Points in Forex: Mapping Your Time Frame
by Raul Lopez of StraightForex.com
It is useful to have a map and be able to see where the
price is relative to previous market action. This way we
can see how is the sentiment of traders and investors at
any given moment, it also gives us a general idea of where
the market is heading during the day. This information can
help us decide which way to trade.
Pivot points, a technique developed by floor traders, help
us see where the price is relative to previous market action.
As a definition, a pivot point is a turning point or condition.
The same applies to the Forex market, the pivot point is
a level in which the sentiment of the market changes from
"bull" to "bear" or vice versa. If the
market breaks this level up, then the sentiment is said
to be a bull market and it is likely to continue its way
up, on the other hand, if the market breaks this level down,
then the sentiment is bear, and it is expected to continue
its way down. Also at this level, the market is expected
to have some kind of support/resistance, and if price can't
break the pivot point, a possible bounce from it is plausible.
Pivot points work best on highly liquid markets, like the
spot currency market, but they can also be used in other
markets as well.
In a few words, pivot point is a level in which the sentiment
of traders and investors changes from bull to bear or vice
Why Pivot Points work?
They work simply because many individual traders and investors
use and trust them, as well as bank and institutional traders.
It is known to every trader that the pivot point is an important
measure of strength and weakness of any market.
Calculating pivot points
There are several ways to arrive to the Pivot point. The
method we found to have the most accurate results is calculated
by taking the average of the high, low and close of a previous
period (or session).
Pivot point (PP) = (High + Low + Close) / 3
Take for instance the following EUR/USD information from
the previous session:
The PP would be,
PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us?
It simply tells us that if the market is trading above 1.2439,
Bulls are winning the battle pushing the prices higher.
And if the market is trading below this 1.2439 the bears
are winning the battle pulling prices lower. On both cases
this condition is likely to sustain until the next session.
Since the Forex market is a 24hr market (no close or open
from day to day) there is a eternal battle on deciding at
what time we should take the open, close, high and low from
each session. From our point of view, the times that produce
more accurate predictions is taking the open at 00:00 GMT
and the close at 23:59 GMT.
Besides the calculation of the PP, there are other support
and resistance levels that are calculated taking the PP
as a reference.
Support 1 (S1) = (PP * 2) - H
Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP - (R1 - S1)
Resistance 2 (R2) = PP + (R1 - S1)
Where , H is the High of the previous period and L is the
low of the previous period
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) - 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 - 1.2537) = 1.2537
S2 = 1.2439 - (1.2636 - 1.2537) = 1.2537
These levels are supposed to mark support and resistance
levels for the current session.
On the example above, the PP was calculated using information
of the previous session (previous day.) This way we could
see possible intraday resistance and support levels. But
it can also be calculated using the previous weekly or monthly
data to determine such levels. By doing so we are able to
see the sentiment over longer periods of time. Also we can
see possible levels that might offer support and resistance
throughout the week or month. Calculating the Pivot point
in a weekly or monthly basis is mostly used by long term
traders, but it can also be used by short time traders,
it gives us a good idea about the longer term trend.
S1, S2, R1 AND R2...? An Objective Alternative
As already stated, the pivot point zone is a well-known
technique and it works simply because many traders and investors
use and trust it. But what about the other support and resistance
zones (S1, S2, R1 and R2,) to forecast a support or resistance
level with some mathematical formula is somehow subjective.
It is hard to rely on them blindly just because the formula
popped out that level. For this reason, we have created
an alternative way to map our time frame, simpler but more
objective and effective.
We calculate the pivot point as showed before. But our
support and resistance levels are drawn in a different way.
We take the previous session high and low, and draw those
levels on today's chart. The same is done with the session
before the previous session. So, we will have our PP and
four more important levels drawn in our chart.
LOPS1, low of the previous session.
HOPS1, high of the previous session.
LOPS2, low of the session before the previous session.
HOPS2, high of the session before the previous session.
PP, pivot point.
These levels will tell us the strength of the market at
any given moment. If the market is trading above the PP,
then the market is considered in a possible uptrend. If
the market is trading above HOPS1 or HOPS2, then the market
is in an uptrend, and we only take long positions. If the
market is trading below the PP then the market is considered
in a possible downtrend. If the market is trading below
LOPS1 or LOPS2, then the market is in a downtrend, and we
should only consider short trades.
The psychology behind this approach is simple. We know
that for some reason the market stopped there from going
higher/lower the previous session, or the session before
that. We don't know the reason, and we don't need to know
it. We only know the fact: the market reversed at that level.
We also know that traders and investors have memories, they
do remember that the price stopped there before, and the
odds are that the market reverses from there again (maybe
because the same reason, and maybe not) or at least find
some support or resistance at these levels.
What is important about his approach is that support and
resistance levels are measured objectively; they aren't
just a level derived from a mathematical formula, the price
reversed there before so these levels have a higher probability
of being effective.
This mapping method works on both market conditions, when
trending and on sideways conditions. In a trending market,
it helps us determine the strength of the trend and combined
with price behavior helps us trade off important levels.
On sideways markets it shows us possible reversal levels.
It also helps us to set the Risk Reward ratio based on where
is the market relative to previous market action.
Written by Raul Lopez, instructor for StraightForex.com,
which offers a Complete Forex trading program including:
ONE-on-ONE coaching, a live conference room, and an online
forex course and guide for traders.