Pivot Points

Pivot Points

In recent years pivot points have become a very well known and widely used technical analysis tool. To understanding pivot point levels you need to understand the ideas behind support and resistance. Support and resistance levels give traders a visual gauge of pressure points within the market, specifically at certain price levels.

Summary of Support & Resistance:

In short, support levels are considered levels at which price decline is continually rejected. Conversely, resistance levels are considered levels at which price increase is continually rejected. Traders looking at a support level and resistance level in conjunction with one another are essentially examining what is referred to as a channel. It is very common to see price trends within the bounds of trading channels; meaning that for hours, or perhaps days at a time, a currency may trade within the bounds of support and resistance levels. Many times throughout a trend the price may test either the support or resistance level, but ultimately if the price is to remain within the channel the support and resistance levels will be tested, but not pushed through.

Just the opposite of what is explained above, if a support or resistance level is tested for hours or days on end without a breakout, and finally the price does push through the bounds of this channel, it may be considered a strong indication that the price will take on an entirely new direction / trend.

Using Support & Resistance to Trade:

Traders watching support and resistance levels are generally looking for one of the following trading opportunities:

A chance to sell after a resistance level has been pushed, but not broken through several times. The trader's entry would likely be at the end of a strong bearish candle that began with a touch of the resistance level.

A chance to buy after the support level has been pushed, but not broken through several times. The trader's entry would likely be at the end of a strong bullish candle that began with a touch of the support level.

Or:

A chance to buy after a previously tested resistance level is finally pushed through with a strong bullish candle. In other words, buyers in the market have tried numerous times to push prices above a resistance level, yet have failed. Finally prices breakthrough in the form of a strong up-candle, indicating that perhaps, buyers will finally have their way and push the price higher.

A chance to sell after a previously tested support level is finally pushed through with a strong bearish candle. In other words, sellers in the market have tried numerous times to push prices below the support level, yet have failed. Finally prices breakthrough in the form of a strong down-candle, indicating that perhaps, sellers will finally have their way and push the price lower.

Understanding the Pivot Point Difference:

There are multiple scenarios in which a trader might utilize support and resistance levels as a means to identify key entry and exit points. Pivot points are simply a series of support and resistance levels, with the inclusion of a median price level. Standard pivot points include 5 levels (levels that are represented as distinct lines on your charts). The median level, or middle line of the 5, is called the ‘pivot point'. The other 4 levels are found above and below the pivot point in the form of 2 support lines (S1 and S2) and 2 resistance lines (R1 and R2).

Using the previous trading session's open, high, low and close in order to calculate these pivot levels gives traders an added advantage beyond simply looking at one support level and one resistance level. Through the use of pivot points, traders are able to gauge support and resistance levels on a scale in relation to an average price range (the pivot point or line itself) for the trading session.

Always bear in mind the crucial importance of market sentiment; mathematically pivot points may or may not correlate with future price movement, but because pivot points are now very widely used by technical traders – their potential to impact price direction is certainly worth considering. Said another way, if millions of technical traders are all watching the same support and resistance levels and buying and selling in accordance with those levels; market sentiment can quickly become market reality. Pivot points may be as effective as they are at times simply because so many traders are basing trades on the same levels.

Calculating Pivot Points:

Key figures are derived from the open, high, low and closing price of the previous day's trading session. These figures should be based on trading days or sessions considered started and ended at 0:00 GMT (Greenwich Mean Time). GMT is used because of the global aspect of currency trading; with various markets (Australia, Asia, Europe, US) constantly opening and closing globally – a 24-hour-a-day market is created. GMT is used to mark the start and end of trading days because it is considered a globally central time.

These calculations are shown for your reference. Most pivot products will draw these levels on your chart for you.

Pivot Point (PP): High + Low + Close / 3

The calculations for support and resistance levels are based on the number calculated for the pivot point itself and are as follows:

First Support (S1): (2 x PP) - High

Second Support (S2): PP - (High - Low)

First Resistance (R1): (2 x PP) - Low

Second Resistance (R2): PP + (High - Low)

Use Discretion:

As is the case with many technical analysis methods, strategies, and indicators – pivot points are far from an exact science. Pivot points may be completely irrelevant technically when trading right after a major fundamental news announcement. Traders should also consider other technical indicators, the overall trend of the currency pair, and the time frame of the chart they are analyzing pivots on in correlation with how long they plan to remain in an open position.

Heads up:

Typically, pivot points tend to work well if traders consider a few of the following tips.

Prices tend to volley between two pivot lines. If a price is right at S1 it is most likely to move back toward PP, only a fairly strong bearish candle would indicate a further break and move towards S2. Conversely, if a price is at R1 it is most like to move back towards PP and only a strong bullish candle would indicate a move towards R2. When prices are trading at the pivot line itself, look for a strong series of bullish or bearish candles to indicate a move back towards R1 or S1.

Pivot points seem to work the best in moderately sideways markets, or on a currency pair that is not experiencing significantly strong bullish or bearish trend over the previous few days.

Prices within pivot points can move two or three lines at a time during major news announcements, or what is more likely; pivot points may be completely irrelevant during news announcements.