Understanding Pivot Trading for Forex

Decades ago, floor trading was the heart of market action. Traders in colored jackets competed for their slice of the cake through shouts, signs, signals and often by sheer physical presence. It was essential to determine a simple rule in this dynamic environment to help them form a correct intraday bias. By taking just 3 pieces of data — high, low and close — they created the concept of a pivot point. And that leads us to pivot trading forex.

Read on to learn what pivot points are and how to apply them to trade forex.

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What are Forex Pivot Points?

A pivot point is a chart technical indicator used to determine an overall trend of the market. Like all of the technical, it is calculated from the price.

Pivot points originated in trading stock and commodity futures. Many technical indicators rose in popularity during those times, including moving averages and various oscillators. Yet, the main advantage that pivot points have over those is that they remain static through an entire trading session when set on the chart.

You get a pivot point by calculating the average of the intraday high and low and the previous day’s closing price. Then, on the next day, you’ll use the pivot point as a sentiment indicator. The price above the pivot point gives you a bullish bias; below the pivot point is bearish.

The simple formula is:

• Pivot point (P) = (High + Low + Close) / 3

In addition to the pivot point, you can project support and resistance levels using these formulas:

• Resistance 1 = (P x 2) – Low
• Resistance 2 = P + (High – Low)
• Resistance 3 = High + 2 (P – Low)
• Support 1 = (P x 2) – High
• Support 2 = P – (High – Low)
• Support 3 = Low – 2 (High – P)

As in other areas of technical analysis, pivot points calculated on higher time frames are more dependable.

How Can Pivot Points Help Investors?

Pivot points are among the oldest chart technical indicators. Here are a few reasons why they are still popular.

Easy to use: Compared to other technical indicators (e.g., trendlines), pivot point gives a precise level to use with a rule that is easy to follow. At any point, there are only 3 possibilities — price is above it, below it or just breaking through it.

Accurate: Pivot points are among the oldest technical indicators. They were initially used on the stock and commodity futures markets before finding the way to forex markets. With so many people looking at this methodology, it becomes a self-fulfilling prophecy providing good risk-to-return odds.

Adjustable: Pivot points work on multiple time frames and in multiple trading strategies. While better suited for lower time frames, higher frame pivot points can help gauge the overall market trends. Furthermore, pivot points can mix with other technical indicators like moving averages (MA) or moving average convergence divergence (MACD).

Great for day trading: The pivot point concept is excellent for day trading as it uses last-day trading data. Then, before the next trading session, you already have several key levels marked and ready to use.

Pivot Points in Practice

One of the main advantages of pivot points is that they are helpful in any market condition. Whether you expect a solid trend move or an uneventful ranging session, pivot points will help you plan to take profit and stop-loss levels.

In Ranging Markets

Expect the pivot point to act as traditional support and resistance. In this scenario, a good long entry would be near support and sell near the resistance — with an opportunity to reverse bias and go short if the price action confirms that the resistance holds.

In Trending Markets

Eventually, every market starts to trend and violate established levels. An excellent example of a pivot breakout trade is when the price crosses resistance 1 level and rejects the pullback. Now you can enter the long and place a stop loss below the pivot point.

You can simply manage the trade, observing how it will behave as it reaches the resistance 2 level and adjusting your stop loss accordingly to avoid missing a potentially significant move.

Statistics and Probabilities

Since trading is all about probabilities, here are some rough estimates of probabilities for pivot points and the levels above and below.

• 40% to close higher than resistance 1
• 40% to close lower than support 1
• 15% to close higher than resistance 2
• 15% to close lower than support 2
• 5% to close higher than resistance 3
• 5% to close lower than support 3

As you can see, the odds of reaching the 3^rd level above and below the market are relatively low. So, take this into account when planning the take-profit levels in intraday trading.

A Tool But Not a Single Solution

Pivot points have been around for decades. The days when the charts were plotted by a hand and pivot points calculated manually are behind us. Nowadays, it is all automated, and a single click of a button can show you all you want to know.

Naturally, this changed the trading game. Simply using pivot points and relying on several horizontal lines might not be enough. While there is no one-size-fits-all solution, pivot points work the best when combined with another indicator or a simple chart pattern concept.

Even then, you can expect to face some losses, but at least you will be stacking the odds in your favor.

Frequently Asked Questions