Forex trading leans heavily on technical analysis. It's a fundamental discipline, a small light in the dark imposed by the (apparent) unpredictability of the market. It's a set of techniques that allows you to understand where the market is going and predict, with a bit of luck, price trends. Technical analysis uses tools, which can be more or less complex: indicators developed based on refined statistical models, moving averages at multiple speeds, and... Pivot Points. These represent the middle ground between complexity and ease of use, in a context where effectiveness plays a priority role. Here's a brief guide on forex pivot points that answers the following questions: what are they really? How are they calculated? How are they used?
What are Pivot Points
Pivot Points are price levels "around" which something special happens; specifically, where the market reacts more intensely. When prices reach Pivot Points, the market comes alive, revealing its true intentions, which in this case means "revealing the trend".
In reality, Pivot Points are nothing more than support and resistance levels, terms with which even less experienced traders have some familiarity. Compared to the supports and resistances most traders draw by eye, however, Pivot Points are the result of a calculation on the previous session's high, low and close, so everyone who uses the same formula sees the same levels. Hand-drawn supports and resistances are usually just past highs and lows, often weekly ones.
An obvious question follows. Is it better to use supports and resistances taken from past highs and lows, or Pivot Points? Operationally, little changes, in the sense that the same techniques are used for both. The difference is objectivity: pivot levels are the same on every screen, while hand-drawn levels depend on who is drawing them. On the other hand, supports and resistances taken from past highs and lows are easier to identify, and therefore immediately usable. Sometimes a glance is enough.
It depends, therefore, on the depth the trader wants to give to their work, and on the approach they take to technical analysis. A trader whose method is built on indicators rather than on levels can live with the simpler version, because levels are not the main course of that approach.
How to Calculate Pivot Points
Another difference between Pivot Points and supports and resistances taken from past highs and lows is the quantity. The standard set has seven levels: the central pivot, three supports and three resistances. It's worth presenting them and explaining how they are calculated. One reassurance: no trader has to calculate them by hand, every platform draws them. It's still good to know where they come from, to understand what they can and cannot do.
Before transcribing the formulas, it's necessary to insert a small legend.
H = High Price.
L = Low Price.
C = Closing Price.
AP = Average Price, which in turn is calculated by dividing the sum of the high, low, and close by three.
Here are the formulas.
First Support S1 = (2 x AP) - H
First Resistance R1 = (2 x AP) - L
Second Support S2 = AP - (R1 - S1)
Second Resistance R2 = (AP - S1) + R1
Third Support S3 = S2 - (High - Low)
Third Resistance R3 = R2 + (High - Low).
The formulas for the third level vary from platform to platform; this is one common version. The first and second levels are the same almost everywhere.
How to Use Pivot Points
Pivot Points have various uses. Moreover, they vary based on the trading style, which can be fast, intraday, swing, and so on. However, two uses are good for all seasons and all approaches.
The first is of a "cognitive" type, if it can be called that. In this case, Pivot Points are used to discover what phase the market is in.
For example, if the price is oscillating between the first support and the first resistance, around the central pivot, the market is congested and is probably moving sideways: on a quiet session that band is where most of the trading happens.
Moreover, if the price breaks the second resistance or the second support, then it means that the market is trending. The first case represents an upward trend, and the second case a downward trend.
The second use is of an operational type, as it allows the trader to understand when it is better to sell and when it is better to buy. Generally, long positions are opened when the first resistance is broken to the upside, with the second resistance as the target, or when price holds the first support and turns up, with the central pivot (AP) as the target.
Short positions mirror that: a break below the first support, with the second support as the objective, or a rejection at the first resistance, with the central pivot (again AP) as the objective.
Pivot Points are also used to identify the most suitable levels to act as Stop Loss and Take Profit. Generally, a good Stop Loss is placed a little beyond a support if the position is long, and a little beyond a resistance if the position is short. The opposite is true for take profit.
Pivot Points Based on Trading Styles
The discussion above covered Stop Loss and Take Profit, but without clarifying the nature of the supports and resistances. First, second, third? In truth, it depends on the approach, the trading style. That is, the time horizon within which one operates. This is not surprising, considering that the first support and the first resistance are close, the second support and the second resistance are far, and the third support and the third resistance are very far.
In a nutshell, if the trader engages in intraday trading, or even scalping, they can only use the first support and the first resistance. Unless "external" events occur that can upset the market (but in this case, the discussion moves into the territory of fundamental analysis), it's really difficult to reach the second Pivot Points, starting from a price X. In reality, then, scalping deserves a separate discussion, since its dynamics are sui generis, but still: even in this case, Pivot Points can be used.
If the approach is more long-term, in swing trading, then it's good to use the second support and the second resistance. If the position is kept open for a few weeks, or even a few months, it's possible that the price will exceed the first support - first resistance range, so the second-level pivots are the useful reference.
The high-probability zones published on this site work on the same principle from the other direction: they start from the support and resistance levels of the daily analysis and score each one by how many independent things line up there, a Fibonacci level of the 30-day range, a fresh candlestick pattern, a round number, past touches. Pivot points are a cheap way to add one more reference line to that picture, and a pivot that falls inside a scored zone is worth more than one that stands alone.
