Pivot point is a level in which the sentiment of traders and investors changes from bull to bear or vice versa. They work simply because many individual traders and investors use and trust them, as well as bank and institutional traders. It is known to every trader that the pivot point is an important measure of strength and weakness of any market.
Floor traders love pivot points. They act as magnet for price
movements. If you observe how price move during any trading
session, you’ll notice that price often stalls or stops at pivot points
before resuming its movement.
To calculate daily pivot points you need High, Low, and Close Price of
the previous day.
Here are the formula for calculating daily pivot points:
Central Pivot Point (P) = (High + Low + Close)/3
Resistance Level 1 (R1) = 2xP – Low
Resistance Level 2 (R2) = P + (R1 - S1)
Resistance Level 3 (R3) = High + 2x(P - Low)
Support Level 1 (S1) = 2xP - High
Support Level 2 (S2) = P - (R1 - S1)
Support Level 3 (S3) = Low – 2x(High - P)
To calculate weekly pivot points, apply the same formula, but using
High, Low, and Close Price of the previous week instead of the
previous day.
As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 7 points, 3 resistance levels, 3 support levels and the actual pivot point.
If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.
The three most important pivot points are R1, S1 and the actual pivot point.
The general idea behind trading pivot points are to 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 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 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.
Pivot points are one of the key tools traders use to determine where price is likely to go and where it is likely to stall. However, you should use the pivot points formulas above to create your own pivot point and then apply them with your own forex trading system.
