Pivot Point is among the most commonly used technical indicators in Forex trading. It is a simple to use indicator and it is recommended even for novice traders. It acts by showing the trader the pivot points. And the pivot points in this case are the levels at which the market trend is likely to change. It is just as the normal pivoting or swinging. The markets are most likely to pivot or swing at the points indicated by the pivot point indicator.
The pivot point is calculated by getting the average of three thing: the closing price, the high and the low of the previous day. Therefore the pivot point indicator normally use the previous day’s history to predict how the markets will swing.
Interpreting the pivot point indicator
The pivot point indicator uses the pivot point (the one described above as the average of the closing, high and low levels) to plot support (S) and resistance (R) levels. It normally plots a number of support and resistance levels. However, the most important support and resistance levels are the first ones (S1 and R1) those that are near the current market price).
Let’s look at how the first three resistance and support levels are obtained.
First Resistance (R1) = P + (P − L)
First support (S1) = P − (H − P)
Second Resistance (R2) = P + (H − L)
Second support (S2) = P − (H − L)
Third Resistance (R3) = H + 2× (P − L)
Third Support (S3) = L − 2× (H − P)
For all the three, P is the pivot point which is obtained by averaging the High (H), Low (L) and the closing price (C). So, P=(C+L+C)/3.
But in some cases, some programmers may opt to use the current open prices in calculating the pivot point. In such cases, P= (O+C+H+L)/4.
The resistance level obtained is usually the level at which the market prices tend to hit during a bullish trend and they move back down. It is usually the level at which the bullish trend normally retraces upon hitting.
The support level on the other hand is usually the level at which the market prices hit during a bearish trend and they seem to retrace back up.
It is therefore easy to know if you have downloaded a good pivot point indicator or not. You simply have to look at the R1 and S1 levels. If the market seems to retrace back upon hitting the plotted R1 S1 lines, then the Pivot Point indicator is okay.
When using the pivot point indicator, you should always ensure that you set the colors of the lines to be distinct from one another and also from the background color.
Using the pivot point indicator to place trades
- When to place a buy order
You should place a buy order when the prices are above the support level and mostly the S1. However, you should avoid placing a buy order when the market price has gone past the middle of the two levels (the support and the reissuance levels).
After placing the buy order, you should ensure that you place a take profit level at ¾ the range between the support (S1) and resistance (R1) levels, which is closer to the resistance level. Then, your stop loss level should be midway between the S1 and S2.
To maximize the profits, you can use the trailing stop with the first level set at ¾ between the S1 and R1 the other levels to increase according to quarterly the distance between the R1 and R2. By using the trailing stops, you can be able to take advantage of any breakouts. In this case a breakout is when the market prices goes past the R1 towards R2 instead of retracing back after hitting the R1.
- When to place a sell order
You should place a sell order when the markets are below the resistance and preferably the R1. This is because the markets have either retraced after hitting the R1 or they are on their way down retracing after hitting a higher resistance level like the R2.
You should then place your take profit at ¾ the distance between the R1 and S1 but on the side closer to the S1. The stop loss should be midway between the S1 and S2.
And in case you want to maximize your profits, you can use the trailing stop with the first level at the ¾ distance between the R1 and S1. Then the other levels can be quarterly the distance between the S1 and S2.
Combining the pivot point indicator with other indicators
The pivot point indicator is better used when in conjunction with other technical indicators and especially the trend indicators.
You can use the pivot points indicator in combination with
- Moving average
- Moving average convergence divergence (MACD)
- Ichimoku Cloud indicator