CHART

← Back to Technical Analysis of the Financial Markets Overview

CHART

Let’s begin with some of the basic differences between point and figure charting and bar charting and look at a couple of chart examples.

The point and figure chart is a study of pure price movement. That is to say, it does not take time into consideration while plotting the price action. A bar chart, by contrast, combines both price and time. Because of the way the bar chart is constructed, the vertical axis is the price scale and the horizontal axis, a time scale. On a daily chart, for example, each successive day’s price action moves one space or bar to the right. This happens even if prices saw little or no change for that day. Something must always be placed in the next space. On the point and figure chart, only the price changes are recorded. If no price change occurs, the chart is left untouched. During active market periods, a considerable amount of plotting may be required. During quiet market conditions, little or no plotting will be needed.

An important difference is the treatment of volume. Bar charts record volume bars under the day’s price action. Point and figure charts ignore volume numbers, as a separate entity. This last phrase, “as a separate entity,” is an important one. Although the volume numbers are not recorded on the point and figure chart, it does not necessarily follow that volume, or trading activity, is totally lost. On the contrary, since intraday point and figure charts record all price change activity, the heavier or lighter volume is reflected in the amount of price changes recorded on the chart. Because volume is one of the more important ingredients in determining the potency of support and resistance levels, point and figure charts become especially useful in determining at which price levels most of the trading activity took place and, hence, where the important support and resistance numbers are.

Figure 11.1 compares a bar chart and a point and figure chart covering the same time span. In one sense, the charts look similar, but, in another sense, quite different. The general price and trend picture is captured on both charts, but the method of recording prices is different. Notice in Figure 11.2 the alternating columns of x’s and o’s. The x columns represent rising prices, while the o columns show declining prices. Each time a column of x’s moves one box above a previous column of x’s, an upside breakout occurs. (See arrows in Figure 11.2.)

Figure 11.1 A comparison of a daily bar chart for the S&P 500 Index (left) and a point and figure chart (right) for the same time period. The point and figure chart uses x columns for rising prices and o columns for declining prices.

Figure 11.2 A buy signal is given when one x column rises above the top of a previous x column (see up arrows). A sell signal is given when a column of o’s falls below a previous o column (see down arrows). Signals are more precise

Correspondingly, when a column of o’s declines one box under a previous column of o’s, a downside breakout occurs. Notice how much more precise these breakouts are than those on the bar chart. These breakouts can, of course, be used as buy and sell signals. We’ll have more to say on buy and sell signals a bit later. But the charts demonstrate one of the advantages of the point and figure chart, mainly the greater precision and ease in recognizing trend signals.

Figures 11.3 and 11.4 reveal another major advantage of the point and figure chart: flexibility. While all three of the p&f charts cover the same price action, we can make them look very different to serve different purposes. One way to change the p&f chart is to vary the reversal criteria (let’s say from a 3 box reversal to a 5 box reversal). The larger the number of boxes required for a reversal, the less sensitive the chart becomes. The second way to vary the chart is to change the box size. Figure 2 uses a box size of 5 points. Figure 11.3 changes the box size from 5 points to 10 points. The number of columns has been reduced from 44 in the 5×3 chart in Figure 11.2 to only 16 columns in Figure 11.3. By using the larger box size in Figure 11.3, fewer signals are given. That allows the investor to concentrate on the major trend of a market by avoiding all the short term sell signals that are eliminated from the less sensitive chart.

Figure 11.3 Increasing the box size from 5 points to 10 makes the point and figure chart less sensitive and fewer signals are given. This is more suitable for a long term investor.

Figure 11.4 Reducing the box size to 3 points produces more signals. This is better for shorter term trading. The last rally from 920 to 1060 produced 6 different buy signals. Protective sell stops can be placed under the highest column of o’s (see S1-S5).

