The market has key support and resistance levels – the market zones wherein a potential reversal is imminent.
However, the financial markets are inherently dynamic. While the price naturally ranges from its S/R levels, it also carries the tendency to break through them.
One way to spot a potential market breakout is to calculate and plot multiple pivot points into your trading chart.
In this lesson, we'll discuss the importance of pivot points in identifying a breakout trend and the best practices to ensure you're correctly trading the breakout with pivot points.
For technical analysts, pivot points are popular leading indicators that help identify the potential for reversal or continuation of the existing trend.
When you plot pivot points into your chart, you mark the historical turning points of the market. Once all points are connected, key support and resistance levels are created.
These levels are important for understanding market dynamics, especially the impact of bulls (buying pressure) and bears (selling pressure) on trend movement.
Since the price moves due to various factors, these levels tend not to hold. This results in a market breakout wherein the price trades beyond the established levels.
When a breakout happened, the broken level's role reversed.
Assume the 4-hour EUR/USD chart shows a support level at 1.2000 and a resistance level at 1.2500. However, the appreciating price action is about to reach 1.2500. If the price bounces back and declines, the price fails to retest the level.
To your surprise, the price continued trading upward – indicating a market breakout. Due to this breakout, the resistance level became the new support level.
Related: TradersUnited – What Are Support and Resistance Levels in Forex?
Before we dig deep into the value of pivot points for breakout trading, we must first understand the two methods used to trade during market breakout.
Aggressive breakout trading involves immediate action upon the price breakout. While this presents profitable opportunities due to immediate exposure in breakout, this carries significant risks due to the probability of a false signal.
The safe or conservative approach is to wait for the price to retest the key levels several times before executing a trade. This is considered a safe way; however, taking this approach means missing out on the initial profits from the breakout.
Now, let us understand the value of pivot points in identifying breakout trends and spotting profitable entry or exit positions.
Related: TradersUnited – Types of Forex Market Breakouts
Buying an asset is not a secret when the price gears upward.
However, it's typically uncommon for traders to anticipate a buy position when the price nears the resistance level.
Why? Simple – it's because a bullish market will likely reverse to bearish when it reaches that level.
Since a potential breakout trend might happen, entering a buy position as the price touches and breaks through the resistance level is correct.
When the price finally broke from the established resistance level, it hinted at strong buying pressure – bound to push the price even higher.
In a declining market, traders usually anticipate a bullish market as the price approaches and touches the support level.
However, it's different when the trader expects the market to break out from its support level.
Essentially, the support level carries immense buying pressure. This is the market level that historically pushed up a declining asset.
However, a breakout market reverses this perspective – technically informing the traders that the market will move beyond the established key support and resistance level.
Thus, a declining price approaching the support level signals a potential market breakout. This ultimately signifies a selling opportunity; wherein traders can either enter a short position or exit a long position.
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