14. How to use Pivot Points in Forex Trading
It is assumed that by now you understand that in forex trading, traders need support and resistance references to determine an opportunity to take position in the market and to place stop losses. Pivot Points can be used to generate Support and Resistance during technical analysis. They have proved to be very useful technical tool in the FX market.
Most traders who use pivot points are short term traders or intraday traders who wish to make profit out of small price movements. Pivot points can be calculated for any time period. They are calculated using the open, high, low and close prices for the previous period.
A pivot point is calculated as:
Pivot Point (PP) for the current period = (High + Close + Low)/3, high, low and close being the prices from the previous period.
Then we calculate the first level Support (S1) and Resistance (R1)
R1 = (PP X 2) – Low
S1 = (PP X 2) – High
PP, R1 and S1 are the key levels. We can calculate the next levels of Support (S2) and Resistance (R2) as shown below:
R2 = PP + (High – Low)
S2 = PP – (High – Low)
R3 = (PP – S2) + R2
S3 = PP – (R2 – S2)
Now, in the chart we will have five horizontal lines to represent five pivot points namely,
Pivot Point (PP)
Don’t worry, you don’t have to do these calculations. Most charting software you use will come with these inbuilt functionalities.
This is just a sample chart to show you how these pivot levels are plotted.
Though Pivot Points are mainly used for a day’s session, they can also be used for hourly trading period. Pivots derived from longer time frames are obviously more reliable than those derived from shorter time frames.
Now, let’s see how we can use Pivot Points in our trading. Always keep in mind that the main Pivot point calculated as (high + low + close)/3 is the most important level. Price is expected to advance above or below this main level towards Resistance or Support. During a new trading period, if the price opens below the pivot point level (calculated using previous period prices) , it is good to take a short position or sell because, price being below the pivot indicates that it may go lower. On the other hand, if price opens above the Pivot level, it means we can take a long position or buy because there are chances that price may go high. Pivot levels indicate support and resistance levels. They are not exact signals but are helpful in providing you with the trend.
So an example of a strategy would be something like this:
- If the price goes above the pivot point (PP), prices are likely to go up. So good to go long.
- If the price goes below the pivot point (PP), prices are going down and hence look to take a short position.
- When the market opens, if the price is near R1/R2 or S1/S2, there is a tendency that price may come back to the Pivot point.
- If a breakout happens at S1 or R1, these points might reverse their roles. That is support S1 might become resistance R1.
This is just a sample of how strategy might be planned using Pivot Points.
Ok, so this is about the standard pivot point method. But there are other methods of calculating pivot points. Next we are going to have a quick look at these other types of Pivot methods:
- Woodie Pivot Point
In Woodie method, the calculations are done as mentioned below.
PP = (High + Low + (2 X Close)) / 4
R1 = (2 X PP) – Low
R2 = PP + High – Low
S1 = (2 X PP) – High
S2 = PP – High + Low
If you look carefully at the formulae you will see that closing price from the previous day is being used in the calculation of the main pivot point level. This is one reason that some traders prefer Woodie method of calculation for their pivot points.
Also, support and resistance points are calculated by the difference between previous day’s high and low which is also known as the range.
- Camarilla Pivot Point
The Camarilla method uses formula similar to Woodie. Let’s see.
PP = (High + Low + Close) / 3
R1 = Close + ((High – Low) x 1.0833)
R2 = Close + ((High – Low) x 1.1666)
R3 = Close + ((High – Low) x 1.2500)
R4 = Close + ((High – Low) x 1.500)
S1 = Close – ((High – Low) x 1.0833)
S2 = Close – ((High – Low) x 1.1666)
S3 = Close – ((High – Low) x 1.2500)
S4 = Close – ((High – Low) x 1.500)
If you see these formulae also use previous day’s closing price and the range (high - low) to calculate Support and Resistance levels. Also in this method you should calculate 4 Support and 4 Resistance levels and in each level you use a multiplier.
- Fibonacci Pivot Point
You might have guessed it by now. Yes, this method uses Fibonacci ratios in its calculations.
PP = (High + Low + Close) / 3
R1 = PP + ((High – Low) x .382)
R2 = PP + ((High – Low) x .618)
R3 = PP + ((High – Low) x 1.000)
S1 = PP – ((High – Low) x .382)
S2 = PP – ((High – Low) x .618)
S3 = PP – ((High – Low) x 1.000)
So, here Pivot point is calculated as it is with the standard method and then previous day’s range (high-low) is multiplied with the corresponding Fibonacci ratios to arrive at the support and resistance levels.
Most if the charting software come with the inbuilt pivot calculation using the standard method. But if you want you can you can use these variations.
As with other indicators, the behaviour of Pivot Points is not guaranteed. But it is really helpful to have them in your charts. Something is better than nothing!!