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:
Open: 1.2386
High: 1.2474
Low: 1.2376
Close: 1.2458
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
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) – 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 – 1.2537) = 1.2537
S2 = 1.2439 – (1.2636 – 1.2537) = 1.2537
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.
How we use our mapping method?
We at StraightForex (www.straightforex.com) use the mapping method in
three different ways: as a trend identification (measure of the
strength of the trend), a trading system using important levels with
price behavior as a trading signal and to set the risk reward ratio
(RR) of any given trade based on where the is the market relative to
the previous session.
