Don’t confuse the two methods as one. I want to make it clear the Fibonacci Retracement and the Pivot Points are two different methods and must not be confused as a single trading method. Both produce mathematically derived support and resistance levels that traders may use either as indicators of possible retracement turns or as zones to watch for breakouts. The horizontal price levels that are generated through Fibonacci retracement levels and the pivot points are calculated using different methods and formulas.
Why Fibonacci retracement levels and the pivot points work most of the time? One question that might bug your mind is that why these Fibonacci retracement levels and pivot points work in the market. What is the secret behind this? What makes these tools work surprisingly well under diverse market conditions is the simple fact that many traders both small and large use Fibonacci retracement levels and pivot points in their trading.
Markets are just people like you and me buying or selling. In our case, trading again buying and selling securities or currencies! Once people start believing in something, it starts getting reflected in the market price action. This is why significant price action occurs around these levels due to the fact that many traders are watching and reacting to these price levels. Therefore the levels derived from these two tools become self fulfilling prophecy.
When the majority does the same thing, it starts effecting the market movement. This phenomenon contributes to the Fibonacci retracement levels and pivot points frequent effectiveness and accuracy in describing the market movement. The most common Fibonacci retracement levels are 23.6%, 38.2% and 61.8%. These three Fibonacci retracement levels are most frequently followed by the traders.
As said above, Fibonacci retracement levels are very popular among the traders. There is a full fledge Fibonacci trading method. You will hear very often, the commentary on CNBC or Bloomberg that price is approaching the 38.2% retracement level and something important like a turn could occur at this level. This shows the popularity of Fibonacci retracement levels among the trading community.
Both Fibonacci retracement and pivot point trading methods have clear cut locations for the stop loss placement similar to most support/resistance trading methods. Fibonacci retracements can be traded either as a breakout opportunity or as a retracement bounce. Fibonacci levels can also be used as profit targets for existing open trades.
Most of the technical indicators used in technical analysis are lagging in nature. Pivot points are leading indictors of the price action in the market. This makes them very useful for the traders. Pivot points are derived mathematically from the previous day’s data that includes the previous day’s high. Low and close. The main pivot point (PP) is calculated by taking the average of the high, low and close of the previous days’ price action.
After calculating the main pivot point (PP), four other primary pivot points are calculated from the main pivot point (PP). Two are below the main PP. Two are above the main PP. The levels above are R1 and R2 where R stands for resistance.
You can still use the main pivot point (PP) as the only number in your trading but traders who frequently use pivot points in trading have refined these numbers into more sub-numbers. The two levels below the main PP are the S1 and S2 where S stands for the Support. Often these pivot points are further extended to R3 and S3. You can easily find a pivot point calculator online. Most of the charting software also can calculate the pivot points.
Many trader use pivot points in their trading! Pivot point trading can be a highly profitable trading method. However, it is always good for the trader to know how these pivot point numbers are calculated. This will give the trader an understanding of how these numbers are calculated and what are the variables that are used to calculate them.
There are a number of pivot points that you need to calculate. How is the pivot levels calculated? Beginning with the main Pivot Point that is calculated from the previous day’s key price points, the resulting support and resistance are subsequently derived from the following calculations:
Resistance 1 R1 = 2PP- Previous Low. Resistance 2 R2 = PP + (R1-S1).
Resistance 2 R3 = Previous High + 2(PP-Previous Low).
Main Pivot Point PP = (Previous Low + Previous High + Previous Close)/3.
Support 3 S3 = Previous Low-2(Previous High –PP). Support 2 S2= PP- (R1-S1). Support 1 S1 = 2PP – Previous High.
The main pivot point is very important. After calculating these pivot points they are plotted on the currency price chart. Trader’s can calculate the current day’s pivot points using the above formulas based on the previous day’s price data.
Breakouts or bounces may be traded with pivot points. Once these pivot levels are calculated and plotted, they are used in much the same way as Fibonacci Retracement.
These pivot points are often also used as profit targets. Pivot points also indicate whether the market sentiment is bullish or bearish. Traders also use pivot points as reference levels to provide information as to whether the current price is relatively low or relatively high within its expected price range for the day.
S1, S2 and S3 as well as R1, R2 and R3 are used as references in pivot point trading. For example, traders may look for long trading opportunities with the view that the price will reasonably move towards equilibrium around the main PP level if the price is near the day’s S2.
Many traders use different time frames in their trading decisions. You can also calculate the pivot levels for a week and for a month time frame too. Instead of calculating the pivot points for the current day you can also calculated the above levels for 4 hour charts as well as 8 hour charts.
When calculating the pivot points for the other time frames just replace the day’s highs, lows and the closing prices with the appropriate time frame highs, lows and closing prices. Both Fibonacci and Pivot Points are excellent technical tools that often encompass entire trading discipline in themselves.
The pivot point can become the target low for the trading session in an extremely bullish market condition. This number represents the true value of a prior session. It is important to understand that especially in strong bull or bear market conditions, it can be used as an actual trading number in determining the high or the low of a given time period.
Traders will step in and buy the pullback until that pivot point is broken by prices trading below that level. A retracement back to the pivot will attract buyers if the market gaps higher above the pivot point in an uptrending market. The opposite is true for the pivot point will act as the target high for the session in an extremely bearish market condition.
Technically speaking, in a bearish market, the highs should be lower and the lows should be lower than in the preceding time frame. Generally prices come back up to test the pivot point if a news-driven event causes the market to gap lower after traders take time interpreting the information and the news. Sellers will take action and start pressing the market lower again if the market fails to break that level and trade higher.