Figure 11.4 reduces the box size from 5 to 3. That increases the sensitivity of the chart. Why would anyone want to do that? Because it’s better for shorter term trading. Compare the last rally from 920 to 1060 in all three charts. The 10×3 chart (Figure 11.3) shows the last column as a series of x’s with no o columns. The 5×3 chart (Figure 11.2) shows the last upleg in 5 columns—3 x columns and 2 o columns. The 3×3 chart (Figure 11.4) breaks the last upleg into 11 columns—6 x columns and 5 o columns. By increasing the number of corrections during the uptrend (by increasing the number of o columns), more repeat buy signals are given either for later entry or for adding to winning positions. It also allows the trader to raise protective sell stops below the latest columns of o’s. The bottom line is that you can alter the look of the point and figure chart to adjust its sensitivity to suit your own needs.

CONSTRUCTION OF THE INTRADAY POINT AND FIGURE CHART

We’ve already stated that the intraday chart was the original type used by point and figure chartists. The technique was originally used to track stock market movement. The intent was to capture and record on paper each one point move of the stocks under consideration. It was felt that accumulation

(buying) and distribution (selling) could be better detected in this manner. Only whole numbers were employed. Each box was given a value of one point and each one point move in either direction was recorded. Fractions were largely ignored. When the technique was later adopted to commodity markets, the value of the box had to be adjusted to fit each different commodity market. Let’s construct an intraday chart using some actual price data.

The following numbers describe 9 actual days of trading in a Swiss franc futures contract. The box size is 5 points. Therefore, every 5 point swing in either direction is plotted. We’ll start with a 1 box reversal chart.

Figure 11.5a is what the previously listed numbers would look like on the chart. Let’s begin on the left side of the chart. First the chart is scaled to reflect a 5 point increment for every box.

• Column 1: Put a dot at 4875. Because the next number—4880—is higher, fill in the next box up to 4880.
• Column 2: The next number is 4860. Move 1 column to the right, go down 1 box, and fill in all the o’s down to 4860.
• Column 3: The next number is 4865. Move 1 column to the right, move up 1 box and put an x at 4865. Stop here. So far you have only 1 x marked in column 3 because prices have only moved up 1 box. On a 1 box reversal chart, there must always be at least 2 boxes filled in each column. Notice that the next number is 4850, calling for o’s down to that number. Do you go to the next column to record the column of declining o’s? The answer is no because that would leave only 1 mark, the x, in column 3. Therefore, in the column with the lone x (column 3) fill in o’s down to 4850.

Figure 11.5a A 5×1 point and figure chart of a Deutsche mark contract is shown in the upper chart. The blackened boxes show the end of each day’s trading. Figure 11.5b shows the same price data with a 3 box reversal. Notice the compression. Figure 11.5c shows a 5 box reversal.

• Column 4: The next number is 4860. Move to the next column, move 1 box up, and plot in the x’s up to 4860.
• Column 5: The next number is 4855. Because this is a move down, go to the next column, move down a box, and fill the o at 4860. Notice on the table that this is the last price of the day. Let’s do one more.
• Column 6: The first number on 5/2 is 4870. So far, you only have one o in column 5. You must have at least 2 marks in each column. Therefore, fill in x’s (because prices are advancing) up to 4870. But notice that the last price on the previous day is blacked out. This is to help keep track of time. By blacking in the last price each day, it’s much easier to keep track of the separate days’ trading.

Feel free to continue through the remainder of the chart to sharpen your understanding of the plotting process. Notice that this chart has several columns where both x’s and o’s are present. This situation will only develop on the 1 point reversal chart and is caused by the necessity of having at least 2 boxes filled in each column. Some purists might argue with combining the x’s and o’s. Experience will show, however, that this method of plotting prices makes it much easier to follow the order of the transactions.

Figure 11.5b takes the same data from Figure 11.5a and transforms it into a 3 box reversal chart. Notice that the chart is condensed and a lot of data is lost. Figure 11.5c shows a 5 box reversal. These are the 3 reversal criteria that have traditionally been used—the 1, 3, and 5 box reversal. The 1 box

reversal is generally used for very short term activity and the 3 box for the study of the intermediate trend. The 5 box reversal, because of its severe condensation, is generally used for the study of long term trends. The correct order to use is the one shown here, that is, begin with the 1 point reversal chart. The 3 and 5 box reversals can then be constructed right off the first chart. For obvious reasons, a 1 point reversal chart could not possibly be constructed from a 3 or 5 box reversal.

