Lesson 2: Pivot Points

In the past, not all floor traders had access to price charts on the trading floor. Pivot points started out as a easy way for floor traders to know where the market was heading because all it took was a calculator and price levels from the previous session. It enabled anyone to quickly determine levels where price might move quickly. An important reason why pivot points were popular besides its convenience was its predictive value.

Calculating pivot points

Pivot points are horizontal support and resistance levels. Traders usually look at seven levels:

1. Pivot point (P) – P = (High + Low + Close)/3
   1. High is the highest price of the previous session
   2. Low is the lowest price of the previous session
   3. Close is the closing price of the previous session
2. The next two most significant levels are support (S1) and resistane (R1)
   1. S1 = 2 x P – L
   2. R1 = 2 x P + L
3. Subsequent levels are S2, S3 and R2, R3.
   1. S2 = P – (H – L)
   2. S3 = P ? 2×(H ? L)
   3. R2 = P + (H ? L)
   4. R3 = P + 2×(H ? L)

Pivots have a fixed sequence

Traders should not be overly concerned about the calculation of pivot points. Rather, understanding the psychology behind their use is more important.

Psychology of pivot points

The three most important pivot points are P, S1 and R1.

P itself is a support or resistance depending on market condition. If the market is ranging, prices will often fluctuate greatly around this level (and between R1 and S1) until a price breakout develops. Trading above or below the pivot point indicates the overall market sentiment.

A break above R1 is read as a bullish trend and R2 serves as an exit point. A break below S1 is read as a bearish trend and S2 serves as exit. Price rarely extends beyond R2 and S2 and these are seen as very bullish sentiment in the market or very bearish.

Pivot points for forex trading

Pivot points are widely followed for forex trading because it is easy to understand. MT4 and most other software have scripts that automatically calculate and display pivot points. It is however not easy to master for beginners as many additional pivot levels exist. These include mid-point pivots, that is the mid level between each set of pivots. Based on the trading horizon or strategy of the trader, there are also daily pivots calculated from daily high, low and closing price as well as weekly-pivots (weekly high, low, close) and monthly-pivots (monthly high, low, close).

Simple rules for the new trader

1. Pivots are horizontal supports and resistance levels.
2. The psychology behind each level is more important than how it is calculated.
3. There are many pivot points and some are better than others.
4. Pivot points are leading indicators that are predictive because of the market sentiment they hint at.
5. Pivot points do not change throughout a trading session as they are calculated using values from the previous session; as such they are superior to most indicators.
6. Most rules of horizontal support and resistance levels apply here as well.
7. The trader must determine which set of pivots are relevant to his/her trading strategy. Otherwise there are too many pivots (39) to contend with.