Forex Trading Pivot Points
Beyond attempting to evaluate trends, pivot points can be
used as part of an entry and exit strategy. An investor might
choose to place an order to purchase a currency pair if the
price breaks through a resistance point.
A technical indicator called 'Pivot Points' is becoming
increasingly popular. The usefulness of any single technical
indicator is always up for debate. But one thing is certain:
pivot points are a valuable idea and should be part of every
Forex trader's toolkit.
One possible reason pivot points have become so widely used
is their sheer simplicity. Many indicators, such as Parabolic
SAR or even Exponential Moving Averages, require some knowledge
of fairly heavy duty mathematics to calculate. Many traders are
reluctant to use an indicator that they only partly understand,
and depth of understanding is only possible when you can
calculate the indicator personally.
To calculate pivot points is simplicity itself. The formula
is:
Pivot Point = (H+L+C)/3
where C is the currency pairs' closing price for a given day,
H is the high for the previous 24 hour period and L the low. In
short, the pivot point is simply the arithmetic mean (the
'average') of the three prices.
Picking the time for C is somewhat arbitrary since Forex
markets trade 24 hours per day. C is often measured at the New
York Forex market closing time, 4 p.m. EST. This number, usually
denoted P, is used in conjunction with several others - called
resistance and support points - in order to form the basis of a
trading strategy. The resistance and support points are also
simple to calculate. The formulae are as follows:
R1 = (P x 2) - L
S1 = (P x 2) - H
R2 = P + (R1 - S1)
S2 = P - (R1 - S1)
Of course, how to choose a price for the resistance and
support levels is key and traders differ, even though there is
often a consensus. Some strategies select the pivot point itself
as a point of support or resistance, depending on the direction
of recent price movements. Others will choose the closing price
of the previous day.
If the price moves above the pivot point, trending upward,
the market is tending bullish and vice-versa. In the first
circumstance the pivot point would be a point of resistance,
since prices 'resist' moving above that level. In the latter
case, it's a support point.
Beyond attempting to evaluate trends, pivot points can be
used as part of an entry and exit strategy. An investor might
choose to place an order to purchase a currency pair if the
price breaks through a resistance point.
Similarly, any good strategy will involve deciding in advance
when to liquidate a position. Pivot points can be used to help
select a stop-loss price in the event it moves below a support
level.
No single indicator can be used reliably as the sole input to
a good trading strategy. Pivot points, however, have been shown
to perform well as part of an overall approach involving other
indicators such as MACD (Moving Average Convergence/Divergence).
Owing to the enormous volume of transactions, currency prices
are not much swayed by the action of any one trader, as is
sometimes the case with stocks. That makes pivot points much
more useful in Forex trading than in equity trading. Keep in
mind, however, that such swings are possible as the result of
central bank interest rate hikes, major political events and
other fundamental factors.
Many analysts hold that pivot points achieve their useful
status as a result of two tendencies.
If the day's price begins above the pivot point, prices will
tend to stay above that point until it reaches the first
resistance point. Remember, 'begin' is a somewhat arbitrary
point in time in Forex trading. Alternatively, if the price
begins below the pivot point, it will tend to stay below that
point until it hits a support point.
Sometimes called 'trading between the lines', this is one
popular approach. Traders wait for the reversal of the trend off
a resistance point, then sell. Similarly, when the price trends
upward after bouncing off a support point, a buy order can be
triggered. If the market trades near R2 or S2, prices will tend
to move back toward the pivot point.
Of course, this approach has to be viewed with some
skepticism, as most strategies should be. Resistance and support
points are broken all the time - that's what makes trading
exciting. So, one has to wonder what makes those particular
numbers resistance and support points.
To what degree those points influence trading decisions is a
matter for debate. But, that they exist and have some influence
is unquestionable.
It's always difficult to judge when a price movement is a
temporary correction versus the beginning of a trend. By the
time the trend is clearly established, it is often too late to
profit. As with any form of trading, there's no substitute for
experience as an aid to forming a sound, independent judgment.
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