4.45 Trading the Breaks with Pivot Points

 

In the previous chapter we saw how to trade the bounces from the pivot point levels. The hard reality is that pivot point levels do fail many a time, and when such ‘breaks’ happen, we should be ready to trade them.

 

If you’re the trigger-happy kind, you could enter the trade right away on the break. If you’re the steady and careful kind you might like to enter after a confirmatory pullback, in which case some pips would have to be sacrificed from the trend move.

 

Trend following is the core strategy behind trading breakouts of pivot points. Most traders only trade breakouts of the pivot point level itself and then R1 and S1 levels as they are the more reliable trading signals. The S2 and R2 levels seldom break, and even when they do, they usually serve as a powerful price barrier. In fact it is quite common to see a retracement back to these levels after a break.

 

We enter long trades immediately after the break of a resistance level, and short trades after the break of a support. For long trades place the stop loss just below the broken resistance level. For short trades the stop loss is best placed above the broken support level.

 

Profit targets are usually set at the next support or resistance as the case may be.

 

Here’s a look at how we work these trades.

 

Using pivot points for breakout trading on a Forex chart.

 

In the above Forex chart, the price broke above the pivot point and that was the first indication that we could go long. But wait. Let's see where the pivot point stood in comparison to the previous open price! It was above that level. In fact it was above both open & close prices and that tells us that the market sentiments are on bullish side. We wait till the price breaks above the high of the resistance zone around the pivot point and then go for a long position. The stop-loss can be slightly below the recent low as indicated by the grey line. The first profit target can be slightly below the first resistance i.e. the R1.

 

The chart shows that the price did go up and hit the R1 level but the resistance of that level forced it to retrace back before moving up again. Let's not take any action in such situation. During this subsequent upward jump the R1 level again came up as resistance. In such case you may decide to go for a range trading position by taking a short-selling position with a very narrow stop-loss, which is just above the R1 level, and a target price which is slightly above the pivot point.

 

The price hit the pivot point and then tried to break that support. We just wait and watch. The support in zone "C" held and price moved up again. Now because the R1 level held as resistance twice, we do not go for another long position and rather wait to see if that resistance holds again or not

 

And yes, this time price breaks above R1 and a long trade was entered immediately at the blue line. We placed a stop at the thick grey line just below R1 and also below the recent resistance of two price bars. The target for booking profits was set just below R2. Please note that if the strength of the trend goes high then the profit target can be moved to just below R3 from R2, as happened in this example.

 

Yet another option is to book the profits for half the position size at R2 and target R3 for the remaining half. See how we caught the target and the trade closed at the set targets. 

 

In the following example, let’s see how this strategy worked on a short trade. 

 

Pivot point with downward breakout.

 

The price plunged through PP and the break triggered our short trade. The stop-loss level is indicated with grey line and the target price level was the next support level i.e. S1. You can see that the short trade paid off. Not only that but we entered another short-position with the break of S1 to target S2 and that went in our favor. 

 

Closing words on pivot breakouts

 

Remember that breakouts can also be fake outs. Temporary spikes in the price may be caused by news events, and these spikes could hustle you into a breakout trade which later turns sour when price returns to the true trend.

 

Always use confirmatory evidence. Cross-check your pivot levels with alternate tools such as historical support and resistance, candlesticks and technical indicators.

 

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