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How to Use Pivot Points for Better Price Action Insights

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June 08, 2014 – Comments (0)

One of forex traders’ fundamental objectives is to get insights on how and when to enter the markets, and where to place stop loss or take profit orders. These reference points are often calculated by popular technical analysis methods such as Moving Averages (MA), Relative Strength Index (RSI), or Bollinger Bands. However, one method that provides estimates of support and resistance levels together with defining the risk involved are the pivot points. Like many other tools, pivot points were traditionally used for the stock markets. However, they are also a valuable method applied by forex traders as the estimated pivot points used for support and resistance levels are particularly effective in assets with high liquidity such as major currency pairs and popular commodities.

 

One of the great advantages of pivot points is their flexibility because both long-term and short-term period traders can use this tool for any time frame of their choice. That is, time periodicity of price data is not an issue when calculating them. For explanation purposes, the period used here will be one day. So, this is how to calculate the main Pivot Point of the current trading day:

 

Pivot Point=(previous day high+previous day low+previous day close)/3

 

The pivot point can subsequently be used to work out the three resistance levels and three support levels for the current trading day:

 

Resistance 1 (R1) = (2 * Pivot Point) - previous day low

Support 1 (S1) = (2 * Pivot Point) - previous day high

 

Resistance 2 (R2) = (Pivot Point - S1) + R1

Support 2 (S2) = Pivot Point - (R1 - S1)

 

Resistance 3 (R3) = (Pivot Point - S2) + R2

Support 3 (S3) = Pivot Point - (R2-S2)


Even though it doesn’t take a mathematics gold medallist to do the above calculations, you can remain calm because most of the forex trading platforms include the option to automatically apply pivot points on any currency pair and for any periodicity. What does matter though is to get an understanding of the accuracy of these support and resistance levels. Statistics have shown that over the last fifteen years on average for the EUR/USD daily prices, the high level was 58% of the times lower than R1, and the low level was 56% of the times higher than S1. Following this example, one may consider setting the take profit order just below R1 or just above S1 as it has more than 50% chance of trend reversal at those levels. However, having increased chances has nothing to do with certainty and nothing is for certain.

 

 

Forex traders with strategies involving different time frames can all use pivot points. Day traders may use them for their daily support and resistance level references, and even position traders who tend to hold on currency pairs for months or even years are able to calculate monthly pivot points by using previous month’s data. The main idea remains the same; these levels give approximations of support and resistance levels and hence possible trend reversal points. Even though these are good approximations, they are by no means certain. Forex traders who are in it for the long term could combine this method with other technical indicators and economic news for a more holistic view of what is happening in the markets and how prices might develop in the future.

 

By David Parker,

www.easy-forex.com 

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