The pivot point is daily calculated. It identifies areas of resistances and supports. Although its calculation is mathematical, the pivot point also plays a very important psychological role for many traders. Similarly as a resistance or a support, the pivot is a line, although it is better to talk about areas. But remain simple. This is the point at which a trend can change. If the pivot point is broken on the rise, it is a signal to buy. On the other hand, it can also be a signal to sell. It is important to note that the pivot point is mainly used in the short term to take advantage of small price changes.
As you can see, the pivot point is a psychological threshold. The first break down immediately triggered an acceleration of the downtrend towards the first support. By contrast, the break up triggered an acceleration of the uptrend even if it failed to reach the first resistance. While the rest of the time, the price has continued to up and down around the pivot.
How to calculate a pivot point?
The pivot point is as I said a calculated point, as well as resistances and supports. Its calculation is performed every day at the end of the trading session to be used at the next session. It depends on 3 factors:
- The highest point of the day
- The lowest of the day
- The closing price
The pivot point (PP) is calculated as follows: PP = (Highest Point +lowest point +closing price) / 3
It allows thereafter to calculate resistances and supports: S1 = (2 * PP)-highest point R1 = (2 * PP) – lowest point
S2 = PP-(highest point-lowest point) R2 = PP + (highest point-lowest point)
How to trade a pivot point?
We considers that you have to play the increase when the price moves above the pivot point with R1 as first goal, and play the decrease when the price moves below with S1 as first goal. Most often, traders put a stop loss just above or below the pivot point to hedge against a reversal. Indeed, the biggest price changes come out when the pivot point is break.
The pivot can play two roles; it may be a resistance or a support. If the price is above the pivot, pivot is then a support. In contrast, if the price is below the pivot, pivot is resistance. As a resistance or a support, most often the pivot is tested but not broken, more difficult it will be to cross it.
Now consider the last case. You entered at the break of the pivot point. Assuming that theprice is now moving above the resistance R1. Instead of let your stop below the pivot point, you up your stop loss just below R1. So you can enjoy the uptrend movement while eliminating your risk. You are then sure to win because you earn at least the difference between the pivot and R1 (level of your stop loss). Your objective is now R2.
The pivot point appears to be a simple and effective method of trading. But the reality is sometimes different. Indeed, the pivot is sometimes broken in one way or another then it’s broken in the other side without your first goal has been reached (S1 or R1). The pivot point is a method of trading, among others. If you have traded a little bit on the Forex or any other market, you have probably realized that there is no perfect method. All have advantages and disadvantages. It's up to you to choose which method you prefer.
