Understanding Pivot Points in Trading

One of the main tasks in trading is to identify points where the trend reverses direction. These points on the chart are called pivot points and indicate the lowest or highest price values over a certain period. Along with the support and resistance levels pivot points are important tools, on which successful trading is based. They allow you to get the maximum profit from the market, so every trader, who wants to succeed in Forex, should know how to define pivot points.

What are pivot points?

"Pivot" is a French word adopted in English and literally means "pivot". In stock market slang, a pivot refers to a pivot point where the price seems to push off and start moving in the opposite direction.  Not surprisingly, pivot points have always attracted a lot of attention, because everyone who enters the stock market strives to catch such price movements. Many techniques and indicators are used to identify pivot points, most of which are related to maximum and minimum prices at certain time intervals.

Initially, pivot points in trading were understood as places on the chart where the trend changed direction from bearish to bullish. But over time, pivot points began to be referred to as any places where the trend broke, as trading on the short side began to gain importance in exchange practice. In the modern sense, pivot points are price levels at which the current trend changes or at least stops. 

There are several varieties of pivot points, differing in their calculation methodology. Among them: 

• traditional;
• classical;
• pivot points Woodie;
• DeMark pivot points;
• Fibonacci pivot points;
• Camarilla pivot points, etc.

Classic and traditional pivot points are the most common in stock trading. Their other varieties are used according to the situation and are suitable when using certain trading strategies. For example, Pivot Camarilla pivot points are mostly used for day trading and are based on the idea that the market tends to return to a certain average value. The strategy involves identifying seven (sometimes eight or ten) support and resistance levels to serve as guides for entering or exiting a position.

How pivot points are calculated

Each of the varieties of pivot points has peculiarities of calculation. As in most cases, traditional or classic pivot points are used, let's talk about them. Traditional pivot points are calculated on the basis of the maximum (High), and minimum (Low) price for the previous day as well as the closing price (Close). These figures are simply added up and divided by three:

P = (High + Low + Close)/3

Three support (S) and resistance (R) zones are calculated using a Pivot point: 

Support levels/Resistance levels

• R1 = P + (P - Low)     
• S1 = P - (High - P)
• R2 = P + (R1 - S1)     
• S2 = P - (R1 - S1)
• R3 = High + 2 * (P - Low)      
• S3 = Low - 2 *(High - P)

Each zone is a beacon to which attention must be fixed. It is believed that the best situation is when the price is slightly below the pivot point at the start of trading, but then starts moving up towards R1. After a small correction, the price may go up to R2 and even to R3, which indicates the beginning of a steady upward trend.

Today there are several online resources that calculate the pivot point automatically and publish this data in the public domain.

How to use a pivot point indicator

To make it easier to understand what pivot points are, several indicators have been developed embedded in the trading terminal. Among them the most popular are:

• Pivot Points Indicator;
• Pivot Points from SwingTree;
• Pivot by Poul Trade Forum.

Each of the indicators can be used depending on the trading strategy used. The first of these indicators allows for calculating all types of pivot points. The second allows only pivot points, while the third uses a special algorithm that connects all types of pivot points together. Those who do not want to delve too deeply into the intricacies of all these indicators should recommend a Forex copying service, through which you can make money on the basis of trading with the most experienced and efficient traders.

Most people in forex prefer to use the Pivot Points indicator with traditional and or classic points. It is used for the purpose of determining the dominant trend at a given time or optimal entry points. When the current price is higher than P2 or P3, the trend is expected to be bullish. However, when the price falls below S2 and even more so, S3, it is considered to be in a bearish trend. 

Pivot points are also often used to determine when to enter or leave the market. But before you use pivot points, you should realize that no indicator, including this one, will guarantee a 100% result. Therefore, you should always remember risk management and the use of stop-losses.

You should use not only the level point indicator but also other tools for successful trading. Those who trade pairs with the euro should pay attention to the European PMI, the DAX 30 Index, and data published by the ECB. It is also useful to visit forex fundamental analysis services online, as there is always useful information about the market.

Pivot point strategies

Pivot points are used in various trading strategies. The essence of most of them lies in the assumption that the price will react in a certain way with the levels determined by the indicator. The classic pivot point strategy assumes that if the instrument is in an uptrend, you must wait for the price to correct to one of the R-points before opening a buy position. On such trades, the Take Profit should be set a little lower than the next R level. Stop-loss should be set at a level that allows the profit/loss ratio to be at least 1:3. Similarly pivot points are used when it is necessary to open short positions. If the price is in a downtrend, the order is opened when the price corrects to one of the S levels.

Another strategy assumes that pivot points will lead to a change in the current trend. For example, at the opening of the market, a situation may arise where the price starts to move downwards and reaches the S2 or S3 level. The last candlestick or bar will form a long tail but will close above the support level. This is a pretty strong signal that a trend reversal or at least a significant correction is about to occur. By opening a buy trade and taking a take profit at the S1 or S2 level, you can try to make a good profit. Because counter-trend trading carries a higher risk, stop-losses should be set as low as possible.

The third trading strategy using pivot points is working inside the channel. It works well when the instrument is flat and has touched support and resistance levels no more than 2-3 times. Traders should wait for the price to reach the S2 or S3 level, or better still, make a false break of one of them. On the next candlestick, you may try to open a buy position, and if the price starts moving in an upward direction, the profit may be substantial. Similarly, a sell position may also be initiated. The best time for that is when a false-break of R2 or R3 levels occurs.