Pivot points are a very widely used indicator which creates support and resistance levels on a trading chart.  These levels to indicate where reversals (i.e where the price action turns ) or breakouts are likely to occur.

The powerful feature of pivot points is that they do not require interpretation or personal judgement in their calculation.  As a result they are objective so you can be confident that many other people are watching the same levels and just like Fibonacci levels  they become a self-fulfilling prophecy.

Calculation of pivot points is fairly simple mathematically.  The pivot points are calculated using the previous day’s session’s open, high, low and close.  Typically most people use the New york session since forex is a 24 hour market.

Pivot point (PP) = (High + Low + Close) / 3

First resistance (R1) = (2 x PP) - Low
First support (S1) = (2 x PP) – High

Second resistance (R2) = PP + (High - Low)
Second support (S2) = PP - (High - Low)

Third resistance (R3) = High + 2(PP - Low)
Third support (S3) = Low - 2(High - PP)

Using pivot points to trade

In everyday life a pivot is a point where something turns.  In the case of forex, the thing that turns, or at least is expected to turn, is the price movement.  The price is expected to reach the pivot point, turn around and reverse.  This is exactly how we set up support or resistance levels in the first place except with pivot points we calculate where these levels are before the price gets there to turn around.

A little refresher from our lesson in support and resistance levels:

Support and resistance levels are important since they show a price point that the market as a whole is reluctant to break through and so it becomes more likely that when the price reaches that point again there is a much higher probability it will not break through again.   As a result they many traders use them to make trading decisions.

Once broken through, these levels are also where breakouts are likely to occur.

If the price action moves down towards a support level, you would place your buy orders just above the level, ready for the price to come back up and with a stop loss below the level in case you are wrong.  The more confident you of the reversal, the closer you would put the stop loss below the level.  The target for take profits would be set at the next pivot point or resistance level

Just like regular support or resistance levels, levels set by pivot point calculations wont hold permanently so they are used by traders to as areas to watch for breakouts to indicate a strong price movement.

In addition, the pivot point (PP) is also used to judge general market sentiment where price trading above the PP line is seen as bullish and price action trading below the line seen as bearish

As with most indicators Pivot points should be used in conjunction with other trading indicators to make a decision since despite being objectively calculated, without further information it can still be tricky to judge whether the level indicates a good area for a reversal or a breakout .