This blog post intends to explain why and how Pivot Points can be of tremendous value for you, the Forex trader, when tackling the markets. Ultimately any indicator added on the chart should help you make clear decisions and earn lots of money – otherwise it will just create noise. Pivot Points provide that value for your trading.
STEP 1: WHAT ARE PIVOT POINTS?
Pivot Points, also described as “PP”, is an indicator which is used in technical analysis for intra-day and intra-week trading. The PP is calculated by taking the average of the high, low and close of the previous trading day. The formula is therefore simple:
(Daily candle close + low + high of the previous trading day) divided by 3 = Pivot Point.
Pivot Point indicators also have other support and resistance levels that are calculated based on the PP. These levels are called “R” for resistance when above the PP and “S” for support when below the PP.
The PP indicator refers to 3 resistance and 3 support levels above and below the main or mid PP, which are named: R1, R2, R3 and S1, S2 and S3. The R1 and S1 are closest to the PP, whereas the R3 and S3 are furthest away from the PP.
STEP 2: WHY USE PIVOT POINTS?
Forex traders use Pivot Points to know where the main support and resistance levels are located. Traders can use the information regarding support and resistance for various purposes such as:
- Scanning for break or bounce spots. PP’s indicate where the critical levels are located on the chart which then can be used to identify trading opportunities. Pivot points offer key decision moments on the charts because the institutional market participants, such as banks, use them as well.
- Assessing if there is confluence of PP’s. Price zones tend to be stronger when more confluence is visible. This in turn could increase the probability of price bouncing at a level. It also increases the importance of a breakout if price fails to bounce and does push through.
A Pivot Point indicator provides Forex traders with automated horizontal levels on the charts for each new trading day. Each of these horizontal levels is one of the PP levels and equals a support or resistance level (depending on whether price is above or below it).
STEP 3: HOW TO USE PIVOT POINTS?
In the WET trading room we add Pivot Points to our Strike Trader template. It helps us automate part of the support and resistance analysis that is crucial for understanding the market structure both quickly and thoroughly at the same time.
Pivot Points are also useful for some specific goals as well. Here are the mains ones:
- Placing take profit levels. Having a target above support and below resistance helps traders enhance the accuracy of their exits and ultimately increases their win probability. Traders do not necessarily have to target the nearest PP but it could be wise not aim too far away either. It provides a good idea whether price will have substantial difficulties reaching the target or whether price is within a striking distance and has a decent probability of reaching it.
- Placing stop loss level(s). Having a stop loss below support and above resistance helps traders improve their negative exits and increases their win probability. Placing the stop loss above or below one of the Pivot Points helps traders quickly assess the risk in terms of the stop loss size. Another option could be to place the stop loss above 2 or more Pivot Point levels. This does increase the stop loss size so sufficient reward must be expected as well to justify using multiple PP levels.
- Filtering out unwanted setups. When price is near a PP level then a Forex trader might exert caution with taking a trade. Therefore a long setup near resistance and a short setup near support could be skipped. Basically, the idea is that traders avoid setups with lower probability. That way they can focus on trading the best setups with the highest odds of success. By doing so, traders preserve their mental capital and stay focused on the process. They are able to implement more consistency and discipline as well.
STEP 4: PRACTICE, TAKE ACTION AND IMPLEMENT
The only way an indicator or method can ever become effective is if a trader adds it in their trading plan, then follows their trading plan, and finally tests and evaluates their performance.
In other words, we need to practice, implement AND above all take action.
This does not mean that we need to do all of the work alone. That is why a trading room, like ours at Winners Edge, has so much value. Traders can see how Casey and Nathan use, among other things, Pivot Points in real live market conditions.
Here above you see an example of the GBPUSD. Price broke out (point 1 in image) within a downtrend (2). Price dropped down to the confluence of PP levels and then stopped there for a while to consolidate. During the consolidation a few triggers appeared (3) but traders could avoid these when using the PP’s. The next breakout (4) however did much better once it broke below the support. The subsequent hook back (5) got rejected at the same PP level and another breakout (6) occurred which went straight to target (7).
This example shows neatly how traders can use the Pivot Points for taking trades, filtering out setups and expecting bounce and break spots.
Conclusion: Pivot Points help traders with both analyzing and trading the Forex charts. PP levels are of great assistance for building a trading road map.
What do you think of Pivot Points yourself?
Are these levels which you use for your trading as well and if so, what do you find most interesting or useful when trading?
Thank you for reading and sharing this post and wish you Happy Hunting!
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