Saturday, February 21, 2009
Pivot Point Trading
To trade forex using a pivot point is basically a value around which it is expected that trends will reverse or breakout and therefore it is a point of a lot of importance around the quantitative day trading that many people do. The idea is to use the numbers for the previous day to calculate the different values that will be of importance in the area and therefore use those calculated numbers to make the trades for that specific day. Professional traders and market makers use pivot points to identify important support and resistance levels.
The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels.
The calculation for a pivot point is shown below:
* O = open price from previous day
* C = closing price from previous day
* H = high value from previous day
* L = low value from previous day
Calculate the pivot point (PP) first…
*PP = (H + C + L) / 3
Then calculate the first support and resistance levels (S1 and R1)…
* S1 = (2*PP) – H
* R1 = (2*PP) – L
Then calculate the second support and resistance levels (S2 and R2)…
*S2 = PP – (R1 – S1)
*R2 = PP + (R1 – S1)
Then calculate the third support and resistance levels (S3 and R3)…
*S3 = L – 2(H – PP)
*R3 = H + 2(PP – L)
The three most important pivot points are R1, S1 and the actual pivot point. Don’t worry you don’t have to perform these calculations yourself. Your charting software will automatically do it for you and plot it on the chart.
There are number of ways that you can apply the pivot point and the support and resistance levels in relation to the pivot point. The only set rule for you to keep in mind is this; if the opening price for the day is below the pivot point, then your preference should be towards sell/short trades whereas if the opening price for the day is above the pivot point, you should be looking primarily for buy/long trades.