By definition, a pivot point is a point of rotation. The prices used to calculate the pivot point are the previous period's high, low and closing prices for a security. These prices are usually taken from a daily chart but the pivot point can also be calculated using information from hourly charts.
Pivot Point Calculation
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
Second level of support and resistance is:
Second Resistance (R2) = P + (R1-S1)
Second Support (S2) = P - (R1- S1)
How to Use Pivot Points
Pivot points are used in two main ways by FX traders.
If you are trading within the range, you would enter a buy order into support level and a sell order into resistance. The levels can also be used with other indicators to identify a breakout when the price breaks through the pivot points and trades outside the range.
In a trading range, the support and resistance lines will be parallel and traders look the market to turn when it approaches them and remain within the range. You will see two of each on your chart - the first support line is twice the pivot point minus yesterday's high. The second support level is the pivot point minus the high minus the low. Resistance lines are the mirror image of support lines in reverse.
To time trading signals into levels you can use various momentum oscillators and popular ones are - the MACD, stochastic and Relative strength Index (RSI) are all popular oscillators to confirm trading signals.
The basic logic of pivot point trading is simple and based on the assumption that prices will tend to fluctuate between support and resistance levels, in line with the current trend and is a simple and easy to understand trading technique.