Forex Mistake #57 – The Pivot Point You Shouldn’t Walk Alone

 Why Pivot Points Could Get You Broke?

Have you ever felt like the pair you are trading is moving between invisible walls, boundaries that make it bounce, turn and then travel to the next destination? If you have, then let me tell you: you weren’t wrong and such invisible walls really exist. They are called Pivot Points and they’re the topic of this article.

 

What Are Pivot Points and How to Use Them

Basically, pivot points are support and resistance levels which, just like any S/R level, can be broken or can reject price. A pair’s movement at or near a pivot point usually decides the next direction: a break of a pivot suggests strength of the current move, while a bounce/rejection, suggests that the other side of the market is starting to gain strength. Ok, ok but what are pivots? They are lines drawn on the chart and calculated using the Open, High, Low and Close of the previous day. And before you tell me you don’t want to calculate anything, let me wipe that though out of your mind because just how there’s an app for almost anything, there’s an indicator for almost anything and pivot points are no exception. There are tens of indicators out there, that plot pivots automatically on your charts.

Pivot points are composed of several elements: Main Pivot (PP) – this is the most important of the bunch; usually traders have a bullish bias if price is above PP and a bearish bias if price is below PP. Next we have three levels of Resistance (R1, R2 and R3) and three levels of support (S1, S2 and S3). Just because they are named Support and Resistance, do not think you can simply buy at support and sell at resistance. It’s not that simple, because just like any S/R level, pivots can be broken. However, some traders wait for exactly that: a breakout. Remember that recent article about breakouts and how to identify a real one? Well, when a pivot level is broken, breakout traders can start to analyze the break and possibly to enter into a position based on their analysis. Trend traders can wait for a retracement against the main trend and then, once price breaks resistance/bounces at support (in an uptrend) or breaks support/bounces at resistance (in a downtrend), they can enter a position in the direction of the main trend. I know that sounds complicated, so let me help with a picture:

Keep in mind that R1, R2 and R3 can turn into support if price is above them and S1, S2 and S3 can turn into resistance if price is below them. Their name doesn’t mean that they will always be support or resistance. Finally, counter trend traders can use Pivot Points as places where the trend can end and reverse: the more price travels, the more likely it is to retrace because any move/trend will eventually become exhausted. Just like any other support or resistance level, pivots are better used in conjunction with other indicators/confirmations in order to give you better results, whether you are using them as reversal points or breakouts in line with the main direction. And this brings us to the next section:

 

Pivot Points and Their Confirmation

“Never walk alone” means: never use just a single indicator when trading. Same goes for Pivot Points. When price approaches a pivot, you must start to look for additional confirmation that it will reverse or continue through. This confirmation can come from multiple sources: chart patterns such as double tops/bottoms, head and shoulders, etc. can be a strong hint that a trend is close to exhaustion. If the double top (or other reversal pattern) forms near R1, R2 or R3, that’s an even stronger confirmation that a retracement is coming. Maybe the trend will continue afterwards so don’t sell the farm, but hey, maybe you want to close part of your long order.

An overbought Stochastic near resistance also suggests that price may come down and an oversold Stochastic near support indicates that a move up might follow. If your favorite Moving Average starts to curve downwards and price bounces at resistance in an uptrend – again, maybe it’s time to exit your buy. Of course, if you are in a downtrend and the moving average starts to move up while price cannot break support, think about closing some or all your positions.

 

The Pivotal Lesson to Be Learned

Sometimes price does the total opposite of what we expect it to do and even if 10 things tell you that it’s going down, it will still shoot up. How to avoid that? You cannot. All you can do is use good money management and don’t put all your eggs in one basket. Pivot Points, just like Fibonacci work because a huge number of traders pay attention to them so if 10 thousand traders (I’m just throwing numbers here) see price moving up and breaking through the main pivot like a hot knife through butter, they might buy so price will continue higher. That’s one of the reasons why pivots work so well, but it doesn’t mean they should be used alone.

 

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