Pivot points can sometimes be a little controversial when it comes to their application in currency trading. Many traders believe them to be a “dinosaur”, and to have no place in the modern trading world. My own personal advice though is to put them on your charts and have a look at some history. Then make up your own mind as to whether you will find them useful, or not.
A brief history on the origin of pivot points
Years ago traders on the floor of the stock exchange, or “the pit” as they were often known, did not have the benefits of small portable computers like they have nowadays. They were not able to quickly chart the price movement of stocks in real-time. Necessity is often the mother of invention however, and what traders did notice was a correlation between the previous days trading limits and the current days trading limits.
Although the correlation was not present all of time, it was enough of a correlation to warrant close observation. The correlation was even higher during periods of range trading, where the market is range bound and without dominant trend direction.
Pivot Points are a Leading Indicator
The pivot points for a particular days trading can be calculated immediately after the previous days market closes. Why is this important?
Well, it means that pivot points can therefore be considered as a “leading indicator”. A leading indicator can be drawn on your chart ahead of time as its value will not change based on market movement. It is extremely handy to have possible levels of support and resistance drawn on your chart ahead of time.
As a leading indicator, you are able to draw in the pivot points on your chart AHEAD of the trading day, and those levels hold for the entire day. They do not change value during the trading day. This is one of very few leading indicators that are available.
How are the pivot points calculated?
There are a few variations on the method used to calculate pivot points. We will only consider here the most commonly accepted method.
At the end of a particular trading day you need just 3 pieces of information from that days price movements. You note the maximum price for the day, the minimum price for the day, and the closing price for the day.
Using these bits of information, and the following simple mathematical formulas, you calculate 7 figures. The first figure is the pivot point itself, then there are 3 levels of pivot support, and 3 levels of pivot resistance.
Pivot level = (maximum + minimum + close) / 3
Pivot Support 1 = (2 * Pivot level) – maximum
Pivot Support 2 = Pivot level – maximum + minimum
Pivot Support 3 = (2 * Pivot level) – (2 * maximum) + minimum
Pivot Resistance 1 = (2 * Pivot level) – minimum
Pivot Resistance 2 = Pivot level + maximum – minimum
Pivot Resistance 3 = (2 * Pivot level) + maximum – (2 * minimum)
Once you have calculated these 7 levels you can draw them in as horizontal lines on your currency chart.
One of the contentious issues with pivot points, as they relate to the forex market, is that the forex market (unlike the stock exchange) has no official closing time. So the question then becomes, what time do you use as the time to end the previous days trading.
Personally, I use GMT as the close/start time for any day. I think there is merit in this as it also is very close to the start of the trading day for the “European session”. The session which accounts for the highest volumes of currency trading out of the 3 accepted global sessions. I have also found that, by using this as my closing time, my pivot point calculations are very accurate for the following 24 hours of trading activity.
If you use MetaTrader for your currency charting software then you do not have to physically calculate these levels every day. A search on Google will quickly point you to a MetaTrader pivot point indicator that you can freely download and install. It will do the calculations, and display the latest pivot levels for you automatically.