Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a forex trader!
Today we will be discussing pivot points and their value to us as forex traders. Historically traders have used pivot points to determine prominent support and resistance levels.
Pivot points are also a very useful tool for range-bound traders for identifying entries. Additionally they are useful for trend traders and breakout traders to spot the key levels that need to be crossed for a move to qualify as a breakout.
Let’s now look at explaining how pivot points are calculated and then how they can be applied to the Forex market as well as combining them with other indicators to develop trading strategies.
Calculating Pivot Points
The prices used to calculate pivot points are the previous period’s high, low and closing prices. These prices are usually taken from the daily charts, but the pivot points can also be calculated using lower time frames such as the hourly charts.
Traders prefer to take the pivot points as well as the support and resistance levels, off of the daily charts and then apply those to the intraday charts. If a pivot point is calculated using price information from a shorter timeframe, this tends to reduce its accuracy and significance. We have discussed this before regarding larger timeframes being generally more reliable as we derive a larger average sentiment.
The exact calculations that pivot points use are not really important as there are so many free indicators that do this for you and display them on our charts like we see here.
Calculating two support and resistance levels is common practice, but it’s also possible to derive a third support and resistance level as well, the third levels are not thought as generally as highly regarded. some traders go beyond the traditional support and resistance levels and also track the mid-point between each of those levels and trade around them.
When applying Pivot Points to the Forex Market the pivot point is seen as the primary support or resistance level. This example is a 30 minute chart for a currency pair with pivot levels applied using the daily high, low and close prices.
The price of this currency pair fluctuates between the support and resistance levels identified by the pivot point calculation. The highlighted areas in the chart are good illustrations of the importance of a break above these levels as when they break the trend tends to continue.
Another widely regarded factor when using pivot points is the Forex Market Opens. There are three market opens which we need to consider which include the U.S. open, the European open and the Asian open.
What we generally see when trading pivot points is that the trading range for the session usually is confined between the pivot point and the first support and resistance levels because a multitude of traders trade this range.
Here we can see in the highlighted area that prices initially stayed within the pivot point and the first resistance level with the pivot acting as support. Once the pivot was broken, prices moved lower and stayed within the pivot and the first support zone.
when trading using pivot points in the Forex market, you may notice breaks tend to occur around one of the market opens.
The reason for this is liquidity and an immediate influx of traders entering the market simultaneously. After assessing the overnight data traders will act accordingly buying or selling the market.
During the quieter time periods, such as between the U.S. close, the Asian open and sometimes even throughout the Asian session prices may remain confined for hours between the pivot level and either the support or resistance level. This can provide the perfect environment for range-bound traders.
Let’s now look at two strategies involving pivot points that you may apply.
There are many strategies that can be developed and applied using pivot points as a foundation. In order to increase the probability of success we can include our knowledge of candlestick formations to work in conjunction with pivot points.
if we observe prices traded below the central pivot for most of the session and then rose above the pivot while simultaneously creating a reversal formation such as a shooting star, doji or hanging man, we could short The market in anticipation of the price resuming trading back below the pivot point.
Take a look at this example. This 30 minute chart had remained range-bound between the first support zone and the pivot level for most of the Asian trading session. When Europe joined the market, traders began taking USD/CHF higher to break above the central pivot. Buying pressure lost momentum as the second candle became a doji formation.
Prices then began to reverse back below the central pivot to spend the next six hours between the central pivot and the first support zone. Traders watching for this formation could have shorted the market right after