Traders and investors have utilized the advantage that pivot points bring to the table to determine the most critical support and resistance levels in the market. Pivots are essential to traders as they help to point out where good entry points are for range investors, trend traders as well as breakout areas for traders that use the breakout strategy in the market. The purpose of this article is to explain how pivot points are calculated, and how they can be applied to your trading strategies.
What is a Pivot Point?
The definition, a pivot point is the center point of a rotational system. When it comes to the foreign exchange market, these points are calculated by taking in the high, low and closing prices, over a certain period, of an asset. They are usually taken from the daily time frame chart, but they can also be used to calculate other time frames as well. The preferred time frame among investors is the daily, as this provides less erratic market noise and more clearly defined support and resistance levels. By taking the pivot points off of the larger time frame, with the help of the S/R lines, a trader will have a more precise measurement of where the future of an asset’s price movement will be – thus more accurate trade entries.
How is a Pivot Point Calculated?
The way that a pivot point is calculated in the foreign exchange market is as follows:
Central Pivot Point = (High Price + Low Price + Closing Price) / 3
With the central pivot point calculated, the next step is to find out where the key support and resistance lines are, which are taken from the following formula:
Support 1 (S1) = (2*P) – High
Resistance 1 (R1) = (2*P) – Low
The second S/R levels are calculated by taking the following into account:
Support 2 (S2) = P – (R1 – S1)
Resistance 2 (R2) = P + (R1 – S1)
Although these two S/R levels are calculated, it is also possible to form a third tier for more precision. But this isn’t commonly done as it becomes more redundant to the analysis of the market.
Application of the Pivot Points
The first pivot point that is formed is referred to as the first support/resistance level as it is where the market has a potential to turn in direction. The other levels are used to determine whether the market is ranging, trending, or is about to make a breakout towards another market behavior. Having a knowledge base on how pivot points work is a great way for investors of all types to stay focused on the market movements and determines the best entry to the market for them. Pivot point trading is very simple to learn and its versatility allows it to be used in many variations, fitting every style of trading that an investor has in their toolbox.