Pivot points can be controversial because there are so many competing versions. The core concept is to use a summary of the current period’s High, Low, and Close to project support or resistance for the upcoming period. Pivot points are a rough-and-ready forecast that some analysts name a “leading indicator,” although they do not actually “indicate” anything except a set of arbitrary projections. Moreover, pivot points lack the nuance of indicators that measure the close against the high, or the close against the high-low range. However, as in all things technical in Forex, if a high proportion of traders use pivot points and if they are all deriving the same or similar projections, pivot points have the capacity to become a self-fulfilling prophecy.
A virtue of pivot points is that once they are charted based on past numbers, they do not change, and so you can watch the price action develop compared to the pivot point projections, which are drawn as horizontal lines off the last close. In equities, it is common to use the H-L-C of the previous week to create pivot points for the upcoming week, but in faster-moving Forex, traders may use yesterday’s H-L-C for the current period or the H-L-C of the first four-hour period for trading on a one-hour basis. You can imagine endless combinations.
The arithmetic for the standard pivot point is straightforward, but at least five versions of pivot points can be found, each tweaking the arithmetic a little. The classic formula starts with the Primary Pivot Point, or P, which is High + Low + Close divided by 3.
The Fibonacci version of pivots points uses Fibonacci numbers to project support and resistance:
DeMark Pivot Points were devised by Tom DeMark, who has invented many other indicators, many of them embraced by hedge fund leaders. The DeMark version makes the important point that it really does matter if the close is over the open or below it when calculating pivots. DeMark inserts a new factor named X:
See the chart below, which shows the DeMark support and resistance levels for the 5-period prices in the circle projected out into the future. The price high manages to break R1 resistance, but not the close. This is an important point — some analysts say that breaking support or resistance by any part of the bar is enough to call it breakout, but Sperandeo is among the experts who say you must insist on the close breaking the line to call it a “breakout.” In this instance, the high was a blow-out top and the price proceeded to crash, and crash through support. Notice that the price wavered and hesitated for a day before the breakout. This suggests that more than one trader was looking at the exact DeMark level.
In this instance, the data used is five periods of data (in EUR/USD) and it took over twenty periods for the final true breakout to occur. This is the final virtue of pivot points — they can serve as an anchor to prevent impulsive, gut-feel trades until the evidence is really in.
Now see the next chart, the classic pivot point calculation (named the “floor pivot points”). The same data is used as in the DeMark example. Notice that the somewhat lower R1 is broken, but for only two periods up to the blow-out top. Then, after the price is falling, it hovers just above support for 6 periods before finally delivering a breakout-by-the-close. Again, this suggests that many traders were placing support at or near this level.
And therein lies a problem. If you were to put all the various pivot point calculations on a single chart, you would be paralyzed by indecision. Which one is “correct”? Well, all of them and none of them. There is no single right answer — there is just the calculation methodology that syncs with your risk appetite and degree of discipline. For example, the DeMark version would have you going short at a higher level (1.37418) than the classic “floor” version (1.36857 for S1).
How do you choose? Pivot points should be used in conjunction with other indicators that suit your trading style. If we add MACD to the classic pivot point chart, for example, we get a sell signal on the date the price breaks the pivot point itself. See the next figure below. You could use that breakout for an initial entry and the breakout of S1 to scale into to a bigger position.