Some traders use nothing but Pivot Points to trade. Most probably you are among the ones who’ve never used the Pivot Points because this method is the banks’ traders favorite strategy. The never talk about their trading strategy anywhere. If you do some research about Pivot Points, you will find it really useful to have them on the charts, even if you follow a different trading system.
Most traders who use Pivot Points are intraday traders. I mean Pivot Points can be used mainly for intraday trading.
What Are Pivot Points?
Pivot Points or Pivot Levels are nothing but some support and resistance levels that you can calculate and plot on your charts very easily. Some trading platforms support Pivot Points and have an indicator to plot them on the charts. But if you use a platform (e.g. MT4) that doesn’t support it, you can easily calculate and plot them on the charts manually.
Pivot Levels are calculated using three types of information from the previous trading day:
- High price
- Low price
- Close price
Even in Forex market which is a 24 hours market we have high, low and close prices for each day. The easiest way to find the high, low and close prices of the previous day is checking the previous day candlestick on the daily chart. Each candlestick on the daily chart takes 24 hours to mature and close. Then the next candlestick opens. So whenever you want to trade, you have to check the previous day’s daily candlestick to find the high, low and close prices of the previous day.
If you don’t know how high, low and close prices can be found in a candlestick, you can read the candlestick article: The Language of Japanese Candlesticks
So Pivot Points that should be used for today’s trading are plotted using the high, low and close price of the previous day. You can plot the Pivot Points (levels) on smaller time frames like one hour or five minutes chart.
Pivot Levels tell you that when and how the price will reverse and change the direction. Like all other indicators and signals, Pivot Points is not a 100% guaranteed indicator, and sometimes it doesn’t work. But as I explained at the beginning of this article, it is good to have them on your charts even if your trading system is not based on the Pivot Points.
The first and most important Pivot level is the average of the high, low and close price of the previous day:
Pivot Point = ( Yesterday High + Yesterday Close + Yesterday Low )/3
Then, we have Resistance 1 and Support 1 or R1 and S1:
Resistance 1 = ( Pivot Point x 2 ) – Yesterday Low
Support 1 = ( Pivot Point x 2 ) – Yesterday High
Pivot Point, R1 and S1 are the most important Pivot Levels, but we can also calculate the Resistance 2 and Support 2 or R2 and S2.
Resistance 2 = Pivot Point + ( Yesterday High – Yesterday Low )
Support 2 = Pivot Point – ( Yesterday High – Yesterday Low )
So we will have 5 horizontal lines on our chart:
- Resistance 2
- Resistance 1
- Pivot Point
- Support 1
- Support 2
The price may react to these levels during the day.
Now let me show you the 5min chart that the Pivot Levels are calculated and plotted on it.
Here is the high, low and close prices:
High = 1.4787
Low = 1.4737
Close = 1.4787
and here is the calculated Pivot Points according to the above formulas:
R2 = 1.4820
R1 = 1.4804
Pivot Point = 1.4770
S1 = 1.4754
S2 = 1.4720
and here is the plotted levels on the 5min chart:
As you see, it is very easy to calculate and plot the Pivot levels. Now let’s see how the price reacted when it reached any of the Pivot levels above.
To do that, I am showing you the chart with a higher magnification and will shift from candlestick to line chart to have a clearer look.
Follow the blue ellipses and numbers on the below chart and read my explanations:
1- This is the beginning of the day.
The price starts moving under the Pivot Level (1.4770) and goes a little down.
2- Then, it goes up to retest the Pivot Level (1.4770) as a resistance.
As you see here the Pivot Level works as a strong resistance that price cannot break above, and so it goes down.
3- Price is stopped from going down, almost by the S1 level (1.4754).
4- Then, it goes up to retest the Pivot Level and this time it succeeds to break above the Pivot Level.
5- It goes down to retest the broken Pivot Level as a support, but fails and goes up.
6- It tests the R1 level and breaks above it.
7- It goes down to retest the broken R1, but fails and goes up.
8- It goes down to retest the R1 and goes up and down immediately and completes the triple top pattern, retests, breaks down the R1 and goes down.
9- It is stopped almost by the Pivot Point as a support.
It goes up and down around that level and then …
10- It goes up to retest the R1, fails once, goes down and then goes up to retest.
Then, it breaks above the R1 level and goes up.
11- It doesn’t show any reaction to the R2 level and goes much higher.
12- It goes down to retest the R2.
This time R2 works as a support and price reacts to it.
It fails to break down the R2 and bounces up and the day is finished.
Now you can plot the Pivot points for the next day using the high, low and close price of the previous and this process can be repeated day after day.
This is how the price went up and down between the Pivot Level and Resistance 1:
As you see, Pivot Levels are important and markets react to them strongly.
How to Trade Using the Pivot Points
The main Pivot Point is the most important [( Yesterday High + Yesterday Close + Yesterday Low )/3].
In a trading day, if price opens under this level, it means it has a stronger tendency to go down and Bears are stronger.
So we can take a short (sell) position.
If the price opens above this Pivot Point, it means Bulls are stronger and we can take a long (buy) position.
All other levels may work as support and resistance and so we have to be careful when price reaches them.
As you see on the above chart, price is opened a little above the Pivot Point while it had already started going up.
It goes up as high as the R1 level and then goes down.
Those who use Pivot Levels to trade would go long at the beginning of the day but for me it will be a little different.
For me, Pivot Points will be considered as the potential support/resistance levels.
I will not take any position just because the price is opened below or above the main Pivot Point.
I use my technical analysis, find patterns and pennants.
Then, I will have an eye on the Pivot Levels to close my trades on time before I lose my profit.
I consider this rule that if price is opened above the main Pivot Point, it may go up and visa versa.
Then, I wait for a breakout and will take the proper position.
In the above example, I would consider that price was opened above the Pivot Point and it had a stronger tendency to go up.
Then, I would wait for the price to break above the wedge, and then I would go long.
Then, I would have an eye on it and as soon as it showed some reactions to the R1 level, I would collect my profit.
So Pivot Points are just some help. They don’t generate buy/sell signals.