Forex pivot point calculations
A pivot point calculator is an arithmetic program used by
forex traders to anticipate price movements. Pivot points
are frequently used by foreign exchange traders as a means to calculate
resistance and support levels which are, in turn, used as visual cues
to execute trades. Unlike fundamental analysis which relies on such
economic indicators as the status of a nation’s unemployment rate, the rise or fall of interest rates, trade balances, and the state of retail sales, pivot point calculations provide traders with visual bench marks that can be used to predict price changes.
As a technical analysis tool, pivot points have proven themselves to be far more effective in currency trading than equities markets. This is largely due to the fact that price movements in the trillion dollar foreign exchange market are not generally subject to the kinds of manipulation that stem from unforeseen insider trading, corporate mismanagement, misrepresentation, or the actions of institutional investors.
Pivot point analysis
Basic forex pivot point trading is based on two prevailing
tendencies. If a day’s price action begins above the pivot point, prices will tend to stay above that point (fulcrum) until it reaches a resistance point. Conversely, if a day’s pricing action begins below the pivot point, the price will tend to stay below that point until it reaches a support point. A resistance level is a price that tends to prevent further upward movement. A support price is a price action point that tends to prevent further downward movement.
In its simplest form pivot point trading is based on these two tendencies and is also knows as “trading between the lines”. The most popular and hence the most successful form of pivot trading is based on reversals. Simply put, when price approaches a pivot above, a trader waits for a reversal at that point and sells. The opposite is true when price action is moving downward. The patient pivot trader waits for a bounce off the pivot of support and places an order to buy.
If the market opens or later trades at the extremes R2 or S2, pricing will exhibit a tendency to trade back toward the pivot point. Hence, traders tend to avoid buying high (at R2) or selling at the low (S2). The wisdom of this is even greater the further the price moves away from the day’s pivot point.
Pivot point calculation
There are a number of formulas traders use to calculate
resistance and support levels and they are based on a variety
of factors but those based on price are the most popular
if, for no other reason, they are the easiest to calculate.
Pivot trading begins with the calculation of the pivot
point which is an average of the previous day’s high, low and closing price. While the forex is a 24 hour market, “closing” is generally defined as 5 p.m. EST which coincides with the closing of the New York Stock Exchange. However, traders use various closing times, 12 a.m. EST also being a popular reference point for calculations.
In the following formula “H” represents the previous day’s high, “L” represents the previous day’s low, and “C” represents the previous day’s closing price.
Pivot Point = (H+L+C)/3
Resistance and support level calculations
Once the day’s pivot point has been calculated, traders turn to the calculation of the initial resistance (R1) and support (S1) levels which assumes that trading will continue pretty much in the same range as the previous day.
Resistance Level 1 = (2*PP)-L
Support Level 1 = (2*PP)-H
A second set of resistance and support points, R2 and S2, are used in the event that the price breaks through the previous day’s
trading range and continues until it meets a second higher
level of resistance or lower level of support.
Resistance Level 2 = (PP-S1) + R1
Support Level 2 = PP – (R1 – S1)
Some traders attend to the calculation of extreme price
fluctuations (R3, S3) but only a small minority of them
actually trade on them because such price movements are
a sure sign of volatility. Resistance Level 3 = (PP-S2)+R2
Support Level 3 = PP – (R2-S2)
Some calculators also generate midpoints – trading levels
that lie at the midpoint between R2 and R1, S2 and S1,
R1 and PP, and finally S1 and PP. As long as trading ranges
are not too narrow, these reference points hold the same
relative importance as their paired resistance and support
levels. M1= (S2+S1)/2
M3 = (R1+PP)/2
M4 = (R2+R1)/2