Risk Disclosure

" is not suitable for all investors and you should make
"Forex trading can involve the risk of loss beyond your initial deposit. It is not suitable for all investors and you should make sure you understand the risks involved; seeking independent advice if necessary"

Saturday, October 13, 2007

Pivot Point Trading Strategy

The pivot point trading strategy has been around for many years, originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.The pivot point is the level at which the market direction changes for the day. By using simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels.These points are collectively known as pivot levels!Every day the market has an open, high, low and a close for the day. Forex markets are open 24 hours a day 5 and a half days a week.

We use 5pm EST as the open and close. This is all the all the data you need to calculate the pivot levels. The reason pivot point trading is so popular is simply because pivot points are predictive rather than lagging. The information from the previous day is used to calculate potential turning points for the current day you are about to trade.Because so many traders use pivot points the market generally reacts at these levels thus creating trading opportunities. The theory is that if the market opens above the pivot point then the bias for the day is long for as long as the price remains above the pivot point. If the market opens below the pivot point then the bias for the day is to stay short for as long as the market remains below the pivot point. The most important pivot levels are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to find a reversal or break of R1 or S1. By the time the market reaches R2, R3 or S2, S3 the market will generally be overbought or oversold and these levels should be used to exit the market rather than enter the market.A good set up would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on the break
of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.

If we look at the above 1 hr GBP/USD chart we can see the open and close of Friday, 12 Oct. The blue line is the pivot point, The Green lines the resistance areas and the red lines the support areas. These specific pivot points are automatic and update my charts daily. Pivot point calculators are freely available on the web. Go to the following; http://www.fxstreet.com/forex-tools/pivot-point-calculator/ to download a free pivot point calculator. If you want auto pivots for the meta trader charts then log onto http://www.forexmt4.com/ and look for free pivot points that update automatically on your charting everyday.

As we can see the market opened below the daily pivot therefore the initial bias should be to look for a short opportunity until the pivot point is breached.

Breakout Trade

If we look at the above chart we can see the market formed a bit of a channel between the S1 and pivot point. I have added in the up and down Trend lines. The price tested the S1 pulled back then failed to penetrate the resistance or down trend line to go higher. With the opening of the European market price broke below the support and uptrend line. We enter the market just below the S1 with the opening of the down candle at 2.0304 our stop is placed just above the previous high at 2.0335 a 31 pip stop. With a 31 pip stop we need to target at least a 31 pip profit target, preferably 46 or more pips with no more than 2% of our equity. As our S2 is only 20 pips away and no guarantee that price will break through that area this might not be the best trade from a risk reward point of view. Or you can go to a 5 min chart to check the last high on that for a more aggressive stop loss.

In this case the market actually stopped just 4 pips short of the S3 target for a 59 pip run down. Even though this is a predictive trading method bear in mind for targeting that support and resistance is an area not necessarily a specific number. In this case the price had 2 attempts to hit the target of 2.0241 but failed. Rather bank the money in this case than let the market retrace all the way back to S2. Also when S2 was hit then move your stop to break even. If you were in the market with more than 1 lot you could have closed half the position when you were 31 pips up on the trade. As there are many ways to trade pivot points let’s see how the day continued and if there were any further pivot trading opportunities on the day.

If we look at the following setup then we see we have a new current down trend line and I have added a relative strength indicator with a setting of 34. When price breaks through the down trend line we can place an order above S2 Targeting S1 and Pivot point. Again the stop is 35 pips so we need to target at least 35 to 70 pips on the trade. Again the distance between S1 and S2 is only 27 pips so we need to consider this trade carefully from a risk reward point of view. In this case the market easily went all the way to the pivot point 64 pips above at 2.0354 from an entry of 2.0287. Note also that the RSI indicator crossed the 50% line confirming the buy. Again we could have closed half our position at 35 pips up and brought our stop loss to break even.

The sudden spike down due to a US fundamental could just as easily have continued down and turned a good trade into a loser had we not done this. For those who want the maths for the pivot point calculations here it is. Start with calculating the pivot point first. As you can see by having the previous days high, low and close we can calculate 7 points of support and resistance.

Resistance 3 = High + 2*(Pivot - Low)Resistance 2 = Pivot + (R1 - S1)Resistance 1 = 2 * Pivot - LowPivot Point = ( High + Close + Low )/3Support 1 = 2 * Pivot - HighSupport 2 = Pivot - (R1 - S1)Support 3 = Low - 2*(High - Pivot)