FOREX Pivot Points

One technique that is becoming increasingly popular in FOREX trading is called 'Pivot Points'. A single technical indicator is usually not useful just by itself but pivot points are a valuable technique and should be part of every Forex trader's toolkit.

Pivot points have become popular due to the simple way to calculate them. Many indicators, such as Parabolic SAR or even Exponential Moving Averages, require some knowledge of statistics and mathematics to calculate them. It is not a good idea to use an indicator that you only partly understand, and understanding an indicator completely is only possible when you can calculate it yourself. 

What are Pivot Points?

Calculating pivot points is simple. 

The formula is: Pivot Point = (High +Low +Close)/3 

Where Close is the currency pairs' closing price for a given day, High is the high for the previous 24 hour period and Low the low for the previous 24 hour period. Traders sometimes wonder when is the close time as the market trades 24 hours a day. The New York Forex market closing time at4 p.m. EST is often used. The pivot point is just the average of the three prices. The Pivot Point number, usually referred to as P, is used together with several other points - 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 influenced greatly 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. However major swings are possible as the result of central bank interest rate decisions to raise or lower rates, 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, the starting point 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. 'Trading between the Lines', is one popular approach. Traders wait for the reversal of a trend off a resistance point and then sell. Similarly, when the price trends upwards after bouncing off a support point, this triggers a buy order. If the market trades near R2 or S2, prices will tend to move back toward the pivot point. 

However, resistance and support points are broken all the time - that's what makes trading interesting. But they do exist and have some influence. It's always difficult to judge when a price movement is a temporary correction or the beginning of a trend. By the time the trend is clearly established, it is often too late to enter and make a profit. As with using any other types of indicators and techniques, build up your own practical experience to aid you to make your own independent judgment.