Pivot points

Professional forex traders and market makers use pivot points to identify potential support and resistance levels. Simply put, a pivot point and its support/resistance levels are areas at which the direction of price movement can possibly change.

The reason why pivot points are so enticing?

It’s because they are OBJECTIVE.

Unlike some of the other indicators that we’ve taught you about already, there’s no discretion involved.

In many ways, forex pivot points are very similar to Fibonacci levels. Because so many people are looking at those levels, they almost become self-fulfilling.

The major difference between the two is that with Fibonacci, there is still some subjectivity involved in picking Swing Highs and Swing Lows. With pivot points, forex traders typically use the same method for calculating them.

Many traders keep an eye on these levels and you should too.

Pivot points are especially useful to short-term traders who are looking to take advantage of small price movements. Just like normal support and resistance levels, forex traders can choose to trade the bounce or the break of these levels.

Range-bound traders use pivot points to identify reversal points. They see pivot points as areas where they can place their buy or sell orders.

Breakout forex traders use pivot points to recognize key levels that need to be broken for a move to be classified as a real deal breakout.

Here is an example of pivot points plotted on a 1-hour EUR/USD chart:

 

 

As you can see here, horizontal support and resistance levels are placed on your chart. And look – they’re marked out nicely for you! How convenient is that?!

Pivot Point Lingo

Here’s quick rundown on what those acronyms mean:

PP stands for Pivot Point.

S stands for Support.

R stands for Resistance.

But don’t get too caught up in thinking “S1 has to be support” or “R1 has to be resistance.” We’ll explain why later.

In the following lessons, you will learn how to calculate forex pivot points, the different types of pivot points and most importantly, how you can add pivot points to your forex trading toolbox!

 

How to Calculate Pivot Points

The first thing you’re going to learn is how to calculate pivot point levels.

The pivot point and associated support and resistance levels are calculated by using the last trading session’s open, high, low, and close. Since forex is a 24-hour market, most forex traders use the New York closing time of 4:00pm EST as the previous day’s close.

The calculation for a pivot point is shown below:

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

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

First level support and resistance:

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

First support (S1) = (2 x PP) – High

Second level of support and resistance:

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

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

Third level of support and resistance:

Third resistance (R3) = High + 2(PP – Low)

Third support (S3) = Low – 2(High – PP)

Keep in mind that some forex charting software plot intermediate levels or mid-point levels. These are basically mini levels between the main pivot point and support and resistance levels.

 If you hated algebra, have no fear because you don’t have to perform these calculations yourself. Most charting softwares will automatically do this for you. Just make sure you configure your settings so that it uses the correct closing time and price.

How to use Pivot Points for Range Trading

The simplest way to use pivot point levels in your forex trading is to use them just like your regular support and resistance levels. Just like good ole support and resistance, price will test the levels repeatedly.

The more times a currency pair touches a pivot level then reverses, the stronger the level is. Actually, “pivoting” simply means reaching a support or resistance level and then reversing.

If you see that a pivot level is holding, this could give you some good trading opportunities.

If price is nearing the upper resistance level, you could sell the pair and place a stop just above the resistance.

If price was nearing a support level, you would buy and put your stop just below the level.

See? Just like your regular support and resistance! Nothing hard about that!

Let’s take a look at an example so you can visualize this. Here’s a 15-minute chart of GBP/USD.

In the chart above, you see that price is testing the S1 support level. If you think it will hold, what you can do is buy at market and then put a stop loss order past the next support level.

If you’re conservative, you can set a wide stop just below S2. If price reaches past S2, chances are it won’t be coming back up, as both S1 and S2 could become resistance levels.

If you’re a little more aggressive and confident that support at S1 would hold, you can set your stop just below S1.

 As for your take profit points, you could target PP or R1, which could also provide some sort of resistance. Let’s see what happened if you bought at market.


And bam! Looks like S1 held as support! What’s more, if you had targeted PP as your take profit point, you would have hit your PT! Woohoo! Ice cream and pizza for you!

Of course, it ain’t always that simple. You shouldn’t rely only on the pivot point levels. You should note whether pivot point levels line up with former support and resistance levels.

You can also incorporate candlestick analysis and other types of indicators to help give you more confirmation.

For example, if you see that a doji has formed over S1, or that the stochastic is indicating oversold conditions, then the odds are higher that S1 will hold as support.

Also, most of the time, trading normally takes place between the first support and resistance levels. Occasionally, price will test the second levels and every once in a while, the third levels will be tested.

Lastly, you should also fully understand that sometimes, price will just break through all the levels like how Rafael Nadal breezes through the competition at the French Open.

What will you do when that happens? Continue to hold onto your trade and be a sucker and watch your account dwindle away? Or will you take advantage and get back some pips?

In the next lesson, we’ll teach you how to take advantage when these levels break down.

 

How to use Pivot Points to Trade Breakouts

Just like your normal support and resistance levels, pivot point levels won’t hold forever.

Using pivot points for range trading will work, but not all the time. In those times that these levels fail to hold, you should have some tools ready in your forex toolbox to take advantage of the situation!

As we showed you earlier, there are two main ways to trade breakouts: the aggressive way or the safe way.

