Pivot points or pivots are useful indicators for determining levels at which the sentiment of the market can change from bullish to bearish or vice versa. Generally seen as markers of support and resistance, pivot points are widely used by day traders in the spot forex market. These traders use pivot points to determine entry, exit, stop and profit taking levels.
Calculating Pivot Points
Pivot points help in identifying potential support and resistance levels and thus minimise the risk involved. These points can correspond to trend lines, Fibonacci levels, moving averages, previous highs/lows or closes, and many more indicators, depending on the individual philosophy of a trader.
Pivot levels assume that a trend or correlation can be identified from the previous session’s data. So, the basic formula to calculate a pivot point is to find the average of the high, low and close prices of a currency on the previous day or session. This pivot point is then used to calculate the estimated support and resistance levels for the current trading day.
- First Resistance = (2x Pivot Point) – Low (previous period)
- First Support = (2 x Pivot Point) – High (previous period)
- Second Resistance = (Pivot Point – First Support) + First Resistance
- Second Support = Pivot Point – (First Resistance 1 – First Support)
- Third Resistance = (Pivot Point – Second Support) + Second Resistance
- Third Support = Pivot Point – (Second Resistance – Second Support)
Now, if a trader sees a pivot level is holding, they might find some good trading opportunities. For instance, if the price is nearing the upper resistance level, one could sell the pair and place a stop just above the resistance. Similarly, if the level is nearing a support level, one could buy and put a stop just below the resistance.
Using Pivot Points
The traditional approach to using pivot points, calls for the use of the break of a session’s mid pivot as a direction signal and then setting the first target as the pivot high or pivot low, depending on the direction of the break. A continuation through this first level means setting the second pivot high or low as the next target.
However, in today’s times, when intra-day trading is more volatile and choppy, the mid pivot is considered less significant and the first and second pivot levels work best in range bound markets for selling strength and buying weakness.
- In a range bound market: Pivot levels work as good targets and entry levels for buying weakness and selling strength.
- In a generally bullish market: The 1st and 2nd pivot levels are useful for buying any intraday weakness in an otherwise bullish market. In such a scenario, traders can set buy levels a few points above and stops a few points below with targets set at the 1st or 2nd pivot high level.
- In a generally bearish market: The 1st and 2nd pivot high levels are great for selling any intraday strength in a bearish market. Traders can set sell levels a few points below and stops a few points above a pivot. Now, targets can be set at the 1st or 2nd pivot low levels.
- In a strong bullish or bearish market: Pivot levels can be used as breakouts in such markets. Traders can now buy on a break of the pivot high or sell on the break of the pivot low.
The best technique for using pivots is to use them along with Fibonacci or other indicators. This is because an indication is of greater significance when backed by another tool or indicator. Pivots are highly useful in markets with a good, but not extreme, amount of volatility. For intra-day trading, daily pivots are useful.