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.
Understand Pivot Point Basics
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. Pivots can be drawn by charting platforms in different ways. 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. If you do not wish to use a visual indicator in your charting platform, you can obtain tables of recent pivots for all pairs from a number of forex news outlets.
Leverage Pivot Psychology
Understanding the market psychology behind pivot points is a key to using pivots to make consistent gains. At a pivot high, many traders have bought into an uptrend, likely at an oversold level, only to see the pair drop sharply in price immediately after. Psychologically, many of these buyers are anxiously waiting for the price to come back to the level at which they bought so that they can get out at a break-even point. When price reaches their break-even point, those buyers sell en masse, increasing supply and driving the price back down at that point. Because of this, previous pivot points can serve as good indicators of future price movements.
Establish Support and Resistance
The psychology behind pivot highs and lows creates a self-fulfilling prophecy. As traders make decisions based on the expectation that pivot points lead to reversals, their trading actions reinforce the phenomenon even further. To take advantage of this, use pivot points to identify high probability points of major and minor support and resistance. Analyze the previous three to five major pivot points on a chart to look for likely support and resistance zones, and then use these zones to inform your trading decisions. When price reaches a likely support or resistance area, the likelihood of price reversing can increase. Use this knowledge in tandem with other indicators, chart patterns and the overall trend to consistently make gains with your trades over time.
Analyze Multiple Timeframes
Analyze pivots at higher timeframes to confirm trends and identify bigger-picture support and resistance areas. Analyze pivots at lower timeframes to time your entries and exits. If you find yourself in a strong uptrend on a five-minute chart, for example, look at pivots on a 15-minute and one-hour chart to see if you are approaching a support or resistance zone in those timeframes. If the price is approaching a major pivot high on a one-hour chart, as another example, look to a 15- or five-minute chart to enter your bearish trade when both timeframes have hit upper support.
David Ingram has written for multiple publications since 2009, including "The Houston Chronicle" and online at Business.com. As a small-business owner, Ingram regularly confronts modern issues in management, marketing, finance and business law. He has earned a Bachelor of Arts in management from Walsh University.