Trading with pivot points

Pivot points are a versatile technical tool that can be used in a range of trading styles and, when combined with other technical tools, can be used effectively across a range of markets.

A pivot point is the average of the previous period’s high, low and close. As you can define the previous period, pivot points can be used by intra-day traders, day traders, swing traders and as a part of longer-term strategies.

The pivot point can then be used to calculate potential support and resistance for the current period.

Resistance 1 = (2 x pivot point) – previous low

Support 1 = (2 x pivot point) – previous high

Resistance 2 = (pivot point – support 1) + resistance 1

Support 2 = pivot point – (resistance 1 – support 1)

Resistance 2 = (pivot point – support 2) + resistance 2

Support 2 = pivot point – (resistance 2 – support 2)

If we use the daily prices of the EUR/USD forex pair as an example, on August 3 the high was 1.43723, the low was 1.41438 and the close was 1.43432. This would make the pivot point 1.42864 ([1.43723 + 1.41438 + 1.43432]/3).

Consequently, support and resistance levels for August 4 would be:

Resistance 1 = (2 x 1.42864) – 1.41438 = 1.4429

Support 1 = (2 x 1.42864) – 1.43723 = 1.42005

Resistance 2 = (1.42864 – 1.42005) + 1.4429 = 1.45149

Support 2 = 1.42864 – (1.4429 – 1.42005) = 1.40579

Resistance 3 = (1.42864 – 1.40579) + 1.45149 = 1.47434

Support 3 = 1.42864 – (1.45149 – 1.40579) = 1.38294

In actual fact, the August 4 trading range was between 1.43685 and 1.40595, so we can see that these levels don’t hold 100% of the time.

However, between the inception of the euro in 1999 and October 2006, it was found that:

The actual low was lower than Support 1 44% of the time

The actual high was higher than Resistance 1 42% of the time

The actual low/high was lower/higher than Support/Resistance 2 17% of the time

The actual low/high was lower/higher than Support/Resistance 3 3% of the time

Consequently, these levels still provide a decent gauge for trading ranges, with the probability of the currency pair trading within support and resistance levels increasing with each level (so there was a higher probability that trading would occur between Support and Resistance 3 than between Support and Resistance 1).

This allows a trader to place a stop below Support 1 and know that probability is on his side, as the currency pair will only fall below that level 44% of the time. The trader could also place a limit order to automatically close his trade just below Resistance 1, as the high of the day surpasses this level only 42% of the time.

That being said, these are just probabilities, and can vary, especially in times of extreme volatility.

Conclusion

Pivot points can be useful for determining potential support and resistance levels across a range of trading styles – intra-day traders could use 15-minute or 1-hour periods to calculate pivot points, while day-traders could use daily periods, swing traders could use weekly periods and position traders could use monthly periods. As only the time frame changes, the system remains the same for every style.

It is also a good strategy across a range of markets, though the size and liquidity of the forex market makes it particularly useful, as this guards the forex market against market manipulation and results in it holding better to technical principles.