Most traders who use Pivot Points are intraday traders. I mean Pivot Points can be used mainly for intraday trading.
What are the Pivot Points?
Pivot Points or Pivot Levels are nothing but some support and resistance levels that you can calculate and plot on your charts very easily. Some platforms support Pivot Points but if you use a platform that doesn’t support it, you can easily calculate and plot them.
Pivot Levels are calculated using three types of information from the previous trading day:
* High price
* Low price
* Close price
Even in forex market which is a 24 hours market we have high, low and close price for each day. The easiest way to find the high, low and close price of the previous day is checking the previous day candlestick in the daily chart. Each candlestick in the daily chart takes 24 hours to become completed and then the next candlestick comes. So if you want to trade today which is - for example - Feb 3th, you need to check the Feb 2th candlestick in the daily chart and find the high, low and close price.
If you don’t know what high, low and close prices can be found in a candlestick, please read my candlestick article:
The Language of Japanese CandleSticks - The Only Real Time Indicators
So the Pivot Points that should be used for today trading are plotted using the high, low and close price of the previous day. You can plot the Pivot Points (levels) on smaller time frames like one hour or five minutes chart. Pivot Levels tell you that when and how the price will reverse and change the direction.
Like all other indicators and signals, Pivot Points is a not 100% guaranteed indicator and sometimes they don’t work but as I explained at the beginning of this article, it is good to have them on your charts even if your trading system is not based on the Pivot Points.
The first and most important Pivot level is the Pivot Point which is the average of the high, low and close price of the previous day:
Pivot Point = ( Yesterday High + Yesterday Close + Yesterday Low )/3
Then we have Resistance 1 and Support 1 or R1 and S1:
Resistance 1 = ( Pivot Point x 2 ) - Yesterday Low
Support 1 = ( Pivot Point x 2 ) - Yesterday High
Pivot Point, R1 and S1 are the most important Pivot Levels but we can also calculate the Resistance 2 and Support 2 or R2 and S2.
Resistance 2 = Pivot Point + ( Yesterday High - Yesterday Low )
Support 2 = Pivot Point - ( Yesterday High - Yesterday Low )
So we will have 5 horizontal lines on our chart:
Resistance 2
Resistance 1
Pivot Point
Support 1
Support 2
These are the levels that the price may show reactions to them during the day.
Now let me show you the 5min chart that the Pivot Levels are calculated and plotted on it. I have chosen the 29 January 2008 high, low and close price to plot the Pivot Levels for the next day (30 January 2008) on the EUR-USD five minutes charts.
Here is the 29 January 2008 high, low and close prices:
High = 1.4787
Low = 1.4737
Close = 1.4787
and here is the calculated Pivot Points according to the above formulas:
R2 = 1.4820
R1 = 1.4804
Pivot Point = 1.4770
S1 = 1.4754
S2 = 1.4720
and here is the plotted levels on the 5min chart:
As you see it is very easy to calculate and plot the Pivot levels.
Now lets see how the price reacted when it reached any of the Pivot levels. To do that I will show you the 30th January chart with a higher magnification and will change the candlestick chart to a line chart for more simplification.
Follow the blue ovals and numbers on the below chart and read my explanations.
1- This is the beginning of the day. The price starts moving under the Pivot Level (1.4770) and goes a little down.
2- Then the it goes up to retest the Pivot Level (1.4770) as a resistance. As you see here the Pivot Level works as a strong resistance and the price can not break up and so it goes down.
3- The price is stopped almost by the S1 level (1.4754).
4- Then goes up to retest the Pivot Level and this time succeeds to break up the Pivot Level.
5- Then it goes down to retest the broken Pivot Level as a support but fails and goes up.
6- It tests the R1 level and break it up.
7- It goes down to retest the broken R1 but fails and goes up.
8- It goes down to retest the R1 and goes up and goes down immediately and completes the triple top pattern, retests, breaks down the R1 and goes down.
9- It is stopped almost by the Pivot Point as a support. It goes up and down around that level and then …
10- Goes up to retest the R1, fails once, goes down and then goes up to retest, breaks up the R1 level and goes up.
11- It doesn’t show any reaction to the R2 level and goes much higher.
12- It goes down to retest the R2. This time R2 works as a support and the price shows a reaction to it. It fails to break down the R2 and bounces up and the day is finished.
Now you can plot the Pivot points for the next day (31 January) using the high, low and close price of the 30 January and this process can be repeated day after day.
see how the price went up and down between the Pivot Level and Resistance 1 on 31 January:
As you see, the Pivot Levels are important and sometimes the price shows strong reactions to them.
How to trade using the Pivot (Points) Levels?
The main Pivot Level is the most important level [( Yesterday High + Yesterday Close + Yesterday Low )/3] . In a trading day, if the price opens under this level, it means the price has a stronger tendency to go down and Bears are stronger. So we can take a short (sell) position. If the price opens above the Pivot Level, it means Bulls are stronger and we can take a long (buy) position. All other levels may work as support and resistance and so we have to be careful when the price reaches them.
As you see at the above chart (31 January 2008), the price is opened a little above the Pivot Point while it had already started going up. It goes up as high as the R1 level and then goes down. Those who use Pivot Levels to trade, would go long at the beginning of the day but for me it will be a little different.
For me, the Pivot Levels will be considered as the potential support/resistance levels and I will not take any position just because the price is opened below or above the main Pivot Level. I use my technical analysis, find patterns and pennants and will have an eye on the Pivot Levels to close my trades on time before I lose my profit. I consider this rule that if the price is opened above the main Pivot Level, it may go up and visa versa. Then I wait for a breakout and will take the proper position.
For example at the above example, I would consider that the price was opened above the Pivot Level and it had a stronger tendency to go up. Then I would wait for the price to break up the wedge and then I would go long. Then I would have an eye on it and as soon as it showed some reactions to the R1 level, I would fix my profit. So Pivot Points are just some help. They don’t generate buy/sell signals.
I hope you enjoyed this article and learned something from it. Please use the below comment submission form to let me know if you need anything to be explained more.
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