THE HORIZONTAL COUNT

One principal advantage of the intraday 1 box reversal chart is the ability to obtain price objectives through use of the horizontal count. If you think back to our coverage of bar charts and price patterns, the question of price objectives was discussed. However, virtually all methods of obtaining price objectives off bar charts were based on what we call vertical measurements. This meant measuring the height of a pattern (the volatility) and projecting that distance upward or downward. For example, the head and shoulders pattern measured the distance from the head to the neckline and swung that objective from the break of that neckline.

Point and Figure Charts Allow Horizontal Measurement

The principle of the horizontal count is based on the premise that there is a direct relationship between the width of a congestion area and the subsequent move once a breakout occurs. If the congestion area represents a basing pattern, some estimate can be made of the upside potential once the base is completed. Once the uptrend has begun, subsequent congestion areas can be used to obtain additional counts which can be utilized to confirm the original counts from the base. (See Figure 11.6.)

The intent is to measure the width of the pattern. Remember we’re talking here of intraday 1 box reversal charts. The technique requires some modifications for other types of charts that we’ll come back to later. Once a topping or basing area has been identified, simply count the number of columns in that top or base. If there are 20 columns, for example, the upside or downside target would be 20 boxes from the measuring point. The key is to determine which line to measure from. Sometimes this is easy and, at other times, more difficult.

Usually, the horizontal line to count across is near the middle of the congestion area. A more precise rule is to use the line that has the least number of empty boxes in it. Or put the other way, the line with the most number of filled in x’s and o’s. Once you find the correct line to count across, it’s important that you include every column in your count, even the ones that are empty. Count the number of columns in the congestion area and then project that number up or down from the line that was used for the count.

Figure 11.6 By counting the number of columns across the horizontal congestion area, price objectives can be determined. The wider the congestion area, the greater the objective.

PRICE PATTERNS

Pattern identification is also possible on point and figure charts. Figure 11.7 shows the most common types.

As you can see, they’re not much different from ones already discussed on bar charting. Most of the patterns are variations on the double and triple tops and bottoms, head and shoulders, V’s and inverted V’s, and saucers. The term “fulcrum” shows up quite a bit in the point and figure literature. Essentially, the fulcrum is a well defined congestion area, occurring after a significant advance or decline, that forms an accumulation base or a distribution top. In a base, for example, the bottom of the area is subjected to repeated tests, interrupted by intermittent rally attempts. Very often, the fulcrum takes on the appearance of a double or triple bottom. The basing pattern is completed when a breakout (catapult) occurs over the top of the congestion area.

BOTTOMS	TOPS
	Fade 4 %
پښې Ī, FULCRUM $\mathbf{u}^{\mathbf{r}}$	ļË. .ia. $\mathbf{F}^{\dagger}$
ħ.	INVERSE FULCRUM
وأيتها मसन	ਦਿੰ ≠≕
Manufacture	æ
	Property Hiddle
46 COMPOUND, FULCRUM
ļm æ,	₩
	INVERSE COMPOUND FULCRUM - क्रम
أأسأسل Тч,
	西西
Ħ
DELAYED ENDING t.	₩
Ţ	DELAYED ENDING
زاج وزغبت أشتشينها Alberta	ᅭ ŧ
ببيق ÿ
INVERSE HEAD & SHOULDERS 一	.मे ५ œ
جت ĨН	W 30
in Trais Program	e la la HEAD & SHOULDERS
ħ 21	čμ.
в
ling	يعترا الملهزع
v	P,
رية. مناطق	画生 تلهي
$4.11 -$	NVERTED v
	$\overline{\mathbb{F}_{2}}_{\mathbb{F}^2}$
₩. And find V EXTENDED	فسلو an T yan,
airig Tirada
	. برايا #at INVERTED EXTENDED v
March	ж
à,
* تاتين DUPLEX HORIZONTAL	بالإنبانيانية
	HORIZONTAL 11 DUPLEX
نبادوا الينينانية lių.	h ÷m,
	₩
	PERS
$\mathbb{F}^{\overline{\mathbb{F}^{\mu}}}$ ÷
SAUCER	Fig. ₩. INVERSE SAUCER
	4 المبية
三种 Service

Figure 11.7 Reversal patterns. (Source: Alexander H. Wheelan, Study Helps in Point and Figure Technique [New York, NY: Morgan, Rogers and Roberts,

Inc., 1954] p. 25.) Reprinted in 1990 by Traders Press, P.O. Box 6206, Greenville, SC 29606.]

