Pivot Point Analysis is a robust and time tested method of market analysis. This strategy works in all markets that have an established range. The range is the high and low of a given time period and it accurately depicts the market participants exuberant bullishness and pessimistic bearishness for a given trading session.
The high and low are the two most important reference points for a given trading session. The high is a reference point for those who bought out of greed thinking that they were missing an opportunity. Similarly, the low depicts selling out of fear thinking that they would lose by staying in the long trade.
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.
Pivot Point P= (H+L+C)/3
Resistance R3=H+2(P-L)
Resistance R2= P+H-L
Resistance R1=2P-L
Support S1 =2P-H
Support S2 =P-H+L
Support S3 = L-2(H-P)
Since there is no formal open and close in the forex market, we can take the NY Bank Settlement at 5:00 PM EST as the close of the daily trading session and 5:05 PM EST as the next day’s trading session open for calculating the daily pivots. It is rare to find the daily trading session go beyond the R2 and S2 levels.
R3 represents extreme bullishness in the market usually caused by news driven price shocks. R2 level is where the market usually experiences significant resistance and this level provides an exit target for long positions. In bearish market conditions, prices will tend to come close to R1 but most times will fail.
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. Read the next article on how to filter these numbers.