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The Secret to Understanding Pivot Points

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Pivot Points are one of the oldest resources available to currency traders. FXTM’s Head of Education, Andreas Thalassinos, gives you the low-down on this crucial trading resource.

What are Pivot Points?

It might look complicated, but a Pivot Point (PP) is simply a benchmark, a price point that indicates which direction the markets are moving in. Markets trading below the PP are bearish, those above it are bullish. Better yet, calculating the PP is easy – it is simply the mean average of the previous session’s high, low and close price, taken from the most recently completed candlestick:

Pivot Point (PP) = (Previous High + Previous Low + Previous Close) / 3

This formula can then be expanded to provide the support (S) and resistance (R) levels:

R3 = High + 2*(PP – Low)

R2 = PP + High – Low

R1 = 2*PP – Low

Pivot Point (PP) = (High + Low + Close) / 3

S1 = 2*PP – High

S2 = PP – (High – Low)

S3 = Low – 2*(High-PP)

 

These indicators are used by many traders to determine market sentiment over a given time period, and are invaluable for identifying support and resistance.

These levels are effectively a pivot point, a benchmark by which to gauge market sentiment. A price movement above R1 is indicative of a bullish market (and potential opportunities for profit taking), while price movements below S1 suggest the bears are out in force. Should the price move below S1 and begin targeting S2, then PP will become the resistance (R1). Similarly, when the price moves above R1 and R2 becomes the target, R1 starts to serve as a support level (S1). In a bullish market, a stop loss order placed below R1 may help to protect forex traders from sudden price movements.

Expert Tip: Prices trading below PP can still find support at S1, and rebound towards the pivot point. Currency pairs trading between S1 and PP could provide a profit taking opportunity, with some traders buying at S1 and selling at PP.

 

Calculating Pivot Points

The Standard method for calculating pivot points, given above, is by far the most popular, but it is only one of five:

  1. Standard
  2. Fibonacci
  3. DeMark’s
  4. Woodie’s
  5. Camarilla

Fibonacci, Woodie’s, and Standard all rely on the same variables – the previous period’s low, high and close price to calculate the pivot point. By contrast, Camarilla also includes the current period’s open price, while DeMark’s uses the relationship between open and close to determine which one of three formulas to use.

The weights assigned to each pivot point level (PP, R and S) differ between formulas, meaning the distance between the levels varies based on the calculation used to determine them. This can make choosing a formula appropriate prevailing market conditions a challenge, regardless of your experience level. For this reason, I advocate the use of pivot points with other indicators. For example, FXTM’s Pivot Point Tool also relies on MACD (Moving Average Convergence Divergence), Momentum and Moving Average analysis to calculate pivot points.

This tool is an industry first, and allows for greater coverage of market sentiment but most crucially – it is an invaluable learning resource. Our traders can quickly and easily determine pivot points, and support and resistance levels for any one of 250+ trading instruments. They can use their choice of pivot point formulas and a time frame to suit their trading strategy (the tool provides pivot points for time periods as short as five minutes). It is the innovative new face, of one of currency trading’s oldest trading tools, and its versatility makes it an essential trading and learning resource.

At its most basic level, a pivot point is simply a benchmark that enables traders to quickly and easily determine market sentiment. Tools like FXTM’s Pivot Points expand on this classic formula, providing greater coverage and PP calculations tailored to your trading instruments and strategy.

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Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.


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