What are pivot points?
One of the most widely used and trusted indicators out there is the pivot points system. Pivots points are technical analysis indicators used to predict the overall trending direction of the market within a given time frame.
They have been widely used in stocks and commodities markets for decades, and have become most frequently used in forex markets in recent years, for a number of good reasons. If you are new to forex trading and are on the hunt for some reliable indicators that can assist you in your trading strategy, read on to find out why pivot points might be what you are looking for.
First off, let’s break down what pivot points actually are and how they can be used in forex trading strategies. As mentioned, pivot points are technical analysis indicators that both traders and market makers use to predict general market direction trends over a given time frame.
They are widely used by both institutional investors and retail traders alike in a wide variety of markets, but they are especially popular within forex markets. The principle behind pivot points is simple and straightforward: a pivot point is calculated by taking the low, high, and closing prices from the previous day and finding the average. There are a couple of other elements to the equation that we explore in more detail further down the page.
Basically, the key trading prices from the previous trading day are used to predict the trading prices for the current day for a particular currency pair market. Pivot points are mostly used to predict support and resistance levels in the current or the next trading day, with those support and resistance levels subsequently being used to calculate the optimum entry and exit points on specific currency pairs.
This is why pivot points are used in forex to determine stop-losses and profit-taking actions. Pivot points can be used from the previous day to indicate trends in the current day, the previous week to predict the week ahead, and so on. Typically, to trade above the pivot point of the previous day would indicate a bullish market sentiment, while trading below that pivot point would be indicative of bearish sentiment.
History of pivot points
Pivot points have a long historical pedigree and are generally considered to be a mainstream, reliable indicator among institutional investors and day traders alike. Pivot points have been widely applied to investment strategies since at least the 1980s when traders on Wall Street began to apply them to futures and equity exchanges.
It was New York-based traders that first discovered that the high, low, and close prices from the previous day could be used as a fairly reliable indicator of the price direction for the subsequent trading day. This simple calculation helped traders to easily visualise the most important price levels throughout specific time periods.
This could, in turn, provide predictive qualities for a variety of highly liquid markets, which led to pivot points becoming one of the leading indicators used among traders. In a nutshell, the pivot point began to be used to calculate the tipping points between bullish and bearish market trends.
When prices in a specific asset class trend above the day’s pivot point, the market is bullish. When prices fall below the pivot point, the market is generally thought to be bearish. In recent years, as forex markets have exploded and become more accessible to retail traders than ever, pivot points have become one of the most popular indicators in this market. Today, pivot points are used more in forex markets than anywhere else, for reasons we shall turn to below.
How do pivot points work?
Let’s talk about how you can calculate pivot points so that you can use them in your own trading strategy on a day-to-day basis. The most popular way to calculate pivot points is with the so-called “five-point system”. This system takes the high, low, and closing prices from the previous day, as well as two resistance levels and two support levels, to calculate a single pivot point.
The support level refers to the price level that an asset (such as a forex pair) does not fall below for a specific period of time. Meanwhile, the resistance level refers to the point at which the price of an asset starts to meet pressure on its way up due to the emergence of a growing number of sellers who wish to sell at that price.
Here is how you can use these indicators to calculate a pivot point:
- The initial pivot point = the high, low, and close price of the previous day divided by three.
- Support 1 (S1) = This pivot point x 2, minus the previous high.
- Support 2 (S2) = Pivot point minus (previous high – previous low).
- Resistance 2 (R1) = Pivot Point x 2 minus the previous low.
- Resistance 2 (R2) = Pivot Point plus (previous high – previous low).
It is clear why many traders tend to rely on pivot points to put together a general strategy for trading popular forex pairs. Although they are not 100% predictive of price trends, they use very reliable data to make logical predictions about where a forex pair is headed in the short term, which is what makes pivot points especially popular among day traders. That being said, using pivot points is not by any means a risk-free strategy. Let’s walk through the main pros and cons of using pivot points when trading forex pairs.
The advantages of pivot points
One of the main advantages of pivot points is that they are simply one of the most accurate leading indicators that we have for the highly volatile forex market. They are able to at least predict support and resistance levels with a huge degree of accuracy.
In addition, pivot points are doubly useful for forex markets simply because currency markets are generally immune from market manipulation and are highly liquid. In addition, most market participants, including traders and liquidity providers, will be using pivot points in all of their trading activities, albeit in conjunction with a number of other technical indicators.
Finally, it is important to note that pivot point calculation is very easy and does not require any additional software for a retail trader to accurately complete.
The risks of pivot points
Pivot points are not fool-proof indicators and using them actually comes with substantial risks, especially if you do not use other indicators when forming your forex trading strategy. First, it should be noted that, if highs and lows in a forex pair are particularly narrow, pivot points are likely to give off false signals due to these small ranges.
In addition, pivot points will also give off false trading signals during non-trading days (i.e. weekends), as the data being used is not reliable market data. This narrowness also means that it can sometimes be very difficult to place a stop-loss using pivot points, which puts you at risk of substantial losses.
Why do traders use pivot points as a strategy?
As mentioned, pivot points remain one of the most reliable market indicators that we can possibly ask for in the forex market. Pivot points can also reliably indicate when a large number of market participants are entering a forex pair at the same time.
Detecting these market inflows is very important, as these tend to lead to the kinds of breakouts where most traders make their money. Calculating pivot points is a very easy and quick way for traders to set the price points at which to open and close a position. Finally, traders prefer pivot points because they can be used to calculate price points on a daily, weekly, monthly, or even yearly trading period.
How to start using pivot points
To start using pivot points, you need to use a forex broker that offers real market data and charts that contain all of the indicators needed to calculate pivot points. Ideally, you should be using candlestick charts, as these contain all of the fundamentals that are required for a pivot point calculation. Once you have the data, you can simply conduct your calculations and use these to decide when to open and close your forex positions.
Choose a reliable broker for forex trading
Using pivot points in forex trading requires a broker that can provide you with the data and indicators that you need to succeed. For this, we have got you covered. Make sure to consult our in-depth forex broker reviews to find the licensed UK platforms that can help you make informed trading decisions.