Those reversal patterns with the most pronounced horizontal ranges obviously lend themselves quite well to the taking of count measurements. The V base, in contrast, because of the absence of a significant horizontal price area, would not be amenable to the taking of a horizontal count. The blackened boxes in the chart examples in Figure 11.7 represent suggested buying and selling points. Notice that those entry points generally coincide with the retesting of support areas in a base or resistance areas in a top, breakout points, and the breaking of trendlines.

Trend Analysis and Trendlines

The price patterns in Figure 11.7 show trendlines drawn as part of those patterns. Trendline analysis on intraday charts is the same as that applied to bar charts. Up trendlines are drawn under successive lows and down trendlines are drawn over successive peaks. This is not true of the simplified point and figure chart, which we’re going to study next. It utilizes 45 degree lines and plots them differently.

3 BOX REVERSAL POINT AND FIGURE CHARTING

In 1947, a book on point and figure was written by A.W. Cohen entitled, Stock Market Timing. The following year, when the Chartcraft Weekly Service was started, the book’s name was changed to The Chartcraft Method of Point & Figure Trading. Several revised editions have been published since then to include commodities and options. In 1990, Michael Burke wrote The All New Guide to the Three-Point Reversal Method of Point & Figure Construction and Formations (Chartcraft, New Rochelle, NY).

The original 1 box reversal method of plotting markets required intraday prices. The 3 box reversal was a condensation of the 1 box and was meant for intermediate trend analysis. Cohen reasoned that because so few 3 box reversals occurred in stocks during the day that it was not necessary to use intraday prices to construct the 3 box reversal chart. Hence the decision to use only the high and low prices, which were readily available in most financial newspapers. This modified technique, which is the basis of the Chartcraft service, greatly simplified point and figure charting and made it accessible to the average trader.

CONSTRUCTION OF THE 3 POINT REVERSAL CHART

The construction of the chart is relatively simple. First, the chart must be scaled in the same way as the intraday chart. A value must be assigned to each box. These tasks are performed for subscribers to the Chartcraft service because the charts are already constructed and the box values assigned. The chart shows a series of alternating columns with x’s representing rising prices and the o columns showing falling prices. (See Figure 11.8.)

The actual plotting of the x’s and o’s requires only the high and low prices for the day. If the last column is an x column (showing rising prices), then look at the high price for the day. If the daily high permits the filling in of 1 or more x’s, then fill in those boxes and stop. That’s all you do for that day. Remember that the entire value of the box must be filled. Fractions or partial filling of the box don’t count. Repeat the same process the next day, looking only at the high price. As long as prices continue to rise, permitting the plotting of at least one x, continue to fill in the boxes with x’s, ignoring the low price.

The day finally comes when the daily high price is not high enough to fill the next x box. At that point, look at the low price to determine if a 3 box reversal has occurred in the other direction. If so, move one column to the right, move down one box, and fill the next 3 boxes with o’s to signify a new down column. Because you are now in a down column, the next day consult the low price to see if that column of o’s can be continued. If one or more o’s can be filled in, then do so. Only when the daily low does not permit the filling in of any more o’s do you look at the daily high to see if a 3 box reversal has occurred to the upside. If so, move 1 column to the right and begin a new x column.

Figure 11.8 Source: Courtesy of Chartcraft, Inc., New Rochelle, NY.

Chart Patterns

Figure 11.9 shows 16 price patterns most common to this type of point and figure chart—8 buy signals and 8 sell signals.

Let’s take a look at the patterns. Since column 2, showing signals S-1 through S-8, is just a mirror image of column 1, we’ll concentrate on the buy side. The first 2 signals, B-1 and B-2, are simple formations. All that is required for the simple bullish buy signal is 3 columns, with the second column of x’s moving 1 box above the previous column of x’s. B-2 is similar to B-1 with one minor difference—there are now 4 columns, with the bottom of the second column of o’s higher than the first. B-1 shows a simple breakout through resistance. B-2 shows the same bullish breakout but with the added bullish feature of rising bottoms. B-2 is a slightly stronger pattern than B-1

for that reason.

