Why Pivot Point Systems Fail

What is a pivot point?

Pivot points are levels at which price may turn (either from bullish to bearish or vice versa). It’s a technique developed by floor traders who calculate the points each day before the market opens (from previous day’s data) and then write those levels on the back of their trading card so they have a quick reference while trading in the pits throughout the day. This is the precise reason why pivot points work -- because institutional traders who drive much of the volume follow the same exact levels.

How are pivot points calculated?

The calculation is easy:

Pivot point (PP) = (High + Low + Close) / 3

Take for instance the following EUR/USD information from the previous session:

High: 1.3381
Low: 1.3328
Close: 1.3367

The PP would be,
PP = (1.3381 + 1.3328 + 1.3367) / 3 = 1.3359

1.3359 is the “Main Pivot”

There are other formulas for determining multiple pivot points that represent additional support and resistance levels:

To determine the trading range for the next period:

2 * Pivot - Low = Resistance 1

2* Pivot - High = Support 1

So, in the previous example. It would be:

2 * 1.3359 - 1.3328 = 1.3390 (Resistance 1 or the high end of the normal trading day range)

2* 1.3359 - 1.3381 = 1.3337 (Support 1 or the low end of the normal trading range)

To determine the extreme trading range, it’s:

Pivot + (resistance 1- support 1) = Resistance 2

Pivot - (resistance 1 - support 1) = Support 2

Keeping with the same example, it would be:

1.3359 +(1.3390-1.3337) = 1.3412 Resistance 2

1.3359 - (1.3390-1.3337) = 1.3306 Support 2

We can go one step further:

High + 2* (pivot-low) = Resistance 3

Low - 2* (high-pivot) = Support 3

Using our working example, it would be:

1.3381 + 2 * (1.3359-1.3328) = 1.3443 Resistance 3

1.3328 - 2* (1.3381-1.3359) = 1.3284 Support 3

For us non-math majors, this should be giving you a slight migrain. The good news is that most charting packages come with pivot points as a tool, so they are calculated and drawn on the chart automatically or you can get a free pivot point calculator at http://www.fxnationlive.com

The other question you might have is when to calculate these pivot points considering Forex is a 24 hour market. Good question. I’ve found the best time is 00:00 EST because it’s a couple hours before the London session opens and will carry you through the NY day. The London and NY sessions combined have the most volume of any time during the Forex day.

I use pivot points as a main indicator. I feel they are absolutely critical to a trader’s success and they work with more accuracy then any other indicator available. The technique is so popular that many Forex courses are dedicated solely to that methodology.

So, why do pivot point systems fail?

In my experience, the biggest negative to trading with only pivot points is that you don’t know which levels are going to hold. Many times traders have expressed their frustration because they start trading every pivot point and often price slices right through only to stop them out.

What’s the Solution?

There are two important solutions to this problem:

1. Know the strength of the move approaching the pivot point. Most traders don’t have a clue about the strength of the moves, for example, going short at a resistance point when the buying is at very high levels. That pivot is most likely not going to hold at that point. We have an exclusive tool in our charting software that is called Buy/Sell Pressure and it shows the strength of the move going into the pivot point so that we know if we are trading in the face of a strong move. At the very least, find a good volume based indicator to use.

2. Know and Follow the Trend. This seems so basic, but you wouldn’t believe how many traders still try to go against the trend. Trade the pivot points that are going to hold based on the longer term trend. For example, let’s say the EUR/USD is in an uptrend, you would want to find SUPPORT pivots as price comes back down and play the bounces back on the upside. This is a much higher probability trade than trying to find resistance in a strong uptrend. (not that it can’t be done, but that goes back to rule #1).

If you follow these two rules along with pivot points, you will see the accuracy of your trading increase dramatically. You will hit trades that even amaze yourself as price turns on a dime at the levels you have set, often times to the exact pip. I hope this helps. Now, go make some money!

DC Bonta has been amongst the most elite traders on the New York and American Stock Exchanges and has traded equities, options and Forex with firms such as Morgan Stanley and TD Waterhouse. You can now get Mr. Bonta’s brand new trading course called the Institutional Forex System II based on the methods mentioned in this article by clicking here

Here’s To Your FX Trading Success,

DC Bonta, The world’s #1 FX money manager