Pivot points are a widely recognized trading tool which have long been used by financial traders. Their use allows for a quick and easy calculation to be made which identifies the expected market bias and potential support and resistance levels either side of the current price.
They were first developed by floor traders as a quick and easy way to calculate near term market direction.
The calculation looks at the previous periods high, close and low to produce the core ‘Pivot Point’. This then provides the basis for projected moves either side of the central pivot.
They are easy to get to grips with and can be used to generate simple pivot point trading strategies to generate binary options signals.
The Theory
The Pivot Level provides the central focus of the strategy. Where the price trades in relation to the pivot is important. This displays the dominant market sentiment.
- If the price trades above the pivot level then the market is seen to have bullish sentiment.
- If the price trades below the pivot level then the market is seen as having bearish sentiment.
The calculation used to determine the pivot point comes from the OPEN, HIGH, LOW and CLOSE price of the preceding candles. This can be made for daily, weekly or even monthly charts allow multiple time-frames to be traded.
In addition to the central pivot, the calculation also yields levels of resistance and support either side of the pivot. These are referred to as R1, R2, R3 and S1, S2, S3.
The three most important levels are R1, S1 and the actual pivot point. These provide a quick visual indication of the directional bias and the nearest price target/ point of resistance.
While many chart packages now offer Pivot Points on your chart at the click of a button, you can use a calculator or manually calculate them from the calculation below if needed: -
- Resistance level 3 (R3) = HIGH + 2 * (Pivot – Low)
- Resistance 2 (R2) = PIVOT + (R1 – S1)
- Resistance 1 (R1) = 2 * PIVOT – Low
- Pivot Point (PP) = ( HIGH + CLOSE + LOW ) / 3
- Support 1 (S1) = 2 * PIVOT – HIGH
- Support 2 (S2) = PIVOT – (R1 – S1)
- Support 3 (S3) = LOW – 2*(High – Pivot)
Entry Signal
The basic idea behind pivot point trading is to use a move towards or a break of R1 or S1 as an entry point for the trade.
This approach is essentially a form of breakout strategy. You are simply backing the momentum anticipating that the break will continue. The entry is therefore at the point that the break of R1 or S1 occurs.
If the price breaks above resistance you place a call trade (backing the direction of the break) and conversely place a Put trade if it breaks lower.
A second way to trade Pivot points is to fade out the move. This is know as trading a price reversal. As the price reaches R2, R3 or S2, S3 it will become increasingly overbought or oversold.
A classic way for the trader to play this move is to enter a position as the market approaches one of these levels in the expectation of a pullback. It can however be quite risky to do this. Therefore it is best to seek additional confirmation that the price is ready to pause. Using an RSI indicator is one way of the easiest ways in which you can add validity to an exhausted move.
Binary Options Pivot Point Strategy Example
Here are two examples of how you can make use of Pivot points to trade with Binary options.
The first is to back the break of R1 or S1. This is easy to implement and involves placing the relevant Call or Put trade in the direction of the break.
The chart above shows the GBP/USD trading above the pivot (purple line). Price breaks through R1 (upper resistance - green line) at which point a Call trade is placed.
Here we could place an hourly expiry or set a contract to expire until the end of the day to take advantage of the move.
This second example shows how you can use R2, R3/ S2, S3 as points of exhaustion and consequently capture pullbacks and counter trend moves.
As with the previous strategy it is best to seek additional confirmation for the pullback. Use Candle patterns or additional technical indicators can help to confirm the counter trend move.
The chart shows the USDJPY rate becoming exhausted as it reaches R2 on the 15 minutes chart. This is confirmed by the pullback on the candle and also the RSI reading showing oversold.
Here a Put hourly or end of day expiry could be placed. Either would have proved profitable.
The keen eyed will also notice there was an opportunity just prior to this. While not as clear cut doing this would have proven profitable on either an hourly or end of day expiry.
Points to Consider
Pivot points are popular among traders because unlike many technical approaches, they are considered to be ‘leading’ rather than ‘lagging’ indicators. They provide an indication of where the market may head in advance of a price reaching the level.
It is because of their popularity that markets have a natural tendency to react at these levels. However what is not known is how strongly the market will react.
This is why when constructing a strategy around pivot points for Binary Options is best to combine them with additional confirmation. Try using additional indicators, chart patterns or Candlestick analysis. You will then be able to filter out false signals and increase the accuracy and ultimately the profitability of the strategy.