Pivot Points: An Effective Forex Trading Tool

Pivot points are used by both market makers and traders to determine unfavourable support and/or resistance levels. Forex market traders use this indicator to find out the overall trend that is prevailing in the market. Range-bound traders in the forex market find this tool to be extremely useful as it helps them to identify entry points. Breakout and trend traders can use this indicator to spot the key levels that the price should break to establish a trend or to qualify as a breakout. (Information credit: Corner Trader).

What is Pivot Point?

A pivot point, as per its definition, means a point of rotation.  It is a technical indicator that is used by traders to identify the overall trend of the market over different time frames. The pivot point is the average of the lowest, highest and closing prices from the previous day. If the market trades above the pivot point on the subsequent day, it indicates a bullish market sentiment.  On the other hand, it indicates a bearish sentiment when the market trades below.

Support and resistance levels are used in conjunction with pivot points to conduct the analysis. One support and resistance level is calculated using the width of the trading range between the high or low of the previous day and pivot point. Another level is calculated using the full width between the high and low prices of the previous day. Pivot points are commonly used as an indicator in intraday trading.  Pivot points are used as indicators in futures, stock and commodities. Although they are used for intraday charts, a shorter time frame price information reduces their accuracy and significance. 

Calculating Pivot Points

The formula of pivot points is as follows:

Central Pivot Point (P) = (High Price + Low + Closing)/3

After the central pivot point has been calculated, the support and resistance levels are calculated using the pivot point. The formula are as follows:-

v  First level support and resistance:

First Resistance (R1) = (2 X P) – Low

First Support (S1) = (2 X P) – High

v  Second level support and resistance:

Second Resistance (R2) = P+ (R1-S1)

Second Support (S2) = P – (R1-S1)

Sometimes, traders also calculate the third level of support and resistance. But the third level is hardly useful for the trading purposes. Traders can also find the mid-point between each level to add depth to the analysis.

Forex Market and Pivot Points

In the foreign exchange market, pivot points acts as the primary level of support and resistance. Traders need to keep in mind that when one of the market opens, breaks tend to occur. This is because of the influx of traders entering the market at the same time. Traders tend to adjust their portfolios according to the changes that occurred overnight. The prices may remain confined between the pivot level and either the support or resistance level during the quieter hours of the market. This is the perfect period for range-bound traders.

An individual trader can become attuned to the market movements by becoming more aware about pivot points. This helps them to make well calculated trade decisions.