Pivot Points for Forex Traders

01/29/2010 12:01 am EST

Focus: FOREX

Some of the oldest technical tools used by traders are pivot points. They were first used by pit traders who did not have access to charts or any other input to help gauge where the market was trading in relation to where it had previously traded.

We have to keep in mind that even though this was before the use of computers that could calculate a technical indicator instantly, these pit traders could not bring a computer into the pit even if it would have been available at the time. But even after computers became a big part of trading, pivot points were still used after many traders realized that technical indicators were not that reliable on the short time-frame charts, while the use of support and resistance levels offered a better chance of success on those short-term trades.

One problem though; the pit traders did not have access to the support and resistance levels that were formed during the current trading session since they were in the pits filling orders. So they needed to have some sort of reference point that could serve as potential support and resistance, which they could write down on one of their trading cards they had with them in the pits, and they had to have these levels before that day's session opened. The solution was to use the high, low, and closing prices from the previous day to use for that day's trading, and hence, pivot points were created.

There have been many formulas created and offered on the Internet that have been called pivot points, and we will introduce some of those in future lessons, but today, we want to start with the most basic formula that is still used today so we can understand the concept of pivot points and how they are used.

On January 26, the high, low, and closing prices for the EUR/USD were as follows:

High: 1.4178
Low: 1.4042
Close: 1.4069

The formula for calculating the pivot point is to simply add these three price levels and divide by three.

1.1478 + 1.4042 + 1.4069 = 4.2289/3 = 1.4096

So, our pivot point for the January 27 session is 1.4096. Keep in mind that this is calculated at the 5:00 pm ET close on January 26 and is used for the January 27 session, which starts at 5:00 pm ET on January 26. Traders used this main pivot point to determine the mood of the day in that if the market opens below the 1.4096 pivot point, that was bearish, and if the market opened above the 1.4096 pivot point, that was bullish. Traders also looked at tests of the pivot point to see if it offered support or resistance.

Here is a five-minute chart of the EUR/USD January 27 session:

First, let’s start with the weekly view of Exxon-Mobil:

Click to Enlarge

We can see that the market opened below the 1.4096 pivot point, which was bearish, and moved up to test the pivot point. There was resistance, which may have offered daytraders a good sell entry, especially when you consider the fact that the market did not move up above the pivot point during the entire January 27 trading day.

This is a basic look at this tool, but a good place to start for today.

By Thomas Long of DailyFx.com

If you do not feel like calculating the daily Pivot Point yourself, no worries, as the team at DailyFX will do that for you and can be found at this link.

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