the upside price gap. These levels would be significant for the upcoming several days. Remember that a daily pivot point is in play for the next day ONLY.

From a PIVOT POINT perspective, 1088, as calculated from yesterday's (10/21) price range was the pivotal level for today (10/22).

The pivot point itself became a short-term and primary support/resistance calculation for today's trade in the S&P 500. Institutional traders especially may anticipate that the most significant price action will occur at and around the pivot price. The two support (S1 + S2) and resistance (R1 + R2) levels, especially S1 and R1 become important to consider when trading in the index is above or below the pivot point price.

If there's a strong move ABOVE the pivot price, traders will keep an eye on the R1 as a possible first technical resistance. If the day's trade is BELOW the pivot point (1088 today in SPX), the expectation is the S1 value is the key technical support.

The second support and second resistance points are WELL above and below the first support/resistance levels as you will see in the 5-point pivot model. They are the levels that might be seen in an extremely sharp upswing or downswing.

To complete the 5-point formula, we need compute the two support and two resistance points per the formula above. First, support points S1 and S2.

SUPPORT 1 and 2 calculations are:

S1 = (P x 2) - H AND S2 = P -(H - L) = P -(R1 - S1)

S1 =(1088 X 2) -1101.4 =1074.6

S2 = 1088 -(1101.4-1080.8) = 1067.4 -(1095.2-1074.6) = 1046.8

Resistance 1 and 2 calculations are:

R1 =(P x 2) - L AND R2 = P +(H - L) = P +(R1 - S1)

R1 =(1088 X 2) -1080.8 =1095.2

R2 = 1088 + (1101.4-1080.8) + 1088 = 1108 +(1095.2-1074.6)= 1128.6

Summing up, the Pivot point for the S&P 500 (SPX) for today (10/22) was 1088. The first key SPX support below the 1088 Pivot (S1) based on yesterday's price range was 1074.6 or approximately 1075. The first key technical resistance (R1) above the 1088 Pivot for today's SPX trade came to 1095.

The two Support points (S1 and S2) and the two Resistance points (R1 and R2) based on YESTERDAY'S price range for SPX are seen on my next chart.

Typically, if the pivot point is pierced on the upside, conditions are seen as bullish. If the pivot point is pierced on the downside during the Open or subsequently, conditions are considered bearish. Both situations were seen today at different times. Amazingly, the PROJECTED first support and first resistance based on yesterday's price range (nothing more!) corresponded almost exactly to TODAY'S High and Low in the S&P 500!!

Pivot points are also used in the day's trading as entry and exit points. A trader might buy a stock if the price breaks above the Pivot point or the first (R1) resistance level or to buy the S&P 500 futures. A short position might be established if a support level is broken in a stock or a short SPX futures position might be entered.

One OIN Subscriber wrote me today saying that:

"As I understand them, they (Pivot points) are used by institutional computers for much of their market making activity and traders should be able to 'pattern' them where in an up-trending market, if you trade an R1, or R2, then the Pivot or S1 should find buying. With more and more stocks now hitting 52-week highs and overhead resistance broken, they are giving some very good targets to help traders assess risk and reward in their trading.

...after the SPX broke above its weekly pivot, SPX hasn't looked back since. I drew an upward trend on the SPX from the March lows to July lows and SPX was still above trend and its 50-day simple moving average."

WEEKLY AND OTHER PIVOT POINT FORMULAS:

Calculating a weekly pivot point on the completed week's High, Low and Close is another means of using the 5-point Pivot formula; e.g., to judge whether conditions are bullish or bearish in the subsequent week and to calculate weekly support and resistance. This is an appropriate set of Pivot Points and Support and Resistance levels for me to include, at least for a time, in my weekly Index Wrap column to see how the 5 points measure up or compare to what happened in the following week.

Another variation of the 5-point pivot method involves using the Open (O) in its calculations.

Tom DeMark, who I worked with in the past in putting on trading seminars, has a number of different Pivot Point formulas depending on whether today's (or this week's) Close was equal to, greater then or less than the Open.

These variations could be gone into in a future article.