The third pattern (B-3), breakout of a triple top, begins the complex formations. Notice that the simple bullish buy signal is a part of each complex formation. Also, as we move down the page, these formations become increasingly stronger. The triple top breakout is stronger because there are 5 columns involved and 2 columns of x’s have been penetrated. Remember that the wider the base, the greater the upside potential. The next pattern (B-4), ascending triple top, is stronger than B-3 because the tops and bottoms are both ascending. The spread triple top (B-5) is even stronger because there are 7 columns involved, and 3 columns of x’s are exceeded.

The upside breakout above a bullish triangle (B-6) combines two signals. First, a simple buy signal must be present. Then the upper trendline must be cleared. (We’ll cover the drawing of trendlines on these charts in the next section). Signal B-7, upside breakout above a bullish resistance line, is self-explanatory. Again, two things must be present. A buy signal must have already been given; and the upper channel line must be completely cleared. The final pattern, the upside breakout above a bearish resistance line (B-8), also requires two elements. A simple buy signal must be combined with a clearing of the down trendline. Of course, everything we’ve said regarding patterns B-1 through B-8 applies equally to patterns S-1 through S-8 except that, in the latter case, prices are headed down instead of up.

Figure 11.9 Source: K.C. Zieg, Jr., and P.J. Kaufman, Point and Figure Commodity Trading Techniques (New Rochelle, NY: Investors Intelligence) p. 73.

There is a difference between how these patterns are applied to commodity markets as opposed to common stocks. In general, all 16 signals can be used in stock market trading. However, because of the rapid movement so characteristic of the futures markets, the complex patterns are not as common in the commodity markets. Much greater emphasis is therefore placed on the simple signals. Many futures traders utilize the simple signals alone. If the trader chooses to wait for the more complex and stronger patterns, many profitable trading opportunities will be missed.

THE DRAWING OF TRENDLINES

In our discussion of intraday charts, it was pointed out that trendlines were drawn in the conventional way. This is not the case on these 3 point reversal charts. Trendlines on these charts are drawn at 45 degree angles. Also, trendlines do not necessarily have to connect previous tops or bottoms.

The Basic Bullish Support Line and Bearish Resistance Line

These are your basic up and down trendlines. Because of the severe condensation on these charts, it would be impractical to try to connect rally tops or reaction lows. The 45 degree line is, therefore, used. In an uptrend, the bullish support line is drawn at a 45 degree angle upward to the right from under the lowest column of o’s. As long as prices remain above that line, the major trend is considered to be bullish. In a downtrend, the bearish resistance line is drawn at a 45 degree angle downward to the right from the top of the highest column of x’s. As long as prices remain below that down trendline, the trend is bearish. (See Figures 11.10-11.12.)

At times, those lines may have to be adjusted. For example, sometimes a correction in an uptrend breaks below the rising support line after which the uptrend resumes. In such cases, a new support line must be drawn at a 45 degree angle from the bottom of that reaction low. Sometimes a trend is so strong that the original up trendline is simply too far away from the price action. In that case, a tighter trendline should be drawn in an attempt to arrive at a “best fitting” support line.

Figure 11.10 Examples of the Chartcraft three point reversal stock charts. Notice that the trendlines are drawn at 45 degree angles. (Source: Courtesy of Chartcraft, New Rochelle, NY.)

Figure 11.11 Two more examples of the Chartcraft 3 point reversal method of point and figure charting. Trendlines on these charts are drawn at 45 degree angles. (Source: Courtesy of Chartcraft, New Rochelle, NY.)

Figure 11.12 The box to the bottom left shows a horizontal target to 92 in British Telecomm PLC arrived at by tripling the base and adding to 50. To the right, a vertical target to 102 is arrived at by tripling the x column and adding to 63. (Source: Courtesy of Chartcraft, New Rochelle, NY.)

