Pivot points are one of the most popular tools that professional forex traders use to trade the markets and have been in use since the days of the floor.
Back then, screen trading did not exist and traders had no real access to some of the complicated technical indicators that we have today so day traders, or ‘locals’ as they used to be called, would rely on a few technical levels that were calculated using the previous day’s price action. Remarkably, these levels have stood up over time as being great levels within the market and since they are now followed by so many pro traders, they continue to have an uncanny knack of predicting major turning points in the market.
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The first thing to do is calculate the main pivot using an average of yesterday’s high, low and close. This is then combined with three more support and resistance lines to give the trader different levels in which to enter or exit the market. Once the pivot points have been calculated, a trader often draws them onto their chart or screen in order to give them a visual idea of where the market is heading.
Pivot = (H + L + C) / 3
Resistance 1 = P + (P − L)
Support 1 = P − (H − P)
R2 = P + (H − L)
S2 = P − (H − L)
R3 = H + 2×(P − L)
S3 = L − 2×(H − P)
How they are used:
Once the key pivot points have been found a trader will typically use them in a number of different ways. In fact, it is acceptable for each pivot level to be used as an entry, exit, profit target or stop loss depending on what is happening in the market.
Typically of course, a trader will buy whenever the market touches a support level and sell whenever it reaches a resistance point however this can be dangerous during strongly trending markets.
A better way is to treat the main pivot as an indicator for the day’s action; whenever the price is below the pivot, we should expect the market to decline and whenever the price is above the pivot, we should expect the market to rally. In this way, the pivot or first resistance/ support can actually become levels in which to buy or sell the market and can help guarantee that we are trading in the same direction of the trend. This method can sometime lead to whipsaws when volatility is low but it is generally a safer strategy than waiting for the market to hit the outer resistance or support levels.
A quick look at the price action for EURUSD last week shows many good examples where this strategy would have worked wonders and you can see many times when the market closed near one of the key resistance levels.Get the 5 most predictable currency pairs