Trading Pivot Points in the Forex Market

By: Dave Hikade

Pivot points are typically used to predict the direction that the Forex market is taking over the course of the day.

By using a simple mathematical formula to find the point where the overall trend in price changes, traders can take advantage of the movement of price, either up or down. They can use it as a gauge to determine the direction they should take whether selling a currency that is declining, or buying a currency that is on the rise.

Originally, trading pivot points was limited to floor traders. Its simplicity and straightforwardness made it an attractive tool for floor traders as it allowed them to determine the direction in which the market was heading throughout the day. The formula is simple, with no advanced mathematical skills necessary.

The most common method for calculating pivot points is a simple five point system. This system is comprised of a mathematical formula that utilizes the high, low and close of the previous day, along with two resistance levels and two support levels. The formula is relatively simple:

R2 = P + (H - L) = P + (R1 - S1)
R1 = (P x 2) - L
P = (H + L + C)/3
S1 = (P x 2) - H
S2 = P - (H - L) = P - (R1 - S1)

In this equation, let:

R = resistance levels
S = support levels
P = pivot point
H = high
L = low
C = close
O = open

It should be noted that when calculating the high, low and close, the New York closing time, which is 4 pm (EST) is generally used in Forex and other 24 hour markets.

Keep in mind the order of operations when solving these equations: solve parentheses first, exponents second, multiplication third, division fourth, addition fifth and subtraction sixth.

A variation that is quite common among Forex traders is to include an additional formula to the five point system.

P = ((Today's O) + (H + L + C))/4

There are many websites that feature pivot point calculators. This is good news to Forex traders who are opposed to doing their own calculations. These calculators simply require some information inputted then perform all the calculations to find the pivot point.

Pivot points can actually serve two purposes. They can indicate an overall market trend. A bullish market will break the pivot point price in an upward movement. A bearish market does just the opposite.

But, they are only effective for the one day, making them short term trend indicators. For the following day they must be recalculated. Pivot points are also useful for entering and exiting the market.

Trading pivot points can be a very useful exercise for Forex traders. These few, simple calculations can be done quickly and can show levels that have a great probability for causing price movement.

However, the success of pivot points relies on the trader's ability to use them effectively with other technical indicators such as MACD. When used in conjunction with such indicators, there is an increased probability for success.

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