Pivot points are one of the most widely used indicators in day trading. The tool provides a specialized plot of seven support and resistance levels intended to find intraday turning points in the market. This article explains what pivot point is and how to use it in forex trading.
Pivots Points are significant levels chartists can use to determine directional movement and potential support/resistance levels. Pivot Points use the prior period's high, low and close to estimate future support and resistance levels. In this regard, Pivot Points are predictive or leading indicators.
The pivot point is the basis for the indicator, but it also includes other support and resistance levels that are projected based on the pivot point calculation. All these levels help traders see where the price could experience support or resistance.
Pivot points can be calculated for various timeframes in some charting software programs that allow you to customize the indicator. For example, some programs may allow you to calculate pivot points for a weekly or monthly interval. But the standard indicator is plotted on the daily level.
The central price level – the pivot point – is calculated as a function of the market’s high, low, and close from the previous day (or period, more generally). These values are summed and divided by three. This is the same concept as the “typical price”.
The other six price levels – three support levels and three resistance levels – all use the value of the pivot point as part of their calculations.
The three support levels are conveniently termed support 1, support 2, and support 3. The three resistance levels are referred to as resistance 1, resistance 2, and resistance 3. You may also see them called by their shorthand forms – S1, S2, S3, and R1, R2, R3, respectively.
These values are calculated as follows:
Since the price levels are based on the high, low, and close of the previous day, the wider the range between these values the greater the distance between levels on the subsequent trading day. Likewise, the smaller the trading range, the lower the distance between levels will be the following day.
It should be noted that not all levels will necessarily appear on a chart at once. This simply means that the scale of the price chart is such that some levels are not included within the viewing window.
Continue reading or start playing around in a risk-free forex demo account for a better understanding of Pivot Points in real-time.
The Pivot Point sets the general tone for price action. This is the middle line of the group that is marked (P). A move above the Pivot Point is positive and shows strength. Keep in mind that this Pivot Point is based on the prior period's data. It is put forth in the current period as the first important level. A move above the Pivot Point suggests strength with a target to the first resistance. A break above first resistance shows even more strength with a target to the second resistance level.
The converse is true on the downside. A move below the Pivot Point suggests weakness with a target to the first support level. A break below the first support level shows even more weakness with a target to the second support level.
Support and resistance levels based on Pivot Points can be used just like traditional support and resistance levels. The key is to watch price action closely when these levels come into play. Should prices decline to support and then firm, traders can look for a successful test and bounce off support. It often helps to look for a bullish chart pattern or indicator signal to confirm an upturn from support. Similarly, should prices advance to resistance and stall, traders can look for a failure at resistance and decline. Again, chartists should look for a bearish chart pattern or indicator signal to confirm a downturn from resistance.
The second support and resistance levels can also be used to identify potentially overbought and oversold situations. A move above the second resistance level would show strength, but it would also indicate an overbought situation that could give way to a pullback. Similarly, a move below the second support would show weakness, but would also suggest a short-term oversold condition that could give way to a bounce.
Pivot Points offer chartists a methodology to determine price direction and then set support and resistance levels. Price direction is determined by looking at the current period's price action relative to the pivot point: starting above or below the pivot point or crossing it in either direction during trading. The set support and resistance points come into play after price direction has been determined. While originally designed for floor traders, the concepts behind Pivot Points can be applied across various timeframes.
As with all indicators, it is important to confirm Pivot Point signals with other aspects of technical analysis. A bearish candlestick reversal pattern could confirm a reversal at second resistance. Oversold RSI could confirm oversold conditions at second support. An upturn in MACD indicator could be used to confirm a successful support test.
Understanding how to use Pivot Points is important, but if you want some help, MetaTrader 5 AM Broker offers a useful Pivot Points toolkit and our trainers can provide you the right guidance. Play around in a forex demo account and notice how Pivot Points can make you serious money.
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