Understanding The Role Of Pivot Points In Forex Trading
While there are several technical indicators that are used in Forex trading, pivot points stand out as being among the most popular if only because of its simplicity and ease of use. Unlike pivot points, calculating most other indicators including Exponential Moving Average and Parabolic SAR can involve some fairly complex mathematics.
Calculating Pivot Points
A pivot point is essentially the mathematical average of three prices; the closing price of the current day, the low of the previous 24 hour period and the high of the previous 24 hour period.
The formula for calculating pivot points is Pivot Point = (H+L+C)/3 where L is the low for the preceding 24 hour period, H is the high and C is the closing price of the current day.
Because Forex trading is done round the clock, determining the value of C can be pretty tricky. In order to avoid any confusion, 4 p.m., which is the closing time of the New York Forex market is considered as standard. This number, which is typically denoted as P is used along with support points and resistance points to form the base of any Forex trading strategy.
The formula for calculating resistance and support points is as follows:
R1 = (P x 2) – L
S1 = (P x 2) – H
R2 = P + (R1 – S1)
S2 = P – (R1 – S1)
Although Forex traders differ in their methodology, the key to successful Forex trading is determining the optimum price for the support and resistance levels. Some traders prefer basing their trade on the pivot point itself whereas others would prefer opting for the previous day’s closing price.
In a bullish market where the price moves higher than the pivot point, the pivot point becomes the point of resistance whereas in the reverse trend where the price moves below the pivot point, the pivot point becomes the support point.
How Pivot Points Are Used In Forex Trading
Understanding pivot points is the key to successful Forex trading. Besides helping traders to evaluate trends, knowing the pivot points can be extremely useful in developing any entry and exit trading strategy.
Investors typically place orders to buy any currency pair when the price breaks through the pre-determined resistance point. In the event that the prices moves below the pre-determined support level pivot points help in determining a stop-loss price.
While it is not advisable to rely solely on a single indicator in Forex trading, pivot points have proven to be pretty reliable especially when used in combination with other technical indicators including MACD (Moving Average Convergence/Divergence).
The effectiveness of pivot points is attributed to two observed tendencies:
- When the day’s prices start higher than the pivot point, the prices typically tend to stay higher than the pivot point until such time that it hits the day’s first resistance point.
- If the day’s prices start below the pivot point, the tendency is to stay lower than that point until such time that it reaches a support point.
Often referred to as ‘trading between the lines’ the approach is quite popular with most Forex traders, while some still view it with some skepticism. While the degree of the influence of pivot points may be debatable, there is no doubt that pivot points do play an important role in Forex trading.