One of the main tasks in trading is to identify points where the trend reverses direction. Such places on the chart are called pivot points and indicate the minimum or maximum price values for a certain period.
Along with the support and resistance levels, the pivot points are the most important tools, on which successful trading is based. They help to receive maximum profit from the market, that’s why every trader who wants to achieve success on Forex should know how pivot points are determined.
To understand what Pivot Points are, it is necessary to know the basic principles of trading Resistance/Support levels. Trading with Resistance/Support is one of the simplest and yet very effective methods of trading in the financial markets.
However, the correct identification of price levels is considered the most difficult task. The practice shows that traders solve this problem in different ways – some traders use the principle of “round” prices, others use “psychological” price levels, others use past price reversal points. And subjectivism is a common problem for all of them. In fact, traders set levels based on their personal experience and their own perception of the market.
To reduce the influence of subjectivism and automate trading on the bounce/pitch, the Pivot Points indicator was used in technical analysis. This indicator is based solely on prices of previous periods, which eliminates a subjective approach in determining important levels of the market rate.
Pivot Point strategies are successfully used to trade a variety of financial instruments – currency pairs, stocks, bonds, precious metals, commodity market assets (e.g., oil, gas, industrial metals), derivative financial instruments (options, futures).
Now you will learn in detail what Pivot Points are and how to work with them.
What are Pivot Points (in simple words)
Pivot points are a price level at which an asset can reverse and continue moving in the opposite direction. Pivot point in simple words is a pivot point or a level on the price chart of a possible change in the current trend.
The indicator owes its appearance to the famous trader and mathematician of the twentieth century, Henry Chase, who, like all traders, was looking for the best way to determine the best point or moment to enter the market. Based on studies of price behavior, which is cyclical, accounted for everything and repeated, the mathematician derived the Pivot Point indicator for determining a possible trend reversal.
Pivot Points form a possible rate reversal line. It is assumed that the rate will turn in the opposite direction, reaching the Pivot Point level. If the rate, figuratively speaking, breaks through the PP level and rushes further in the direction of this breakdown, we can say that the market signals that the trend will continue.
Thus, the Pivot Point is a kind of resistance price level or support price level, determined by special methods.
Most often, trading on Pivot levels is practiced by traders working on short-term or, alternatively, intraday intervals. Pivot point in simple words is a technical indicator that helps to identify potential resistance and support areas on a price chart.
The standard approach to determining the Pivot Point assumes that PP values are calculated using prices of the previous trading session. The strategy can be used not only for intraday (short-term) trading, but also for longer horizons.
How Pivot Points Work
To understand how pivot points work, it is sufficient to understand how they are calculated and what values are included in the formula. Nevertheless, there is a small catch here as well, because there are quite a few variations in the calculation of pivot points. Before proceeding to formulas, let us briefly list some varieties of Pivot Point calculations:
- Traditional – a simple method used on Wall Street for many decades.
- Classic – almost similar to the previous variant, there are only small differences in the formula.
- Woodie – gives great importance to the previous day’s closing price.
- DeMark was developed by a famous analyst from SAC Capital Advisors, a hedge fund, who predicted the market peaks and troughs in 2011-13.
- Fibonacci – related to price correction levels by numbers of the legendary mathematician.
- Camarilla is one more non-traditional variant of calculation with a slight difference from the classics.
We should separately note the features of calculations in the most popular variations.
How key levels are calculated
Technical analysts use the high, low, and closing prices of the last day to calculate key points. For example, the forex markets are open 24 hours a day, so calculations related to a particular session assume that the session ends at 5:00 p.m. EST.
There are several methods for determining pivot points.
In the classic form, the calculation of the pivot point is carried out according to the following formula:
The closing price, the maximum and minimum price for the selected time period are summed, the obtained result is divided by 3:
Pivot = (High + Low + Close) / 3
- High – the high of the previous day;
- Low – the minimal price of the asset at the last session;
- Close – yesterday’s closing price.
