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:
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
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.
.gif)
