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Thursday, January 10, 2008

Pivot Points

Pivot Points
The pivot point trading strategy has been used extensively by professional traders and market makers for many years. Originally used by floor traders prior to the advent of computers, this was a simple way for floor traders to determine where the market was heading during the course of the day. By using a few simple calculations that could be done prior to the markets open, traders were in a position to determine market directions for the day.

A pivot point is the level at which the market direction changes for the day. By using simple arithmetic and the previous days high, low and close, a series of points are derived. These points are often critical support and resistance levels. Collectively we call these pivot levels. Every day the market has an open, high, low and a close for the day.

From these calculations we derive the following levels which we plot on our chart at the start of the day. Pivot Point (central point for previous days trading range) S1 (support 1) S2, S3 and R1 (resistance one) R2, and R3.

We use 5pm EST as the open and close. This daily candle is all the data you require to calculate the pivot levels. Pivot points are predictive as opposed to other lagging indicators making them very popular with day traders. The Pivot levels supply us with entry points, profit targets and stop loss points.

Because of the popularity of pivot points many orders are placed at these levels causing the market to react at these levels thus creating trading opportunities.

The theory is that if the market opens above the pivot point then the bias for the day is long, provided price remains above the pivot point. If price opens the new day below the pivot point then the bias for the day is to stay short, provided the market remains below the pivot point. The most important pivot levels are R1, S1 and the actual pivot point.

In general we wait for a reversal or break of R1 or S1. Once price reaches R2, R3 or S2, S3 the market could be considered overbought or oversold therefore these levels should be used as profit taking areas rather than entry points.

Click to enlarge

On the above GBP/USD chart the first vertical red line is the at close at 5pm est. The second vertical line is London opening. The Blue line is the Pivot Point. As we can see price opened below the Pivot Point. The obvious trade to look for was short unless the Pivot Point was Breached.

Price tested the pivot point then dropped back below the S1 where we entered short with the first target at S2 closing half our position. At this point we could also move our stop loss to just above S2 on the remaining lots. Price tested the S2 level but failed to break through then resumed its downward journey to the S3 level to hit our target.

Many traders use weekly and monthly Pivot Points as these are considered major support and resistance areas. Pivot points can be calculated for the individual trading sessions. ie Asain, European and US trading sessions.

Pivot points can be used as a range trading Strategy as well as a breakout Strategy.
Pivot Point Calculations
Resistance 3 = High + 2*(Pivot - Low)Resistance 2 = Pivot + (R1 - S1)Resistance 1 = 2 * Pivot - LowPivot Point = ( High + Close + Low )/3Support 1 = 2 * Pivot - HighSupport 2 = Pivot - (R1 - S1)Support 3 = Low - 2*(High - Pivot)

For more trading Ideas on Pivot Points Click Here

Down load an Automatic Pivot Point Calculator for Meta Trader

1 comment:

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