The reversal price level on the chart is indicated by the central horizontal line – PP. Support (S1, S2, S3) levels are formed on both sides of the signal line from below and resistance (R1, R2, R3) levels from above.
These zones are calculated as follows:
- R1 = 2Pivot – Low;
- S1 = 2Pivot – High;
- R2 = Pivot + (R1 – S1);
- S2 = Pivot – (R1 – S1);
- R3 = High + 2 × (Pivot – Low);
- S3 = Low – 2 × (High – Pivot), where:
- R1, R2, R3 are resistance levels (resistance);
- S1, S2, S3 – support levels.
Methods of building and calculating the pivot point can be carried out in addition to the classical model using additional tools of tehanalysis, so there are models: by Fibonacci, building by Demark, using the formula “camarilla” (camarilla).
These levels from the famous analyst are more for the analysis of the current trend and range, they are not so accurately determine the critical points. The peculiarities of the calculation are as follows:
- for Close < Open will be Pivot = High + 2 × Low + Close;
- for Close > Open there will be Pivot = 2 × High + Low + Close;
- for Close = Open there will be Pivot = High + Low + 2 × Close;
- S1 = Pivot / 2 – Low;
- R1 = Pivot / 2 + High.
As you can see, there is a new variable in the conditions of the formula for the opening of the day (Open).
The Woodie formula
This type of calculation is similar to the traditional version, but it gives more weight to close prices of the previous day. The formulas themselves look as follows:
- Pivot = (High + Low + 2 × Close) / 4;
- S1 = 2 × Pivot – High;
- S2 = Pivot – High + Low;
- R1 = 2 × Pivot – Low;
- R2 = Pivot + High – Low.
The Close is multiplied by two, which gives it much more weight in the formula.
Another set of levels, which includes 8 price values from R4 to S4. The general rule is to use them for placing stop orders and taking profit. The formulas look a little different:
- S1 = Close – (High – Low) × 1.1 / 12;
- S2 = Close – (High – Low) × 1.1 / 6;
- S3 = Close – (High – Low) × 1.1 / 4;
- S4 = Close – (High – Low) × 1.1 / 2;
- R1 = (High – Low) × 1,1 / 12 + Close;
- R2 = (High – Low) × 1,1 / 6 + Close;
- R3 = (High – Low) × 1,1 / 4 + Close;
- R4 = (High – Low) × 1,1 / 2 + Close.
Important note: there are quite a few different formulas for identifying reversal levels. All of them are oriented on the highs and lows of the previous day, as well as on the closing prices. It is up to each one of them to decide which one to use because different calculations may work well for different instruments and markets. The trader does not need to understand all of these formulas and manually count points. Today there are a lot of services for automatic calculation (Tradingview, Investing.com). It will at least save you from routine work.
How to use Pivot Points in Forex Trading
Let’s move on to the practical application of Pivot Points. They are used quite often at Forex, but a lot of problems arise:
- With the different closing times of different trading sessions, because this is an interbank market, not an exchange market. It works 24 hours a day. Many traders use-values according to their terminal, for example, when the daily candle closes, others prefer to use the New York closing time. In reality, this does not play a big role, it is enough to stick to the standard option in the automatic calculation.
- With the difference in the types of Pivot Points, which of them is more effective and better to use. This question is solved completely individually, but our experience shows that the traditional counting variant works best.
When trading Forex it is also important to consider:
- The average volatility during the day, for which to evaluate indicators
- The direction of the global and local trends.
- Potential news during the day, which can change the volatility.
Considering the above nuances, a trader will use Pivot points on Forex correctly.
Pivot point trading strategies
Perhaps the most important aspect is not so much the rules of building levels as the strategies of the Pivot Points. Precisely due to a correctly planned trading plan it is possible to earn on the pivot points because no indicator gives a 100% signal to enter the trade, we are dealing only with the potential probability.