Pivot points provide a convenient method to identify intraday support and resistance levels.
This post will first explain how pivot points are calculated and interpreted. I’ll then use them to program a simple mean reversion strategy for the EURCHF.
You can download this strategy in the Free Strategies section.
As algorithmic traders, identifying support and resistance levels can be a challenge. Market structures that are easily discernable by the human eye are sometimes tedious to program.
Fortunately, pivot points provide a simple mathematical definition of support and resistance levels.
In this post, I’ll explain how pivot points are calculated, and how you can combine them with limit orders to produce a simple intraday mean reversion strategy.
What are Pivot Points?
Pivot points appear as a series of horizontal levels overlaid on prices. By default, they are calculated at the start of the trading day, and remain fixed until the close.
The central pivot point (PP) is an indication of the previous day’s average price.
Surrounding the central pivot are the first three intraday support and resistance levels, termed S1-S3 and R1-R3.
Pivot points are not a standard indicator in MT4; you can download an excellent one here.
Pivot Points Calculations
Different types of pivot point calculations have appeared over the years, but I’ll use the most common version here: the classic or floor pivot.
The previous day’s high (H), low (L) and close (C) prices will be used.
If you’re trading off intraday price levels, daily pivots are a good choice. If you’re a longer-term swing or position trader, you can also use weekly or even monthly pivots.
Interpreting Pivot Points
The central pivot point is an indicator of market sentiment. The market is bullish when trading above the pivot point, and bearish when trading below it. Prices fluctuate around the pivot during flat markets.
Like standard support and resistance levels, the S1-S3 and R1-R3 levels indicate potential market turning points. If a price penetration occurs, resistance levels usually become supports, and vice versa.
The chart below shows USDCAD interacting with the pivot supports on multiple occasions.
These support and resistance levels are typically used to determine trade entries and exits.
For instance, trend followers can go long when price penetrates R1, with a stop loss placed at the central pivot.
Lastly, since the second and third support/resistance levels are calculated using the previous day’s price range, the spacing between these levels gives an indication of prevailing market volatility.
Pivot Points Forex Trading Strategy
Since I’ve uploaded many longer-term trend following strategies, I’ll try my hand at intraday mean reversion this time.
Let’s attempt to fade moves on the 5-minute EURCHF, a traditionally ranging market.
I’ll break down each aspect of the strategy below.
It is crucial to select appropriate trading hours when developing a mean reversion strategy. Such strategies usually perform better during the quiet Asian hours, which is the trading window between the New York close and London open.
Within this low volatility window, random noise can cause temporary price extensions that quickly revert to the mean.
For this strategy, I’ll only open trades within the 0100-0900 hr (GMT +2/+3) window. Notice that I excluded the first hour after the New York close. This hour usually contains the largest spread and slippage, which can destroy the expectancy of intraday mean reversion strategies.
The idea is to expect a reversal when prices reach the support/resistance levels.
Recall that the pivot point and its associated support/resistance levels are calculated using daily prices. After some observation, it became apparent that the 5-minute EURCHF rarely reaches even the S1/R1 levels, especially during the quiet Asian hours.
To get more trades, I’ll use the midpoint between the pivot and S1 for long entries, and the midpoint between the pivot and R1 for shorts.
I’ll go long when price crosses above the PP-S1 midpoint, and short when price crosses below the PP-R1 midpoint.
I like to experiment with limit orders when taking a mean reversion approach. With a limit order, you can get a more favourable price and reduce your risk of slippage.
I’ll place the limit order 3 pips below the midpoint for longs, and 3 pips above the midpoint for shorts.
When combined with the entry condition above, this limit order means I’m betting that prices will retest the midpoint support/resistance after breaking through.
This makes sense because quiet markets typically don’t exhibit strong rejections of price around support and resistance levels. Prices usually hover around these levels, before gradually moving away from them.
I’m hoping the moves will run out of steam after this retest and quickly revert towards the pivot point, much like an overstretched rubber band snapping back into place.
Like day traders, I’ll reduce market exposure by closing any open trades at 2355 hr.
A 20-pip profit target and 60-pip stop loss will complete the strategy.
The pivot points entry condition is shown below.
When configuring the pivot points indicator, the Start Hour and Start Minute fields let you specify the start of each trading day.
Since I’m taking the New York close to be the start of the next trading day, I’ve input a starting time of 0000 hr (GMT +2/+3 broker).
And here are the trading actions.
The ConvertPipsToPrice function converts 3 pips to 0.0003.
Backtesting the Pivot Points Strategy
I decided to backtest with 1-minute OHLC prices for better precision because:
- Short-term mean reversion strategies usually have small expectancies
- Using limit orders means entries will occur within the 5-minute bars
Since the strategy trades during relatively quiet hours, I also specified a 1-pip slippage along with a 2-pip spread.
Here are the results from 2003-2021:
Nothing too impressive, but the equity curve shows the strategy has performed fairly consistently over the years.
Recall that this strategy only uses a single entry condition. It offers a good starting point for further development.
I recommend using the pivot points in conjunction with other indicators.
For example, taking mean reversion trades in the direction of a longer-term moving average can improve your win rate.
The pivot points indicator is a great tool when developing support and resistance-based strategies.
The central pivot point can be used as a barometer of market sentiment, while the surrounding support and resistance levels indicate potential turning points.
Look for impulsive breakouts around these levels if you’re a trend follower, or signs of overextension/weakness if you’re into mean reversion.
For higher probability trades, look for confluence between the pivot points and other indicators such as moving averages/Donchian channels/Fibonacci levels.
The strategy above can be downloaded in the Free Strategies section.