Either method will work just fine. Just always remember that if you take the safe way, which means waiting for a retest of support or resistance, you may miss out on the initial move.

Using Pivot Points to Trade Potential Breakouts

Let’s take a look at a chart to see potential breakout trades using pivot points. Below is a 15-minute chart of EUR/USD.

Here we see EUR/USD made a strong rally throughout the day. We see that EUR/USD opened by gapping up above the pivot point. Price made a strong move up, before pausing slightly at R1.

Eventually, resistance broke and the pair jumped up by 50 pips!

If you had taken the aggressive method, you would have caught the initial move and been celebrating like you just won the World Cup.

On the other hand, if you had taken the safe way and waited for a retest, you would have been one sad little trader. The price did not retest after breaking R1. In fact, the same thing happened for both R1 and R2!

Notice how EUR/USD bulls tried to make a run for R3 as well.

However, if you had taken the aggressive method, you would have gotten caught up in a fake out as the price failed to sustain the initial break. If your stop was too tight, then you would have gotten stopped out.

Later on though, you’ll see that the price eventually broke through. Notice how there was also a retest of the broken resistance line.

Also, observe how when the pair reversed later in the day and broke down past R3. There was an opportunity to take a short on the retest of resistance-turned support – turned resistance (read that again if you have to!).

Remember that, when support levels break, they usually turn into resistance levels.

This concept of “role reversal” also applies for broken resistance levels which become support levels. These would have been good opportunities to take the “I think I’ll play it safe” method.

Where do you place stops and pick targets with breakouts?

One of the difficult things about taking breakout trades is picking a spot to place your stop. Unlike range trading where you are looking for breaks of pivot point support and resistance levels, you are looking for strong fast moves.

Once a level breaks, in theory, that level will likely become “support-turned-resistance” or “resistance-turned-support.” Again, this is called a role reversal…since the roles have been reversed.

If you were going long and price broke R1, you could place your stop just below R1.

Let’s go back to that EUR/USD chart to see where you could place your stops.

As for setting targets, you would typically aim for the next pivot point support or resistance level as your take profit point. It’s very rare that price will break past all the pivot point levels, unless a big economic event or surprise news comes out.

Let’s go back to that EUR/USD chart to see where you would put those stops and take profit.

In this example, once you saw price break R1, you would have set your stop just below R1. If you believed that price would continue to rise, you could keep your position and move your stop manually to see if move would continue. You’d have to watch carefully and adjust accordingly. You’ll learn more about this in later lessons.

As with any method or indicator, you have to be aware of the risks with taking breakout trades.

First of all, you have no idea whether or not the move will continue. You might enter thinking that price will continue to rise, but instead you catch a top or bottom, which means that you’ve been faked out!

Second, you won’t be sure if it’s a true breakout, or just wild moves caused by the release of important news. Spikes in volatility are a common occurrence during news events, so be sure to keep up with breaking news and be aware of what’s on the forex calendar for the day or week.

Lastly, just like in range trading, it would be best to pop on other key support and resistance levels. You might be thinking that R1 is breaking, but you failed to notice a strong resistance level just past R1. Price may break past R1, test the resistance and just fall back down.

You should make use of your forex knowledge of support and resistance, candlestick patterns, and momentum indicators to help you give stronger signals as to whether the break is for real or not.

How to Use Pivot Points to Measure Market Sentiment

There is one other way to incorporate pivot points into your forex trading strategy, and that’s to use it to gauge market sentiment.

What this means is that you can tell whether traders are more inclined to buy or sell the pair. All you would need to do is to keep an eye on the pivot point. You could treat it like the 50 yard line of a football field. Depending on which side the ball (in this case, price) is on, you can tell whether buyers or sellers have the upper hand.

If the price breaks through the pivot point to the top, it’s a sign that traders are bullish on the pair and you should start buying the pair like it’s a Krispy Kreme donut. Here’s an example of what happened when the price stayed above the pivot point.

In this example, we see that EUR/USD gapped up and opened above the pivot point. The price then rose higher and higher, breaking through all the resistance levels.

Now, if price breaks through the pivot point to the bottom, then you should start selling the pair like it’s Enron stock. The price being below the pivot point would signal bearish sentiment and that sellers could have the upper hand for the trading session.

Let’s take a look at a chart of GBP/USD.

 

In the chart above, we see that the price tested the pivot point, which held as a resistance level. Next thing you know, the pair keeps going lower and lower. If you had taken the clue that price remained below the pivot point and sold the pair, you would have made some nice moolah. GBP/USD dropped almost 300 pips!

Of course, it doesn’t always work out like this. There are times when you think that forex traders are bearish on a pair, only to see that the pair reverses and breaks through to the top!

 

In this example, if you saw price breaking lower from the pivot point and sold, you would have had a sad, sad day. Later on during the European session, EUR/USD popped higher, eventually breaking through the pivot point. What’s more, the pair stayed above the pivot point, showing how buyers were rockin’ away.

The lesson here?

Traders are fickle!

How forex traders feel about a currency can shift dramatically day to day, even session to session. This is why you cannot simply buy when price is above the pivot point or sell when it is below it.

Instead, if you choose to use pivot point analysis in this way, you should combine it with other indicators to help you determine overall market sentiment.