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How to trade breakouts - Pivot points

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Lesson 11

The Pivot points are regular horizontal lines that act as support and resistance in technical analysis. These levels are considered quite helpful for traders when trading breakouts. Due to the technical nature of this method of analysis, traders find it easy to automate it.

Using Pivot points in your technical analysis could be beneficial, especially if you are speculating on the short term.

The Pivot points are often used across a wide range of markets and not just confined to forex trading. The primary use of Pivot points is part of trend identification. Basically, when a Pivot point is breached, traders use the market context and the prevailing trend to trade accordingly.

When using the Pivot levels, it could be beneficial to implement one or two additional indicators. Some of the common indicators that can add confirmation to the Pivot signals are trend strength indicators, such as the ADX and EMA.

How are Pivot points calculated?

Many types of Pivot points have been used in recent times. By default, the daily Pivot points are ideally used when you are day trading. A simple Pivot point is calculated based on the average price of the high, low and close.

The values can be determined based on the previous day’s prices. Thus, the Pivot point forms the central level to price on the current day. Once the point is formed, you can then create support and resistance levels.

The first resistance level is identified based on the formula of multiplying the Pivot point by two and subtracting from the previous day’s low. Similarly, the first support level is identified by multiplying the Pivot point by two and subtracting from the previous day’s high.

Once the initial, or first, support and resistance levels are created, the next step is to create the second level of resistance and support levels. To do this, the difference between the first support and resistance levels is added to the pivot point. This creates the second level of resistance.

Conversely, to create the second level of support, subtract the difference between the first support and resistance levels from the pivot point value.

You do not need to bother much about the calculations as many Pivot point indicators tend to automatically do it for you. You can also build custom Pivot indicators, such as those based off the weekly prices or even monthly prices.

Some traders also prefer to use lower Pivot points, such as those based on 4-hour sessions. Regardless of what time frame you use, the basic concept of trading with Pivot points remains the same.

How to use Pivot points in Forex

In the forex markets, traders can apply the Pivot indicator to a time frame of their choice. Typically, you would use the daily Pivot points on a 1-hour chart, while a weekly Pivot point level is useful on a 4-hour chart.

You should note that the higher time frame Pivot points have stronger support and resistance levels than the short term. Thus, the weekly Pivot points are stronger than the daily.

Trading breakouts

Trading breakouts can occur when you have already identified the underlying trend in the larger time frame. For example, when you see an uptrend on the daily chart, then use the 1-hour session with the daily Pivot points added and trade the breakout from the first level of resistance in an uptrend. Stop loss could be set on the recent low below the resistance.

Similarly, you would short when price breaks the first support level in a downtrend. Stop loss could be set on the recent high above the support.

Range trade

Some traders also buy or sell from the support and resistance levels and target the pivot point. However, prices can break past the initial support or resistance level and move to the next support and resistance level as well.

Therefore, you can have three levels of support and resistance. The third level of support and resistance is often considered the strongest.

Range trading is ideal when price has settled into a sideways range. However, in reality, this is always hard to identify as price unfolds.

Pivot points trading strategy

Traders can look at the trend in the instrument they are analysing and gain a general idea of the way the markets are moving. Once the trend and the breakout align themselves, traders can open Long or Short positions accordingly. However, the downside to this method is traders have to constantly watch the charts to trade the signals.

Pivot Buy Signal

Pivot Buy Signal

In the first example, we are looking at a Long position. In the above chart, we have a 1-hour EURUSD with Pivot points. We already know the currency pair is in an uptrend. Therefore, we simply wait for price to first consolidate before a breakout emerges.

If you look back to the two days prior to the Buy signal, you can see prices were moving flat. However, once price breaks out above the first level of resistance, we can buy EURUSD.

Pivot Sell Signal

Pivot Sell Signal

In the above Sell signal, we are looking at the USDCAD currency pair with the daily pivot levels. Here, you can see the previous day’s session saw the price action staying consolidated within a range. Considering the USDCAD is in a downtrend, we wait for prices to break out from this range to the downside.

Once USDCAD breaks below the first support level, we can sell the currency pair.

The above strategy shows one of the many ways traders can use the Pivot points to profit on the forex market. However, you have to remember blindly trading the Pivot signals will not bring you success in the long term. To become a successful trader, you need to know the big picture and be able to identify the candlestick patterns on the chart.