
For many years, traders and market makers have used pivot points to identify critical support and/or resistance levels. Pivots are also frequently used in the forex market and can be an extremely useful tool for rangebound traders to identify points of entry and for trend traders and breakout traders to spot the key levels that need to be broken for a move to qualify as a breakout. In this section, we'll explain how pivot points are calculated, their applications in the forex market, and how they can be combined with other indicators to develop alternative trading strategies.
Calculating Pivot Points
By definition, a pivot point is a point of rotation. The input prices used to calculate the pivot point are the previous period's high, low and closing prices for a security. These prices are typically taken from a stock's daily charts, but the pivot point can also be calculated using information from hourly charts. Many traders prefer to take the pivots, as well as the support and resistance levels, off of the daily charts and then apply those to the intraday charts (for example, every 60 minutes, every 30 minutes or every 15 minutes). If a pivot point is calculated using price information from a shorter time frame, this tends to reduce its accuracy and significance.
The textbook calculation for a pivot point is as follows:
Central Pivot Point (P) = (High + Low + Close) / 3 
Support and resistance levels are then calculated off of this pivot point using the following formulas:
First level support and resistance:
First Resistance (R1) = (2*P)  Low First Support (S1) = (2*P)  High 
Likewise, the second level of support and resistance is calculated as follows:
Second Resistance (R2) = P + (R1S1)
Second Support (S2) = P  (R1 S1) 
Common practice is to calculate two support and resistance levels, but it's not unusual to derive a third support and resistance level as well. (However, thirdlevel support and resistances are a bit too esoteric to be useful for the purposes of trading strategies.) It's also possible to go further into pivot point analysis  for example, some traders go beyond the traditional support and resistance levels and also track the midpoint between each of those levels.
Applying Pivot Points to the FX Market
Generally speaking, the pivot point is seen as the primary support or resistance level. The following chart is a 30minute chart of the currency pair GBP/USD with pivot levels calculated using the daily high, low and close prices.
The green line is the pivot point (P).
The red lines are resistance levels (R).
The blue lines are support levels (S).
The yellow lines are midpoints (M).
Figure 1 demonstrates how the pivot line served as support for the GBP/USD pair for most of the European trading hours. Once the U.S. market opened and U.S. traders joined the market, however, prices began to break higher, with each of the breaks first testing and resisting either the midpoint or the R1 and R2 levels; then the break occurred off of those levels (see areas circled). This chart also shows something that occurs often in the forex market, which is that the initial break occurs at a market open. There are three market opens in the FX market: the U.S. open, (at approximately 8am EST), the European open (at 2am EST), and the Asian open (at 7pm EST).
Figure 1: This chart shows a common day in the FX market. The price of a major currency pair (GBP/USD) tends to fluctuate between the support and resistance levels identified by the pivot point calculation. The areas circled in the chart are good illustrations of the importance of a break above these levels. 
Source: FXTrek Intellicharts 
What we also observe when trading pivots in the forex market is that the trading range for the session usually stays between the pivot point and the first support and resistance levels because a large proportion of traders play this range. In Figure 2 (a chart of the USD/JPY), you can see in the areas circled that prices initially stayed between the pivot point and the first resistance level with the pivot acting as support. Once the price broke through the pivot level, the chart moved lower and stayed predominately within the pivot and the first support zone.
Figure 2: This chart shows an example of the strength of the support and resistance calculated using the pivot calculations. 
Source: FXTrek Intellicharts 
Several strategies can be developed using the pivot level as a reference point, but the accuracy of using pivot lines increases when Japanese candlestick formations can also be identified. For instance, if prices traded below the central pivot (P) for most of the session and then made a foray above the pivot while simultaneously creating a reversal indication (such as a shooting star, doji or hanging man), you could sell short in anticipation of the price resuming trading back below the pivot point.
Figure 3: This chart shows a pivot point being used in cooperation with a candlestick pattern to predict a trend reversal. Notice how the descent was stopped by the second support level. 
Source: FXTrek Intellicharts 
Figure 4: This is an example of a currency pair "obeying" the support and resistance identified by the pivot point calculation. These levels become more significant the more times the pair tries to break through. 
Source: FXTrek Intellicharts 

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