What Are Pivot Points?
Pivot points are technical indicators that can prove helpful to investors, giving them one more tool for assessing the market. Trend, range and breakout traders can all harness pivot points, using them to determine when to enter and exit positions. Additionally, pivot points are strategically applicable to equities, futures, debt and forex trading.
By calculating these points, investors can gather several helpful pieces of information. Technical analysts can use pivot points to not only determine levels of support and resistance, but also to gauge whether a market is bearish or bullish. In addition, these points can be especially helpful for determining stop-loss prices and profit targets. Forex pivot points are an effective aspect of technical analysis and are used by day traders around the globe.
At their most basic level, pivot points are areas where a security's price trend might change. Accordingly, they are valuable tools for active trading as they define areas of support and resistance. In the case of falling price action, the lower pivot point is recognised as a potential support level; for rising price action, the upper pivot point is characterised as a possible resistance level.
As either support or resistance, pivot points are technical indicators that can help one obtain a better sense of how financial instruments will behave in the short term. Subsequently, intraday traders, day traders, swing traders and investors frequently use pivot points for this specific purpose.
Calculating Pivot Points
To calculate pivot points, technical analysts harness the high, low and closing value of a security, and in some cases additional external levels of support and resistance. These values can be from the last day, week or even month. The forex markets are open 24 hours a day, so calculations that involve a particular session will assume the session ends at 5 p.m. EST. Known as daily pivot points, this type of calculation is useful for identifying trends as well as the broader market state.
There are several methods for determining a pivot point, with the most basic one involving averaging the high, low and closing prices for the prior day. Another technique, called the five-point system, adds two support levels and two resistance levels to the aforementioned price levels.
To illustrate how a set of pivot points is calculated, assume you are trading the EUR/USD on the daily timeframe. The vital pieces of information necessary for the calculation are the target day's high, low and closing values. After that data set is gathered, the numbers are simply entered into the following framework, which generates a collection of pivot point support and resistance levels:
P= Pivot Point
R1 = Resistance Level 1
R2 = Resistance Level 2
S1 = Support Level 1
S2 = Support Level 2
High = Previous trading period's upper extreme value
Low = Previous trading period's lower extreme value
Close = Previous trading period's closing value
P = ((High + Low + Close) / 3 )
R1 = ((P * 2) - Low)
R2 = P + (High - Low)
S1 = (P * 2) - High
S2 = P - (High - Low)
As you can see in the example above, once a trader has identified the pivot point, he can then use this piece of information to calculate support and resistance levels. To determine the first levels of support and resistance, the trader can start with the pivot point and then measure the width between this point and either the high or low prices from the previous day. These widths are referred to as "trading ranges."
To calculate the second level of support and resistance, the investor can utilise the full width between the prior session's high and low prices.
How To Use Pivot Points
Once traders have identified pivot points, as well as their corresponding levels of support and resistance, they can harness this information. There are many uses of these data points, with some being more straightforward than others.
As an example, let's say that the EUR has entered a brief consolidation period versus the global majors. To capitalise on the muted price action, you decide to implement a rotational trading strategy using pivot points. Assuming that the EUR/USD had a previous daily high of 1.1800, a low of 1.1750, and a close of 1.1775, your pivot points are as follows:
P = ((1.1800 + 1.1750 + 1.1775) / 3) = 1.1775
R1 = ((1.1775 * 2) - 1.1750) = 1.1800
R2 = 1.1775 + (1.1800 - 1.1750) = 1.1825
S1 = (1.1775 * 2) - 1.1800 = 1.1750
S2 = 1.1775 - (1.1800 - 1.1750) = 1.1725
A key benefit of using a pivot point trading strategy is simplicity. In the case of our rotational EUR/USD scenario, all one needs to do is to sell from the areas of R1 and R2 when price reaches these thresholds. Conversely, buy orders may be warranted if the USD strengthens vs the EUR and exchange rates fall to S2 and S1. Given their straightforward calculation, pivots are exceedingly simple to trade.
Another basic application is that if a currency is trading above a pivot point derived from the previous day's values; this situation helps show the bullish feelings of the global markets. In such a case, a forex trader looking to make use of trends might want to take a long position in the belief that he can capitalise on the sentiment of the market. For instance, GBP/USD traders may want to implement a bullish breakout strategy if rates break above the R1 and R2 pivots. In doing so, profiting from a rallying GBP or a fading USD becomes possible.
However, if a currency is trading below the prior session's pivot point, an investor can take this as evidence of bearish sentiment. In cases like these, a trader may want to take a short position on the currency.
Pivot Points In Range Trading
Range traders can potentially use pivot points, as well as their corresponding levels of support and resistance, to find better times to enter and exit trades. For these investors, pivot points can serve as reversal points. In addition, support levels can provide a good place to enter a buy order. Once a currency nears one of these levels, a range trader might find it a good time to take a long position.
In contrast, resistance levels can help give investors a good place to sell. When a currency approaches such a level, this might indicate an opportunity to close out a position and take profits.
Applying additional technical indicators can lend credence to a set of pivot point support and resistance levels. Many traders add tools such as Fibonacci levels or a moving average to their pivot point trading strategies. If the indicators converge, it's believed that a confirmation of the pivot points occurred.
As an example of confirmation, assume that you are applying daily pivot points and Fibonacci extensions to the GBP/USD. In the event that a Fibonacci extension level coincides with an R1, R2, S1, or S2 pivot point, the pivot point in question is "confirmed." As a general rule, the convergence of multiple indicators strengthens an area of support or resistance.
Pivot Points In Breakout Trading
Investors interested in breakout trading can also make use of pivot points. More specifically, these traders, who study charts in an attempt to identify instances where a security will experience a significant price fluctuation in a short time frame, can use pivot points to gauge when breakouts are genuine.
If used effectively, pivot points can potentially be a valuable tool for traders. If investors take the time to learn about these points, they may find they have one more tool for evaluating the market and determining when to enter and exit positions.
This article was last updated on 7th September 2021.
FXCM Research Team
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