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Thursday, March 17, 2011

The Pivot Point Forex trading system explained

The 'Pivot point trading system' is a method of predicting the movement of a financial instrument such as currency in the foreign exchange market or forex; it is used by day traders and other market speculators.The pivot points are mathematically determined points of price support and resistance and the pivot point strategy applies trend hypotheses to the pivot points to predict future price movement.


For example, if a currency's closing price of 1.762 is below a price average of 1.765, and the previous days close was also 1.765, today's closing price has dropped below the pivot points where support is established around the prices moving average. For a trader, this drop through the pivot point would signal a potential entry point to 'sell short' i.e. bet on the price going down.

The usefulness of the Pivot Point System


The pivot point system is useful because it gives individuals an idea of how to better allocate financial assets. The method brings a mathematically derived sense of order, to a possible free flowing series of price movement. In other words it assists in identifying patterns and price movements so the trader is better equipped to take advantage of those patterns. In the case of the pivot point system those patterns are drops and rises below and above the pivot point, support levels and resistance levels.

How the pivot points are used


When all the pivot points are determined a day trader will watch the price movement of a price throughout the day, when a suitable entry or exit point is indicated by the pivot point system, the trader may then decided to take a financial position by buying or selling. While the pivot point method is primarily a short-term method, it may in some case be applied long term if the analyst so chooses. In such an instance, an analyst may replace the previous days average price with a moving average.

The stronger indicator in a pivot point system is the primary pivot point such as the previous days price average in short term analysis, and the moving average in long term analysis. When a price breaks above this point, market sentiment is indicated as 'bullish' suggesting a buy may be in order. The reverse is the case for drops below the main pivot point. The resistance and support levels either confirm or dis-confirm the primary pivot points indication by following the movement trend or not i.e. if the resistance level is also broken in addition to the pivot point market sentiment is 'bullish' and if the support level as well as the pivot point are broken downward, sentiment is 'bearish''. All these indicators can be presented on charts and graphs pre-calculated by software programs for a more efficient use of pivot point system.

Calculating the Pivot Point


The main information used in this trading analysis is the  average price, support level and resistance level. Once the trader knows what these indicators are (s)he may then proceed to either enter or exit a financial position in a particular stock, commodity, currency etc. as prices move through, above and below these price levels. There are several ways to calculate pivot points depending on what one wants the pivot point to measure. Below are two methods for calculating the pivot point:

Method A: Simple average price method

• Calculate previous days average price by adding the high, low and close prices and then dividing by three.
•When the next days price moves above or below this level a pivot point has be established.

Method B: 'Five Point Pivot Point'

This method is called the five point pivot point method because it uses five points rather than one average price in method A. In this method the five points are the pivot point, first level of resistance, the first level of support, the second level of resistance and the second level of support.

1. The Pivot point: Using method A above will yield the pivot point calculation.

2. Resistance point 1: To calculate resistance point 1, multiply the pivot point by 2 then subtract the previous day's low.

3. Support point 1: To Determine the first support level multiply the pivot point by 2 but subtract the previous days high instead of subtracting the previous day's low.

4. Resistance point 2: Subtract the result of #3 from the result of # 2 then add the result
to #1.

5. Support point 2: Subtract the result of #3 from the result of #2, but then subtract the result of #1 instead of adding it.

These five steps gives one the five pivot points with which the trader on analyst uses to determine perceived suitable entry and exit points.

The pivot point trading system is one of many techniques used in what is called the 'technical analysis' of financial instruments. The primary purpose of the pivot point trading system is to determine whether or not a pre-determined price level has been passed through or dropped below. Several techniques of price movement interpretation have been developed around the pivot point method such as pivot point reversals and complex pivot points that are formed over a few days. 

However, these differing interpretations center around the primary idea there is a pivot point which through which prices either moved behind, past or in tandem with. The pivot point trading system is used in foreign exchange analysis but may also be applied to stock and other financial instrument's price movements. The pivot point trading system is one of many technical analysis tools available to day traders and may or may not indicate the actual future movement of a price. However, by using the pivot point trading system, a day trader is better equipped and prepared to estimate future price movements.

Sources:

1. http://www.squidoo.com/pivotpointforextrading/
2. http://ezinearticles.com/?Using-Pivot-Points-For-Greater-Profits&id=126794
3. http://www.investopedia.com/articles/technical/04/041404.asp
4. http://www.incrediblecharts.com/technical/pivot_point_reversal.htm
5. http://www.thebulltrader.com/612/strategies-for-trading-stock-pivot-points/