October 16, 2017
Pivot points are significant price levels used by traders to determine potential support and resistance levels. As pivot points use the previous period’s high, low and close price to predict future price movement, they are considered as leading indicators. They are especially popular in the forex market, as pivot points require a very liquid market to provide reliable signals. There are many different methods of calculating pivot points, but we will stick to the most popular method – the five-point system.
How are Pivot Points Calculated?
The five-point system of calculating pivot points consists of five significant price levels which act as support or resistance levels. These are the pivot point, the support 1, the support 2, the resistance 1 and the resistance 2. As the names suggest, the pivot point is the most significant price level which acts both as support and resistance depending on the current price-level, while the support 1 and resistance 1 have higher importance as potential support and resistance levels and support 2 and resistance 2.
The following table summarizes how these points are calculated. Keep in mind that all price levels in the formulas are related to the previous period’s data.
Pivot Point (P) = (High + Low + Close)/3
Support 1 (S1) = (P x 2) – High
Support 2 (S2) = P – (High – Low)
Resistance 1 (R1) = (P x 2) – Low
Resistance 2 (R2) = P + (High – Low)
The pivot point is simply the arithmetic average of the sum of previous high, low and close price. The S1 line is the pivot point level multiplied by 2, minus the previous period’s high. The S2 line is the pivot point minus the previous high and previous low, etc.
It’s important to note that different time frames use different data to calculate the pivot point levels.
Pivot Points for 1-, 5-, 10- and 15-minute charts use the prior day’s high, low and close, the 30- 60- and 4-hour charts use the prior week’s high, low and close. Pivot Points for daily charts use the prior month’s data, and finally weekly and monthly time frames use the prior year’s data to calculate the pivot points. The following chart shows how pivot points look on the EUR/USD 4-hour chart, based on the previous week’s high, low and close prices. Keep in mind that once a week starts and pivot points are plotted on the chart, they remain the same for the entire week at the 30-, 60-, and 4-hour charts.
Using Pivot Points for Range Trading
Using pivot points for range trading is very straight-forward, as you can use all the pivot levels as regular support and resistance levels. If, for example, the price tests the S1 level and reverts back, it’s a good opportunity to open a long position just above S1, and to place stop loss just below the S1 level. On the other hand, if the price reaches the R1 level, you could trade the bounce off the level with a stop loss order just above the R1 level. The following chart shows the use of pivot points during a ranging market.
At point (1), the price tried to break the S1 level but failed, with the following candlestick closing above the support level. This gives an opportunity to go long, with a stop loss just below the S1 level. At point (2), the price tested the R1 level but reverted, signaling an opportunity for going short.
Using Pivot Points to Trade Breakouts
Trading Pivot Point breakouts is similar to trading regular support and resistance breakouts. Pivot levels won’t hold forever, and when they break they provide trading opportunities. The following chart shows how to trade pivot breakouts, combined with trading price reversals from the pivot lines. Trading pivot breakouts can be done in two ways: the aggressive way, where you enter a trade as soon as the pivot line breaks, and the safe way, where you wait for the price to test the broken pivot line again.
At point (1), the price breaks above the pivot point on the EUR/USD pair. Using the aggressive approach, you could open a long position right away at this point. At point (2), the price breaks the R1 level, but tests the same level again. This would give a good opportunity to enter the market the safe way. Point (3) shows the price testing the R1 level the next day, but failing to break it – this is where you would enter a short position. Point (4) shows a breakout of the pivot point, which would make a good trade based on the aggressive approach. And finally, the price tests the S1 level at point (5) signaling the opportunity for going long. Stop loss levels are always placed just above or below the previous pivot levels, depending on if they act as support or as resistance levels.
Using Pivot Points to Measure Market Sentiment
Pivot points can also be used to measure the current market sentiment. To do this, you simply need to determine if the price trades above or below the main pivot point (P). If the price trades or breaks above the pivot point, this signals that buyers are in charge and that the overall market sentiment is bullish. On the other hand, a break below the pivot point means that seller are starting to dominate, and the market sentiment shifts to bearish. The following chart shows an example of trading the break below the pivot point (P), with a stop loss places just above the pivot point.
Pivot points are a great addition to regular support and resistance lines, as they work great in the liquid forex market. We introduced the five-point method of calculating standard pivot points: the main pivot point (P), support 1 and resistance 1, and support 2 and resistance 2. Pivot points can be used both in ranging markets, where traders place trades when the price tests a pivot level and reverses, as well as trending markets, where breakouts above or below the pivot points give solid trading opportunities. Keep in mind that different timeframes are based on different pivot points calculations, and that all pivot points are calculated using the previous period’s data.
Test Your Knowledge: What are Pivot Points
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What are Pivot Points
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Which of the following is the correct formula to use when calculating Pivot Points:Correct
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Pivot Points for 1-, 5-, 10- and 15-minute charts use the prior day’s high, low and close.Correct