MEASURING TECHNIQUES

Three point reversal charts allow the use of two different measuring techniques—the horizontal and the vertical. For the horizontal, count the number of columns in a bottom or topping pattern. That number of columns must then be multiplied by the value of the reversal or the number of boxes needed for a reversal. For example, let’s assign a $1.00 box value to a chart with a 3 box reversal. We count the number of boxes across a base and come up with 10. Because we’re using a 3 box reversal, the value of that reversal is $3.00 (3x$1.00). Multiply the 10 columns across the base by $3 for a total of $30. That number is then added to the bottom of the basing pattern or subtracted from the top of a topping pattern to arrive at the price objective.

The vertical count is a bit simpler. Measure the number of boxes in the first column of the new trend. In an uptrend, measure the first up column of x’s. In a downtrend, measure the first down column of o’s. Multiply that value by 3 and add that total to the bottom or subtract it from the top of the column. What you’re doing in effect with a 3 box reversal chart is tripling the size of the first leg. If a double top or bottom occurs on the chart, use the second column of o’s or x’s for the vertical count. (See Figure 11.12.)

TRADING TACTICS

Let’s look at the various ways that these point and figure charts can be used to determine specific entry and exit points.

• 1. A simple buy signal can be used for the covering of old shorts and/or the initiation of new longs.
• 2. A simple sell signal can be used for the liquidation of old longs and/or the initiation of new shorts.
• 3. The simple signal can be used only for liquidation purposes with a complex formation needed for a new commitment.
• 4. The trendline can be used as a filter. Long positions are taken above the trendline and short positions below the trendline.
• 5. For stop protection, always risk below the last column of o’s in an uptrend and over the last column of x’s in a downtrend.
• 6. The actual entry point can be varied as follows:
  • a. Buy the actual breakout in an uptrend.
  • b. Buy a 3 box reversal after the breakout occurs to obtain a lower entry point.
  • c. Buy a 3 box reversal in the direction of the original breakout after a correction occurs. Not only does this require the added confirmation of a positive reversal in the right direction, but a closer stop point can now be used under the latest column of o’s.
  • d. Buy a second breakout in the same direction as the original breakout signal.

As you can readily see from the list, there are many different ways that the point and figure chart can be used. Once the basic technique is

understood, there is almost unlimited flexibility as to how to best enter and exit a market using this approach.

Adjusting Stops

The actual buy or sell signal occurs on the first signal. However, as the move continues, several other signals appear on the chart. These repeat buy or sell signals can be used for additional positions. Whether or not this is done, the protective stop point can be raised to just below the latest o column in an uptrend and lowered to just over the latest x column in a downtrend. This use of a trailing stop allows the trader to stay with the position and protect accumulated profits at the same time.

What to Do After a Prolonged Move

Intermittent corrections against the trend allow the trader to adjust stops once the trend has resumed. How is this accomplished, however, if no 3 box reversals occur during the trend? The trader is then faced with a long column of x’s in an uptrend or o’s in a downtrend. This type of market situation creates what is called a pole, that is, a long column of x’s and o’s without a correction. The trader wants to stay with the trend but also wants some technique to protect profits. There is at least one way to accomplish this. After an uninterrupted move of 10 or more boxes, place a protective stop at the point where a 3 box reversal would occur. If the position does get stopped out, reentry can be done on another 3 box reversal in the direction of the original trend. In that case, an added advantage is the placement of the new stop under the most recent column of o’s in an uptrend or over the latest column of x’s in a downtrend.

ADVANTAGES OF POINT AND FIGURE CHARTS

Let’s briefly recap some of the advantages of point and figure charting.

• 1. By varying the box and reversal sizes, these charts can be adapted to almost any need. There are also many different ways these charts can be used for entry and exit points.
• 2. Trading signals are more precise on point and figure charts than on bar charts.
• 3. By following these specific point and figure signals, better trading discipline can be achieved. (See Figures 11.13-11.18.)

Figure 11.13 This chart of Treasury Bond futures prices covers more than two years. The arrows mark the buy and sell signals. Most of the signals captured the market trend very well. Even when a bad signal is given, the chart quickly corrects itself.

