Pivot Points-a Powerful Trading Tool!

Many traders are not familiar with the pivot point analysis despite the fact that it is one of the most robust, time tested and proven method of market analysis. Pivot Points work in all markets whether it is forex, futures, stocks, commodities or ETFs that have an established range. Range means the high and low in a trading period.

The importance of these high and low formed in a trading session cannot be under emphasized. High is the reference point that shows buying out of greed while low is a reference point that shows selling out of fear. Fear and greed are the two emotions that rule any market.

Pivot Point Analysis incorporates these three most important reference points for a given trading session that is the High (H), Low (L) and the Close (C). Here's how we calculate the Pivot Points and the three different support and resistance levels based on the prior trading period.

Forex is a 24 hour market with no formal open and close. While calculating the daily pivots, we need the open and the close prices. PRO traders use the NY Bank Settlement Time of 5:00 PM EST as the close of a trading day and 5:05 PM EST as the open for the next trading day. You can also use this same convention while calculating the daily pivot points. Most trading platforms can calculate these pivot point levels so you don't need to worry about doing it manually anymore. S2 and R2 are important support and resistance levels while S3 and R3 rarely come into play!

R3 is the extreme resistance level that is usually caused by the news driven price shock and most of the time does not come into play. R2 is the level where the price action mostly experiences significant resistance. However, in case of a bearish market, price action will most often fail to break the resistance level R1.

P is the focal price level. As a rule, if the market opens above the Pivot Point P, the sentiment is considered to be bullish and if the market opens below the Pivot Point P, the market sentiment is considered to be bearish. S1 is the price level where price action tends to reverse under bullish market conditions but most times falls short. The market often sees significant support at or near the S2 level under bearish market conditions. S3 level represents price decline mostly caused by news driven price shocks.

Now, you might be feeling analysis paralysis due to information overload caused by too many levels used in pivot point analysis. Here is how you are going to filter these numbers. Pivot Point can be used as the actual trading number in determining the high or low of a given time period. Read the next article on how to filter these numbers.