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Pivot Points in Forex: Mapping your Time Frame
It is useful to have a map and be able to see where the price is
relative to previous market action. This way we can see how is
the sentiment of traders and investors at any given moment, it
also gives us a general idea of where the market is heading
during the day. This information can help us decide which way to
trade.
Pivot points, a technique developed by floor traders, help us
see where the price is relative to previous market action.
As a definition, a pivot point is a turning point or condition.
The same applies to the Forex market, the pivot point is a level
in which the sentiment of the market changes from "bull" to
"bear" or vice versa. If the market breaks this level up, then
the sentiment is said to be a bull market and it is likely to
continue its way up, on the other hand, if the market breaks
this level down, then the sentiment is bear, and it is expected
to continue its way down. Also at this level, the market is
expected to have some kind of support/resistance, and if price
can't break the pivot point, a possible bounce from it is
plausible.
Pivot points work best on highly liquid markets, like the spot
currency market, but they can also be used in other markets as
well.
Pivot Points
In a few words, pivot point is a level in which the sentiment of
traders and investors changes from bull to bear or vice versa.
Why PP work? They work simply because many individual traders
and investors use and trust them, as well as bank and
institutional traders. It is known to every trader that the
pivot point is an important measure of strength and weakness of
any market.
Calculating pivot points There are several ways to arrive to the
Pivot point. The method we found to have the most accurate
results is calculated by taking the average of the high, low and
close of a previous period (or session).
Pivot point (PP) = (High + Low + Close) / 3
Take for instance the following EUR/USD information from the
previous session:
Open: 1.2386 High: 1.2474 Low: 1.2376 Close: 1.2458
The PP would be, PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us? It simply tells us that if the
market is trading above 1.2439, Bulls are winning the battle
pushing the prices higher. And if the market is trading below
this 1.2439 the bears are winning the battle pulling prices
lower. On both cases this condition is likely to sustain until
the next session.
Since the Forex market is a 24hr market (no close or open from
day to day) there is a eternal battle on deciding at white time
we should take the open, close, high and low from each session.
From our point of view, the times that produce more accurate
predictions is taking the open at 00:00 GMT and the close at
23:59 GMT.
Besides the calculation of the PP, there are other support and
resistance levels that are calculated taking the PP as a
reference.
Support 1 (S1) = (PP * 2) - H Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP - (R1 - S1) Resistance 2 (R2) = PP + (R1 -
S1)
Where , H is the High of the previous period and L is the low of
the previous period
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404 R1 = (1.2439 * 2) - 1.2376 =
1.2502 R2 = 1.2439 + (1.2636 - 1.2537) = 1.2537 S2 = 1.2439 -
(1.2636 - 1.2537) = 1.2537
These levels are supposed to mark support and resistance levels
for the current session.
On the example above, the PP was calculated using information of
the previous session (previous day.) This way we could see
possible intraday resistance and support levels. But it can also
be
calculated using the previous weekly or monthly data to
determine such levels. By doing so we are able to see the
sentiment over longer periods of time. Also we can see possible
levels that might offer support and resistance throughout the
week or month. Calculating the Pivot point in a weekly or
monthly basis is mostly used by long term traders, but it can
also be used by short time traders, it gives us a good idea
about the longer term trend.
S1, S2, R1 AND R2...? An Objective Alternative
As already stated, the pivot point zone is a well-known
technique and it works simply because many traders and investors
use and trust it. But what about the other support and
resistance zones (S1, S2, R1 and R2,) to forecast a support or
resistance level with some mathematical formula is somehow
subjective. It is hard to rely on them blindly just because the
formula popped out that level. For this reason, we have created
an alternative way to map our time frame, simpler but more
objective and effective.
We calculate the pivot point as showed before. But our support
and resistance levels are drawn in a different way. We take the
previous session high and low, and draw those levels on today's
chart. The same is done with the session before the previous
session. So, we will have our PP and four more important levels
drawn in our chart.
LOPS1, low of the previous session. HOPS1, high of the previous
session. LOPS2, low of the session before the previous session.
HOPS2, high of the session before the previous session. PP,
pivot point.
These levels will tell us the strength of the market at any
given moment. If the market is trading above the PP, then the
market is considered in a possible uptrend. If the market is
trading above HOPS1 or HOPS2, then the market is in an uptrend,
and we only take long positions. If the market is trading below
the PP then the market is considered in a possible downtrend. If
the market is trading below LOPS1 or LOPS2, then the market is
in a downtrend, and we should only consider short trades.
The psychology behind this approach is simple. We know that for
some reason the market stopped there from going higher/lower the
previous session, or the session before that. We don't know the
reason, and we don't need to know it. We only know the fact: the
market reversed at that level. We also know that traders and
investors have memories, they do remember that the price stopped
there before, and the odds are that the market reverses from
there again (maybe because the same reason, and maybe not) or at
least find some support or resistance at these levels.
What is important about his approach is that support and
resistance levels are measured objectively; they aren't just a
level derived from a mathematical formula, the price reversed
there before so these levels have a higher probability of being
effective.
Our mapping method works on both market conditions, when
trending and on sideways conditions. In a trending market, it
helps us determine the strength of the trend and trade off
important levels. On sideways markets it shows us possible
reversal levels.
How we use our mapping method? We at StraightForex
(www.straightforex.com) use the mapping method in three
different ways: as a trend identification (measure of the
strength of the trend), a trading system using important levels
with price behavior as a trading signal and to set the risk
reward ratio (RR) of any given trade based on where the is the
market relative to the previous session.
About the author:
Raul Lopez is the founder of www.straightforex.com A site
dedicated to provide high quality training for Forex traders.
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