Pivot Points in Forex
Pivot points are technical analysis tools used in forex trading to identify potential support and resistance levels. They are calculated based on the high, low, and closing prices of a currency pair over a specific period, typically the previous trading day.
Calculation
The following formulas are commonly used to calculate pivot points:
Pivot Point (P): (High + Low + Close) / 3
Resistance 1 (R1): 2 P — Low
Resistance 2 (R2): P + (High — Low)
Resistance 3 (R3): P + 2 (High — Low)
Support 1 (S1): 2 P — High
Support 2 (S2): P — (High — Low)
Support 3 (S3): P — 2 (High — Low)
Interpretation
Support Levels (S1, S2, S3): Potential price levels where the downtrend may reverse and buyers may enter the market.
Resistance Levels (R1, R2, R3): Potential price levels where the uptrend may encounter resistance and sellers may enter the market.
Pivot Point (P): The theoretical equilibrium point where neither bulls nor bears are in control.
Usage
Forex traders use pivot points in various ways:
Identifying Support and Resistance: Pivot levels can help traders identify potential areas of support and resistance where the price can bounce or reverse.
Trend Confirmation: Breaking above resistance or below support levels can provide confirmation of a trend reversal.
Trade Entry and Exit: Traders may enter trades near support levels with a buy stop order or near resistance levels with a sell stop order. They may also exit trades at profit targets set near pivot points.
Risk Management: Pivot levels can help traders set stop-loss orders below support levels or above resistance levels to limit potential losses.
Limitations
Pivot points are not predictive and should not be used in isolation. They are more effective when combined with other technical indicators and market analysis. Additionally, they can be more reliable in highly liquid forex markets with clear trend patterns.