Pivot Point Analysis
FOREX traders try to predict the direction of movement of currency pair trades so that they can profit from the moves. One method of technical analysis that FOREX traders have found useful for that purpose is Pivot Point Analysis.
Pivot point calculations are used by financial traders to predict support and resistance levels. They are commonly used in the forex and commodity futures markets. The calculated support and resistance levels are overlaid on the price history charts so that traders can quickly execute trades based on the visual overlay.
Floor traders originally used this method because it was a way for them to predict where the market was heading during the course of the day with only a few simple calculations; so it has been used for many years.
Pivot Points are support and resistance levels that are calculated using the high, low, and close, from the previous trading session. Standard pivot points include the pivot point itself, three full support levels, and three full resistance levels, but two half way support levels, and two half way resistance levels are also often included. Daily pivot points are the most commonly used, but weekly and monthly pivot points are used sometimes also. Pivot points are displayed on price charts as horizontal lines, referred to as pivot levels.
Pivot Points are easily calculated from the following equations using the high, low, and close, from the previous trading session:
YHigh = high of the previous trading session
YLow = low of the previous trading session
YClose = close of the previous trading session
PP = (YHigh + YLow + YClose) / 3
S1 = (PP * 2) - YHigh
S2 = PP - (YHigh - YLow)
S3 = (2 * PP) - ((2 * YHigh) - YLow)
R1 = (PP * 2) - YLow
R2 = PP + (YHigh - YLow)
R3 = (2 * PP) + (YHigh - (2 * YLow))
S1, S2, S3 are three calculated support levels.
R1, R2, R3 are three calculated resistance levels.
For markets that trade around the clock, like the FOREX market, a specific time can be used for the close of the trading session (even though it doesn't close), such as the end of the US trading session.
Pivot points are used as support and resistance levels, and as areas where significant price movement should be expected (such as reversals, or breakouts).
Some traders who use this method look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should then be used for exits rather than entries.
A perfect set would be for the market to open above the pivot level and then stall slightly at R1 before going on to R2. Traders would enter on a breakout above R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of the position.
There are several trading systems that use pivot points, so there are several different uses of pivot points, but in general they are used as support and resistance levels.
Pivot Points are also used to guage sentiment. Many traders believe that if the market is trading above the pivot point PP (from the calculation above), then the bulls are in control and it is likely to stay that way for the session. Similarly, if the market is trading below the pivot point PP, then the bears are in control and it is likely to stay that way for the session.
The reason pivot points are so popular is that they are predictive; they are a leading indicator, not a lagging indicator. The information from the previous trading session is used to calculate potential turning points for the new trading session.
Because so many traders follow pivot points, it can become a self-fulfilling prophecy; the market will often react at these levels, providing trading opportunities.
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