Pivot point trading strategy
Pivot points trading strategy has not found great significance among forex traders primarily because of little or no understanding of how pivot points work. Nonetheless, proper knowledge of pivot points will guide a forex trader on when to enter, exit, stop loss, and limit orders to maximize profits and reduce loss. There are several technical analysis tools and indicators used in trading, most of which are prone to human errors. Pivot points have, however, found a more significant advantage in this regard as it takes analysis out of the trader’s hands and puts it into the capable mathematical hands of the computer. Other trading tools such as Fibonacci may have a few limitations in that it has no inherent rules of objectivity.
Commonly used technical analysis tools such as Parabolic SAR, Exponential Moving average (EMA), Elliot waves, and others may generate some false forecast, and this makes it difficult to be objective in choosing which combinations of indicators to
The pivot point is somewhat similar to Fibonacci levels. However, there exists a significant difference between the two in that in Fibonacci. There is a level of subjectivity involved (the trade would have to pick the swing highs and swing lows) whereas, in pivot points, forex traders use the same method and formula for calculations. Pivot points are a critical tool for short-term traders seeking to take advantage of small price swings.
Pivot Point Calculations
Pivot points calculations are typically done using the previous (last) trading session’s open, highs, lows, and close. Forex, however, is a 24-hour market, so most forex traders use the New York closing time of 4:00 pm EST as the previous day’s close.
The calculations for pivot point using the formula is shown thus:
- Pivot point (PP) = (High + Low + Close) / 3
Various resistance and support levels are then calculated thus:
- First Resistance (R1) = (2 × Pivot point) – Low
- First support (S1) = (2 × Pivot point) – High
For the second level of Resistance and Support:
- Second Resistance (R2) = Pivot point + (High - Low)
- Second Support (S2) = Pivot point - (High - Low)
For the third level of Resistance and Support:
- The third Resistance (R3) = High + 2 (Pivot point - Low)
- The third Support (S3) = Low – 2 (High – Pivot point)
As shown in the calculations above, by just knowing the previous days open, highs, lows, and close, you can eventually arrive at 7 points, i.e., 3 Support levels, 3 Resistance Levels, and the actual pivot point. You don’t necessarily need to perform these calculations yourself as most charting software will automatically do the calculations, be sure to make the right configuration in your settings so it can use the correct closing time and price.
Use of Pivot Point in Range Trading
Pivot points can be applied to forex trading in the same way other support and resistance tools are applied, the more a currency pair touches a pivot level, the stronger the level is. (Pivoting simple means approaching a particular Support or Resistance level and the Reversing). The most important pivot points are R1, S1, and the actual pivot point.
If the price is approaching the upper Resistance level, you could sell the pair and place a stop just above the resistance. If a price is approaching a Support level, you could buy and put a stop just below the level. The logic is to put a focus on S1 or R1 for reversal or break such that as the market reaches R2, R3, or S2, S3, the market will already be overbought or oversold, and the right decision to take at these levels is to exit rather than entry.
Pivot Point and Trade Breakouts
There are two main approaches to trade breakouts: the aggressive approach and the safe approach. Either of the two ways may be promising. Note, however, that if you take the safe path, which means waiting for a retest of Resistance or Support, you may miss out on the initial move. The concept of ‘Role reversal’ (once a level breaks, in theory, that level will likely become “Support-turned-Resistance” or “Resistance-turned-Support”) also applies.
If you were going long and price broke R1, you could place a stop just below R1. It is sporadic for a price to break past all pivot point levels, except for rare occasions where a significant economic event has taken place, or a piece of surprise news plays out.
As with all other methods or indicators, you must be aware of the risk of taking breakout trades. As you have no idea whether or not the move will continue, secondly, you won’t be sure if it’s an actual breakout or just a wild swing as a result of a surprise piece of news. It is, therefore, pertinent to keep up with news and be aware of happenings around the economic calendar for the day or week.
How to Measure Market Sentiments Using Pivot Points
An advantageous way to incorporate pivot points into your forex trading strategy is to apply to gauge market sentiments. You can use it to tell whether traders are more inclined to buy or sell the pair. All you need do is to keep a focus on the pivot point. If the price breaks through the pivot point to the top, traders are likely aggressive on the pair, and you should as well start buying the pair like it’s a Krispy Kreme donut.
The pivot point is excellent for range trading, but certainly not to 100% all the time. The bitter truth must, however, be told as unfortunate events may happen as life is not that simple. There is every need to deal with each trading day the best way possible, so in those times in which the pivot point will fail to hold, it is only wise to have some tools in your forex toolbox to leverage on the situation. On the whole, the pivot point trading strategy offers the advantage of objectivity.