What are pivot points?
Pivots originated in the very early days of the grain trading pits, way before computers or electronic devices existed.
The pit traders used the previous session’s trading range prices to draw up a series of levels which they used as reference points for the current day’s trading.
This crude attempt to predict the current session’s price action around certain price levels proved surprisingly successful, and was soon picked up by other traders. Thereafter, the idea of using pivot points gained popular acceptance.
This in turn made the actual pivot levels even more powerful, as many more traders were now watching “key” levels, ready to place orders when price approached them.
This same system of plotting a daily central price level and other price levels stepping off from that, forms the basis of forex pivot trading. Forex pivots are a set of price levels plotted for the current day based on the previous day’s high, low and closing price.
How to identify them ?
The calculation to get the central pivot is to add the previous high, low and close together and divide by three:
Central Pivot = (HIGH+LOW+CLOSE) / 3
The offsets from this central pivot are considered to be either resistance levels – R1, R2 etc – or support levels – S1, S2 etc. How far you want to take these extra levels away from the central pivot is a matter of choice, personally I go no further than R2 for resistance and S2 for support.
The calculations for these support and resistance levels are mathematically simple, attained by the following method:
R2 = (Central Pivot-S1)+R1 R1 = (Central Pivot+(Central Pivot-LOW)) Central Pivot = (HIGH+LOW+CLOSE) / 3 S1 = (Central Pivot-(HIGH-Central Pivot)) S2 = (Central Pivot-(R1-S1))
The result is a chart that looks like this:
There are levels in between these support and resistance levels which can also be plotted, known as Mid-Point Pivots. The calculations to include the mid-point pivots expands our formula to the following:
R2 = (Central Pivot-S1)+R1 M4= (R1+R2)/2 R1 = (Central Pivot+(Central Pivot-LOW)) M3 = (Central Pivot+R1)/2 Central Pivot = (HIGH+LOW+CLOSE)/3 M2 = (Central Pivot+S1)/2 S1 = (Central Pivot-(HIGH-Central Pivot)) M1 = (S1+S2)/2 S2 = (Central Pivot-(R1-S1))
There are variations to the manner in which the calculations are achieved. Some people factor in the daily open as well. But the methodology described above is the most common, with the exception of the M levels which are rarely used (but powerful just the same!)