Pivot Points in Forex StraightForex[ See company's profile at FXstreet.com Directory ]
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Pivot Points in Forex Wednesday, June 28, 2006 10:00 AM GMT by Raul Lopez

Mapping Your Time Frame
It is useful to have a map and be able to seewhere the price is relative to previous market action. This way we cansee 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 duringthe 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. Thesame applies to the Forex market, the pivot point is a level in whichthe sentiment of the market changes from “bull” to “bear” or viceversa. If the market breaks this level up, then the sentiment is saidto be a bull market and it is likely to continue its way up, on theother hand, if the market breaks this level down, then the sentiment isbear, 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 ifprice can’t break the pivot point, a possible bounce from it isplausible.

Pivot points work best on highly liquid markets, like the spotcurrency 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 individualtraders and investors use and trust them, as well as bank andinstitutional traders. It is known to every trader that the pivot pointis an important measure of strength and weakness of any market.

Calculating pivot points There are several ways to arrive to the Pivotpoint. The method we found to have the most accurate results iscalculated by taking the average of the high, low and close of aprevious 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 themarket is trading below this 1.2439 the bears are winning the battlepulling prices lower. On both cases this condition is likely to sustainuntil the next session.

Since the Forex market is a 24hr market (no close or open from dayto day) there is a eternal battle on deciding at white time we shouldtake the open, close, high and low from each session. From our point ofview, the times that produce more accurate predictions is taking theopen at 00:00 GMT and the close at 23:59 GMT.

Besides the calculation of the PP, there are other support andresistance 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 ofthe previous session (previous day.) This way we could see possibleintraday resistance and support levels. But it can also be calculatedusing the previous weekly or monthly data to determine such levels. Bydoing so we are able to see the sentiment over longer periods of time.Also we can see possible levels that might offer support and resistancethroughout the week or month. Calculating the Pivot point in a weeklyor monthly basis is mostly used by long term traders, but it can alsobe used by short time traders, it gives us a good idea about the longerterm trend.

S1, S2, R1 AND R2...? An Objective Alternative As already stated, the pivot point zone is awell-known technique and it works simply because many traders andinvestors use and trust it. But what about the other support andresistance zones (S1, S2, R1 and R2,) to forecast a support orresistance level with some mathematical formula is somehow subjective.It is hard to rely on them blindly just because the formula popped outthat level. For this reason, we have created an alternative way to mapour time frame, simpler but more objective and effective.

We calculate the pivot point as showed before. But our support andresistance levels are drawn in a different way. We take the previoussession high and low, and draw those levels on today’s chart. The sameis done with the session before the previous session. So, we will haveour 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 givenmoment. If the market is trading above the PP, then the market isconsidered in a possible uptrend. If the market is trading above HOPS1or HOPS2, then the market is in an uptrend, and we only take longpositions. If the market is trading below the PP then the market isconsidered in a possible downtrend. If the market is trading belowLOPS1 or LOPS2, then the market is in a downtrend, and we should onlyconsider short trades.

The psychology behind this approach is simple. We know that forsome reason the market stopped there from going higher/lower theprevious 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 marketreversed at that level. We also know that traders and investors havememories, they do remember that the price stopped there before, and theodds are that the market reverses from there again (maybe because thesame reason, and maybe not) or at least find some support or resistanceat these levels.

What is important about his approach is that support and resistancelevels are measured objectively; they aren’t just a level derived froma mathematical formula, the price reversed there before so these levelshave a higher probability of being effective.

Our mapping method works on both market conditions, when trendingand on sideways conditions. In a trending market, it helps us determinethe strength of the trend and combined with price behavior helps ustrade off important levels. On sideways markets it shows us possiblereversal levels. It also helps us to set the Risk Reward ratio based onwhere is the market relative to previous market action.
Published on Wed, 28 Jun 2006 05:00:41 GMT
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