Figure 11.14 The early 1994 sell signal (first down arrow) lasted all the way through 1994. The buy signal at the start of 1995 (first up arrow) lasted for two years until 1997. A sell signal in mid-1997 turned into a buy at the start of 1998.

Figure 11.15 This chart condenses the previous dollar chart by doubling the box size. Only two signals are given on this less sensitive version. The last signal was a buy (see up arrow) in mid-1995 near 85, which has lasted for almost three years.

Figure 11.16 This point and figure chart of gold gave a sell signal (see down arrow) near $380 during 1996. Gold prices fell another $100 over the next two years.

Figure 11.17 The crude oil point and figure chart gave a sell signal (see down arrow) near $20 during October 1997 and caught the subsequent $6 tumble. Crude oil prices would have to rise above the last x column at 16.50 to reverse the downtrend.

Figure 11.18 This point and figure chart of the Semiconductor Index gave four signals over a period of two and a half years. The down arrows mark two timely sell signals in 1995 and 1997. The buy signal during 1996 (first up arrow) caught most of the ensuing rally.

P&F TECHNICAL INDICATORS

In his 1995 book, Point & Figure Charting (John Wiley & Sons), Thomas J. Dorsey espouses the Chartcraft method of 3 point reversal charting of stocks. He also discusses point and figure application to commodity and options trading. In addition to explaining how to construct and read the charts, Dorsey also shows how the P&F technique can be applied to relative strength analysis, sector analysis, and in the construction of an NYSE Bullish Percent Index. He shows how p&f charts can be constructed for the NYSE advance decline line, the NYSE High-Low Index, and the percentage of stocks over their 10 and 30 week averages. Dorsey credits Michael Burke, the publisher of Chartcraft, (Chartcraft, Inc., Investors Intelligence, 30 Church Street, New Rochelle, N.Y. 10801) with the actual development of these innovative p&f indicators which are available in that chart service.

COMPUTERIZED P&F CHARTING

Computers have taken the drudgery out of point and figure charting. The days of laboriously constructing columns of x’s and o’s are gone. Most charting software packages do the charting for you. In addition, you can vary the box and reversal sizes with a keystroke to adjust the chart for shorter or longer term analysis. You can construct p&f charts from real-time (intraday) and end of day data, and you can apply them to any market you want. But you can do a lot more with a computer.

Kenneth Tower (CMT), technical analyst for UST Securities Corporation, (5 Vaughn Drive, CN5209, Princeton, N.J. 08543) uses a logarithmic method of point and figure charting. A screening process that measures the volatility of a stock over the last 3 years determines the right percentage box size for each stock. Figures 11.19 and 11.20 show examples of Tower’s logarithmic p&f charts applied to America Online and Intel. The box size for AOL in Figure 11.19 is 3.6%. A 1 box reversal, therefore, would require a retracement of 3.6%. Since that happens to be a 2 box reversal chart, prices would have to retrace 7.2% to start a new column. Each box size for the Intel chart shown in Figure 11.20 is worth 3.2%.

Figure 11.19 A logarithmic point and figure chart of America Online. The reversal criteria is based on percentages. Each box is worth 3.6%. Since this is a two box reversal chart, a reversal is worth 7.2%. Notice the horizontal upside counts to 69.7 and 136.5 (see arcs). (Chart courtesy of UST Securities Corp.)

Figure 11.20 A one box reversal point and figure chart of Intel using percentages. A reversal of 3.2% is needed to move into the next column. Measuring horizontally from right to left along the base, upside counts can be made to 33 and then to 87.6 (see arcs). (Chart courtesy of UST Securities Corp.)

The arcs you see on both charts are examples of using horizontal price counts across a price base to arrive at short and long term price objectives. The Intel chart, for example, shows a short term objective to 33, arrived at by measuring halfway across the price base (lower arc). The larger arc, which measures to 87.6, is arrived at by measuring across the entire price base and

projecting that distance upward. If you look closely at Figures 11.19 and 11.20, you’ll also see price dots trailing the price action. Those dots happen to be moving averages.

