A vast majority of currency traders use pivot points to recognise sentiment in the market, specifically, whether the market is feeling bullish (the prices are increasing in value) or bearish (the prices are decreasing in value). It’s an essential technical tool that can be used to pinpoint potential support and resistance levels, as well as reveal the course of possible reversal points of the instruments that are being traded, writes Andreas Thalassinos, FXTM’s Head of Education.
In its simplest definition, a pivot point in forex is the combined average of the high, low and close prices from the previous trading session. Analysing pivot points is even easier than defining them, which is what makes them so appealing to FX beginners; the rule of thumb is that an instrument trading over the pivot point is regarded as bullish, while the instruments trading below the pivot point is considered to be bearish.
Reading Pivot Points
Essentially, a pivot point is a responsive price level (represented by a straight line that divides support and resistance on a price chart). Many traders use it as a standard tool for analysing market sentiment.
This is the formula for calculating pivot points:
Pivot Point (PP) = (Previous High + Previous Low + Previous Close) / 3
Once the PP is calculated, traders can then use this value to determine the three support and resistance levels, like so:
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)
In a way, each level becomes its own version of a pivot point – if the market moves beyond R1, currency traders get the sense that it’s a bullish market and potential profit opportunities become clearer. In this scenario, putting a stop loss order right below R1 protects traders from unpredictable price movements.
Also, once the price passes R1, and gets closer to R2, then R1 starts to act as a support level. At the same time, if the price were to fall under PP, S1 comes into play and the PP takes the role of resistance.
Prices that have gone under PP may use S1 as support and rebound back to PP. If the movement of an instrument is confined within this narrow space, between PP and S1, forex traders could very well interpret S1 as a potential opportunity to buy and the PP level as a potential opportunity to sell.
Pivot Point Formulas
Five types of methods are used by traders to calculate pivot points. These are:
The Standard method is the most widely used, and – along with Woodie’s and Fibonacci – utilises the low, high and close prices from the previous period to determine the PP. DeMark’s method is a little different; it uses the connection between open and close prices and selects one of three formulas for its calculation. Finally, Camarilla also includes the current period’s open price in its calculation.
Depending on which pivot point formula is used, a different weight will be allocated to each level in question – PP, S and R – to conclude the distance between them. Regardless of how experienced you are in the markets, pinpointing that one formula that will determine market sentiment, is easier said than done. This is why the FXTM Pivot Point tool I have designed, combines data from other indicators, as a way to – hopefully – provide a clearer picture of the market to the user.
By using the MACD, Moving Average and Momentum indicators in tandem with pivot point calculations, the trader is given more filtering freedom. It’s a wholly unique approach, never before seen in the industry, and can be used as a highly informative educational tool. Designed with a user-friendly aesthetic that’s easy to grasp by traders of all levels, FXTM Pivot Points Strategy allows for customised calculations and timeframes on any one of the 250+ financial instruments that the broker offers. The feature also includes real-time commentary that is tailored to the trader’s preferred instrument and calculation method.
As one of the most traditional trading tools for assessing market direction and sentiment, pivot points cannot be ignored, if you’re serious about building a robust forex trading strategy. The FXTM Pivot Point Strategy takes the ‘best of all worlds’ approach by combining pivot point methods with three popular indicators, and allows the traders to filter and customise the tool according to his or her specific trading needs. As such, it generates a bigger picture of the market’s sentiment and should be considered an essential educational resource.