Currency trading requires reference points which are used to determine when to enter the market, place stops and take profits. However, many beginning traders divert too much attention to technical indicators such as moving average convergence divergence (MACD) and relative strength index (RSI) and fail to identify a point that defines risk. Unknown risk can lead to margin calls, but calculated risk significantly improves the odds of success over the long haul.
Forex traders use a wide range of technical indicators to guide their trading decisions. Pivot points are a useful indicator for identifying support and resistance levels or impending trend reversals, which can increase traders' probability of making trades in the right direction. Understanding how pivot points work and how to use them to add confirmation to your trading setups is vital to using this indicator to generate consistent gains in currency trading.
A pivot point signals the end of a short, medium or long-term trend and the beginning of either a trend reversal or a temporary pullback in price. The technical definition of a pivot point is a price close that is higher than the two previous and two subsequent price closes in the case of an upper pivot, or lower than the same in the case of a lower pivot. Most pivot indicators differentiate between major and minor pivots drawn on the chart, and pivot points change depending on the timeframe in which a chart is drawn.
The prices used to calculate the pivot point are the previous period's high, low and closing prices for a security. These prices are usually taken from a daily charts, but the pivot point can also be calculated using information from hourly charts. Most traders prefer to take the pivots, as well as the support and resistance levels, off of the daily charts and then apply those to the intraday charts (for example, hourly, every 30 minutes or every 15 minutes). If a pivot point is calculated using price information from a shorter time frame, this tends to reduce its accuracy and significance.
A day trader can use daily data to calculate the pivot points each day, a swing trader can use weekly data to calculate the pivot points for each week and a position trader can use monthly data to calculate the pivot points at the beginning of each month. Investors can even use yearly data to approximate significant levels for the coming year. The trading philosophy remains the same regardless of the time frame. That is, the calculated pivot points give the trader an idea of where support and resistance is for the coming period.
