Pivot points work as a filter in all markets that have established ranges. They should be taken as powerful leading indicators in your technical analysis tool kit. Most of the other indicators used in technical analysis are lagging. Lag means they only inform you about the price action that has already taken place.
Pivot points are a simple mathematical calculation that determines the next time periods range based on the previous time periods data. It includes the high, the low and the closing price.
What is a range? A range is the high and low of a given time period. The high represent the market participants exuberant bullishness. The low represents the market participants pessimistic bearishness for that particular trading session.
A pivot point is that special line drawn in sand where most traders turn from being bearish to bullish or bullish to bearish. These points are used in currency trading to tell if the market sentiment has shifted from being positive/long to negative/short. If the price is trading above the point, you should take a long position. And if the price is trading below the pivot point, you should take a short position.
Now lets calculate the pivot point (P) for one trading session. P= (L+H+C)/3 where L is the low, H is the high and C is the close for that session. You can use a 4 hr chart to calculate the pivot point for the next 4 hr session. Just plug in the values of low, high and close for the 4 hr session to calculate the pivot point for the next session. This way, you can have 2 pivot points for each 8 hour session and 6 pivot points for the day session.
Once you have calculated the pivot point, trade long as long as the price stays above and trade short as long as the price is below the pivot point. The thinking behind the pivot points is simple but powerful. If the buyers are willing to pay more for a currency pair now than they were 4 hours ago, than at least for the time being the markets are bullish.
Pivot point works as a filter for you in telling you about the mood of the majority investors at that point. You should only buy if the price action is above the pivot point. And you should only sell if the price action is below. We have used the example of 4 hour charts but you can also use daily, weekly and monthly charts to calculate these points for those sessions.
You can determine the entry and exit for each position using pivot points. You can also use them in conjunction with other technical indicators. Pivot point analysis is a time tested, robust and a reliable market analysis tool.
Many new currency traders ignore learning pivot points considering them complicated. Its a myth. They are very easy to use. Learn how to use them to determine the market sentiments in any timeframe you want to trade. But always keep this in your mind; it is only a guide. These numbers should not be taken as the Holy Grail. They can help you filter out excess information and avoid analysis paralysis from information overload.
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