P&F MOVING AVERAGES

Moving averages are usually applied to bar charts. But here they are on point & figure charts, courtesy of Ken Tower and UST Securities. Tower uses two moving averages on his charts, a 10 column and a 20 column moving average. The dots you see in Figures 11.19 and 11.20 are 10 column averages. These moving averages are constructed by first finding an average price for each column. That is done by simply adding up the prices in each column and dividing the total by the number of x’s or o’s in that column. The resulting numbers are then averaged over 10 and 20 columns. The moving averages are used in the same way as on bar charts.

Figure 11.21 shows two point and figure charts of the same stock with 10 column averages (dots) and 20 column averages (dashes). The bottom chart is a 2.7% reversal logarithmic chart of Royal Dutch Petroleum going back to 1992. Notice that the faster moving average stayed above the slower moving average from 1993 to the 1997 during the four year uptrend. You can see the two moving averages coming together during the second half of 1997 in what turned out to be a consolidation year for that stock. To the far right, you can see that Royal Dutch may be on the verge of resuming its major uptrend. A closer look at that potential upside breakout is seen in the upper chart in Figure 11.21.

The upper chart is a traditional one point reversal linear chart of the same stock. The time frame covered in the linear chart is much shorter than the long chart. But you get a closer look at the late 1997 and early 1998 price action and can see the short term upside breakout at the start of 1998. The stock still needs to close through 60 to confirm a major bullish breakout. The moving averages haven’t been much help during the trading range (they never are), but should begin to trend higher once again if the bullish breakout materializes. By adding moving averages to point and figure charts, Ken Tower brings another valuable technical indicator to p&f charting. The use of logarithmic charts also adds a modern wrinkle to this old charting method.

Figure 11.21 Two point and figure versions of Royal Dutch Petroleum. The bottom chart is a log chart spanning several years. The upper chart is a linear chart for one year. The dots and dashes represent 10 and 20 column moving averages, respectively. (Prepared by UST Securities Corp. Updated through March 26, 1998.)

CONCLUSION

Point and figure charting isn’t the oldest technique in the world. That credit goes to the Japanese candlestick chart, which has been used in that country for centuries. In the next chapter Greg Morris, author of two books on candlesticks, will introduce that ancient technique that has gained new popularity in recent years among Western technical analysts.

INTRODUCTION

While the Japanese have used this charting and analysis technique for centuries, only in recent years has it become popular in the West. The term, candlesticks, actually refers to two different, but related subjects. First, and possibly the more popular, is the method of displaying stock and futures data for chart analysis. Secondly, it is the art of identifying certain combinations of candlesticks in defined and proven combinations. Fortunately, both techniques can be used independently or in combination.

CANDLESTICK CHARTING

Charting market data in candlestick form uses the same data available for standard bar charts; open, high, low, and close prices. While using the exact same data, candlestick charts offer a much more visually appealing chart. Information seems to jump off the page (computer screen). The information displayed is more easily interpreted and analyzed. The box below is a depiction of of a single day of prices showing the difference between the bar (left) and the candlestick(s). (See Figure 12.1.)

Figure 12.1

You can see how the name “candlesticks” came about. They look somewhat like a candle with a wick. The rectangle represents the difference between the open and close price for the day, and is called the body. Notice that the body can be either black or white. A white body means that the close price was greater (higher) than the open price. Actually, the body is not white, but open (not filled), which makes it work better with computers. This is so that it will print correctly when printing charts on a computer. This is one of the adaptations that have occurred in the West; the Japanese use red for the open body. The black body means that the close price was lower than the open price. The open and close prices are given much significance in Japanese candlesticks. The small lines above and below the body are referred to as wicks or hairs or shadows. Many different names for these lines appear in Japanese reference literature, which is odd since they represent the high and low prices for the day and are normally not considered vital in the analysis by the Japanese. (See Figure 12.2.)

Figure 12.2 shows the same data in both the popular bar chart and in a Japanese candlestick format. You can quickly see that information not readily available on the bar chart seems to jump from the page (screen) on the candlestick chart. Initially, it takes some getting use to, but after a while you may prefer it.

Figure 12.2

The different shapes for candlesticks have different meanings. The Japanese have defined different primary candlesticks, based upon the relationship of open, high, low, and close prices. Understanding these basic candlesticks is the beginning of candlestick analysis.