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Using Pivot Points in Forex Trading: A Simple but Effective Trading System

15 Years ago | August 18, 2014 9/25/22, 12:00 AM

Trading requires reference points (support and resistance), 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) (to name a few) 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.... Click below to read more

One tool that actually provides potential support and resistance and helps minimize risk is the pivot point and its derivatives. In this article, we'll argue why a combination of pivot points and traditional technical tools is far more powerful than technical tools alone and show how this combination can be used effectively in the FX market.*

*These are the introductory paragraghs from an article entitled Using Pivot Points in Forex Trading by Jamie Saettele in Investopedia. It is the basis for the following, which was sent to me by a GTA member, who has used pivot points to develop a simple but effective trading system that he offered to share with our members.

From our GTA member:

Trading requires reference points (support and resistance), 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) (to name a few) 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.

One tool that actually provides potential support and resistance and helps minimize risk is the pivot point and its derivatives.

Jamie shows how a combination of pivot points and traditional technical tools is far more powerful than technical tools alone and show how this combination can be used effectively in the FX market.

He shows that the number of days that the low was lower than each S1, S2 and S3 and the number of days that the high was higher than the each R1, R2 and R3.

In his presentation there have been 2,026 trading days since the inception of the euro as of October 12, 2006, which at time of publication meant approximately 7.75 years assuming 260 trading days in a year, which makes the following reasonably "fresh".   There is nothing preventing one some other time period for their preferred statistics.

  • The actual low has been lower than S1 892 times, or 44% of the time
  • The actual high has been higher than R1 853 times, or 42% of the time
  • The actual low has been lower than S2 342 times, or 17% of the time
  • The actual high has been higher than R2 354 times, or 17% of the time
  • The actual low has been lower than S3 63 times, or 3% of the time
  • The actual high has been higher than R3 52 times, or 3% of the time

This information is useful to a trader; if you know that the pair slips below S1 44% of the time, you can place a stop below S1 with confidence, understanding that probability is on your side. Additionally, you may want to take profits just below R1 because you know that the high for the day exceeds R1 only 42% of the time. Again, the probabilities are with you.

It is important to understand, however, that theses are probabilities and not certainties. On average, the high is 1 pip below R1 and exceeds R1 42% of the time. This neither means that the high will exceed R1 four days out of the next 10, nor that the high is always going to be 1 pip below R1. The power in this information lies in the fact that you can confidently gauge potential support and resistance ahead of time, have reference points to place stops and limits and, most importantly, limit risk while putting yourself in a position to profit.

Using the Information

The pivot point and its derivatives are potential support and resistance. RSI

Divergence at Pivot Resistance/Support: To see an example of a setup using pivot point in conjunction with the popular RSI oscillator, refer to the link to Investopedia.

This is typically a high reward-to-risk trade.

The risk is well-defined due to the recent high (or low for a buy).

The rules for the setup are simple:

For shorts:

1. Identify bearish divergence at the pivot point, either R1, R2 or R3 (most common at R1).

2. When price declines back below the reference point (it could be the pivot point, R1, R2, R3), initiate a short position with a stop at the recent swing high.

3. Place a limit (take profit) order at the next level. If you sold at R2, your first target would be R1. In this case, former resistance becomes support and vice versa.

For longs:

 1. Identify bullish divergence at the pivot point, either S1, S2 or S3 (most common at S1).

2. When price rallies back above the reference point (it could be the pivot point, S1, S2, S3), initiate a long position with a stop at the recent swing low.

3. Place a limit (take profit) order at the next level (if you bought at S2, your first target would be S1 … former support becomes resistance and vice versa).

In sum:

Jamie provides the formula.

Global-view.com's Chart Points provide the numbers to plug into it.  

Credit: Jamie Saettele, Jamie Saettele CMT is a Senior Technical Strategist for DailyFX via Investopedia

 

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