Pivot Points as a Leading Indicator for Forex Currency Charts
Pivot points have an interesting history, and can often be accurate at locating unnoticed, or hidden, levels of support and resistance on forex currency charts.
Years ago, traders on the floor (or in the "pits" as they are known) in the stock exchanges, did not have the luxury of personal computers to continuously track the market movements. They did notice however, that there was often a calculable relationship between the current days trading range and the previous days market movement.
A set of simple equations was derived that could easily be calculated and kept on a notepad.
Leading and Lagging Indicators
Most indicators that you will see on your currency charting software are known as LAGGING indicators. They are all mathematically derived from continuous historical data. You cannot extrapolate a lagging indicator forward in time.
A LEADING indicator on the other hand can be drawn on your charts AHEAD OF TIME. There are very few of these. A prime example of a leading indicator are Fibonacci levels, which you will learn about in detail in another tutorial.
Pivot points are another good example of a leading indicator.
The calculations for pivot points are very simple, and results in a set of 7 different price levels. The middle level is P and is known as the pivot level. This is the level that the market is expected to pivot around today. R1, R2 and R3 are 3 different resistance levels above the pivot point that have a strong chance of influencing the market. A further 3 levels, known as S1, S2 and S3 are support levels below the pivot point level that may also influence the market movement.
Pivot points are an attempt to define/determine the current days trading range before the days trading actually takes place.
Calculating the Pivot Point Levels
There are several different sets of equations used to do the actual calculations, but the following set of equations that we describe here are the most commonly used for the forex market.
In order to calculate the pivot points for today you need the following information from yesterday - the maximum price of yesterdays market movement (H), the minimum price from yesterday (L), the closing price of yesterdays session (C).
Unlike a stock exchange, the forex market never really "closes". So, for the sake of calculating the pivot levels we use 00:00 GMT as the threshold from one day to the next.
For the sake of our calculations we will use these symbols -
H = yesterdays HIGH
L = yesterdays LOW
C = yesterdays CLOSE
P = the pivot level
R3 = resistance level 3
R2 = resistance level 2
R1 = resistance level 1
S3 = support level 3
S2 = support level 2
S1 = support level 1
These levels are calculated as follows -
- R3 = 2P + (H - 2L)
- R2 = P + (H - L)
- R1 = 2P - L
- P = (H + L + C) / 3
- S1 = 2P - H
- S2 = P - (H - L)
- S3 = 2P - (2H - L)
You may be lucky enough that your charting package includes pivot points as one of its indicators. If you use MetaTrader 4, as I do, then pivot points are available. If you do not already see it in your indicator list then you can click here to download it from our server, and install it on your own charts.
How to Interpret the Pivot Levels
The pivot levels that you will have drawn on your chart are price levels that are worth keeping an eye on.
Once you start drawing them on your charts you are also going to notice the frequency with which these levels coincide with other levels of support and resistance, thus further strengthening the validity of those levels. Something else you will quickly notice is the high correlation between the levels on consecutive days. It happens quite often where yesterdays S1 level will be todays Pivot level for example, further illustrating the often cyclical nature of the market.
Personally, I do not trigger trades simply when a pivot level is violated, or if a bounce in price happens off of a specific pivot level. I have no doubt that there may well be profitable strategies that can do this successfully.
However, I will be very careful of entering a trade just before an indicated pivot level.
They can be quite handy with stop placements. I also incorporate them into my own exit strategy, using them as an indication of where I should be taking some profits on my trades.
Have a look at the chart below - it is the EUR/USD 15 minute chart from last Thursday (15 March 2007).
The orange dashed line is the pivot level, the blue dashed line above is the R1 level, and the blue dashed line below is the S1 support level. Remember, these lines were already drawn on the chart BEFORE the days trading took place.
Notice how the pivot line acted as support for the first 30 bars or so, before the price broke below. Shortly after the price broke the pivot it then retraced and the previously supportive pivot level then became resistance. Price then moved towards the S1 level, bounced, and moved back towards the pivot, which it finally broke through again, and ended the day by rallying through the R1 level. The ugly price action just after midday resulted from a mixed bag of fundamental announcements.
This chart is also a good example of what I mentioned earlier, about how the levels often relate to each other from day to day. Notice how todays S1 level is almost identical to yesterdays pivot level. You can also see how close todays pivot is too yesterdays R1, and todays R1 is to yesterdays R2.
Do you think these pivot levels on your charts would have helped you with your trading on this day ?
Lets have a look at another example. Here is the very next day, the 16th March 2007.
The price action for the day opens about halfway between the pivot level and R1. It continues to rally to R1 where it finds resistance, bounces, and then rallies back to R1. Price breaks through R1 where it rallies to R2, and then spends the balance of the day bouncing between R1 and R2, before closing out the week on R1.
What about this day, would having the pivot points on your chart have helped you trade ?
I think so :-)
In Conclusion
Pivot points can be an excellent LEADING indicator.
They are drawn on the chart at the beginning of the current trading day, and provide 7 levels "of interest" that we can watch during the course of the trading day.
The best charts to draw them on are 30 minute time frame or less. Pivot points are only valid for a particular day, so its quite pointless to put them on the longer time frame charts, and in fact the indicator script may produce errors or erroneous results on longer time frames.
Note : If the market is trending strongly then pivot points may not work very well at all. They are much more valuable in range bound markets, where they can often show the exact ranges for the day.
Thank you for reading.
I hope you found this tutorial useful, and that your own trading is more profitable with your use of pivot points.
