Pivot Points

Pivot points identify important support and resistance levels (levels at which the direction of price movement can possibly change).

Pivot points are displayed as horizontal lines on a graph. These horizontal lines are based on formula that calculate the previous days high, low, and closing price.

These lines, like any technical indicator, simply provide a suspect price level at which the market 'may' establish its next support or resistance level.

Here is an example of pivot points plotted on a 5-minute EUR/USD chart:

PP = main Pivot Point

R1 = first level of resistance

R2 = second level of resistance

R2 = third level of resistance

S1 = first level of support

S2 = second level of support

S3 = third level of support

Calculating Pivot Points With the click of a mouse, your charting software will automatically calculate pivot points and plot them as lines on your chart. But it's useful to understand the computation.

The main pivot point (PP) and associated support and resistance levels (S1, S2, R1, R2) are calculated using the last trading day's open, high, low, and close. Since forex is a 24-hour market, most traders use the New York closing time of 4:00pm EST as the previous day's close.

The calculation for the main pivot point is shown below:

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

Support and resistance levels are then calculated off the pivot point like this:

First level support and resistance:

First support (S1) = (2 x PP) - High

First resistance (R1) = (2 x PP) - Low

Second level of support and resistance:

Second support (S2) = PP - (High - Low)

Second resistance (R2) = PP + (High - Low)

 

Other Pivot Points Some charting software provides additional pivot points such R3, R4, S3, S4.
Weekly and monthly pivot points are also available.

We find it very useful to trade with daily, weekly, and monthly pivot points on our chart. The market tends to respect them.

Trading with Pivot Points

 

Breakout Trades

Breakout traders use pivot points to recognize key levels that, when broken, may result in an escalation of price beyond the key level.

The breakout trader initially focuses on the main pivot point (PP), because it is the main support/resistance level.

When price reaches the main pivot point the trader is better able to determine whether to buy or sell, and where to set his profit targets and stops. Generally, if prices are above the main pivot, the market is considered bullish; if prices are below, the market is considered bearish.

Let’s say the price is hovering around the main pivot point and eventually closes below it. The breakout trader may decide to sell. He would set his stop loss above PP. He would likely set his initial profit target at S1 (the first level of support).

But if prices continue to fall below S1, instead of taking profit at S1, he may move his existing stop loss order just above S1. Typically, S2 (the second level of support) will be the expected lowest point of the trading day and should be his ultimate profit objective.

 

The converse applies during an uptrend. If price closed above PP, the breakout trader may enter a long position (buy). He would set his stop loss below PP. He would likely use the R1 (first level of resistance) and R2 (second level of resistance) as his profit objectives.

Range-bound Trades

Range-bound traders use pivot points to identify reversal points.

The strength of support and resistance at the different pivot levels is determined by the number of times the price bounces off the pivot level. The more times a currency pair touches a pivot level then reverses, the stronger the level is.

When the pair nears an upper resistance level, range-bound traders tend to sell the pair, placing a tight protective stop just above resistance.

If the pair keeps moving higher and breaks out above resistance, this is considered an upside ‘breakout’. The trader who had earlier sold would get stopped out of his trade. But if he believes that the breakout has good follow-through buying strength, he may reenter with a long position. He would then place a protective stop just below the former resistance level that was just penetrated and is now acting as support.

If the pair is nearing a lower support level, the range-bound trader would buy the pair and place a stop below support.

 

How Reliable are Pivot Points?

Pivot points don’t work all the time. Price tends to hesitate around pivot lines and at times it’s difficult to predict its next move.

Sometimes the price will stop just before a pivot line and then reverse. Other times, it may seem that a pivot line is a strong support level and the range-bound trader goes long (buys) only to see the price fall, stop him out, then reverse back in his direction.


For those reasons, many professional traders frown upon the strategy of buying at support, and selling at resistance. In a strong trend, price will break through a pivot line and keep going.

This chart shows just how difficult or easy pivot points might be.

 

Look at the first and second green ovals. S1 was for the most part respected. If you bought at those points you would have made some pips.

Now look at the series of purple ovals. Support (S1, PP, S2, and S3) was broken each time. If you bought at any of those points you would have lost big time.

See the last purple oval. Given S3 was broken earlier it ought now to serve as resistance. But price pushes up past it. If you sold at that point hoping price would rebound, you would have lost.

Bottom line: Pivot Points don’t work all the time.