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Lesson 7
Point & Figure Charting
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(To obtain this as a PDF document click here)
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This method of charting has been in use since around the year 1880 and was given the name "book method" by Charles Dow in one of his editorials in the Wall Street Journal around 1901. The name "Point and Figure" was only used as late as 1933 by a man called Victor deVilliers.
Point and Figure charting is an extremely complex subject so we'll begin by looking at some differences between Bar charts and Point and Figure charts:
Bar Charts are constructed using the highest price traded for the day and the lowest price traded for the day in a vertical line, with a horizontal dash on the vertical line to denote the closing price for the day. It is plotted at specific time intervals (daily, weekly, monthly etc.) no matter whether there is a change in price for the subsequent times or not. That is, no change in the price for the following day would be reflected by using the closing price of the previous day and representing it as a dash - no high and no low. So, the bar chart combines both price and time. That is, the vertical axis is the price scale and the horizontal axis is the time scale. The daily (or weekly, or monthly etc.) price action moves one space or bar to the right on each successive day (week, month etc.), even if there was no change in price for the day. So something always has to be placed in the next space for the next trading period. In other words, Bar charts give a one-dimensional view of price action.
Gaps, or price areas on the chart where no trading has taken place, are represented in bar charts by an empty vertical space between one period of trading and another.
In Point and Figure Charts only the price changes are recorded, so that if no price change has occurred, no plotting is done. However, much plotting may be required when there is considerable market activity. Point and Figure charts are constructed using a combination of X's and O's known as "boxes". Each successive rise in price is represented with an X in the same vertical line and each successive fall in price with an O in the next vertical line. Two things have to be taken into consideration when plotting a Point and Figure chart:
First, the size of each box must be determined. The smaller the box size the more the trading activity is detailed and the larger the box size the less the detail of price movement. So, to decide the size of the box it is important to consider whether you're wanting to look at a short, medium or long-term view. The longer-term the chart, the larger the box size must be, otherwise the chart becomes too large and unwieldy.
Second, the type of Point and Figure Chart must be chosen (ie. a regular chart or a reversal chart). In the regular chart, each price change is recorded, whereas in the reversal a new series of X's or O's cannot begin until prices have moved by a specified amount in the opposite direction to the prevailing trend.
Although volume is not recorded under the Point and Figure chart, volume activity is not totally lost as heavier or lighter volume is reflected in the amount of price changes recorded on the chart.
The original type of Point and Figure charts used were intra-day charts. The intent was to record each “one point” move of the stocks under consideration on paper, the aim being to find a way of "fine-tuning" the detection of accumulation and distribution. Only whole numbers were used and each "box" was assigned the value of one point. Each one-point move in either direction was recorded.
Today, it is more common to vary the size of the box according to the value of the stock under consideration and according to the sensitivity the chartist wishes to obtain.
As with the values, the reversal size can also be changed. The reversal criterion means the number of boxes that the price of a stock must retrace before it is filled into the next column on the right. The most popular reversal size is the three point reversal, which means that the price reversal must be equal to the value of three boxes before the boxes are filled.
The size of the box and the reversal size then, are the only ways in which the Point and Figure chart can be varied.
For the very short-term trader, mostly in the futures arena, where intra-day trading is often the order of the day, the one point reversal is the most useful. The most popular reversal criterion is the three point reversal, which is most used for the study of the intermediate trend, and the five point reversal is used for long-term trends because of its severe condensation.
Time reference points can be included for interest sake, but have no bearing on the interpretation of the chart.
Constructing a Point & Figure Chart
The choices you make regarding the box size and the reversal size are essentially based on personal judgement.
Commonly a box size of about 1% is a good starting (and often ending) point. Thus if the current share price is 1000, you would use a box size of 10.
Thus every time the share moves up by 10 cents, we plot an X, and every time it moves down by 10 cents we plot an O.
If the share moves up by only 9 cents, no X is plotted - it must move by a full 10 cents before we mark an X.
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The whole object of the point and figure chart is that it smooths out minor fluctuations in the graph so that only major trends are reflected.
In addition to selecting a “Box” size we must also select a “Reversal” size.
The “reversal” is an additional smoothing tool in Point and Figure charting. - if we have a reversal of 3,
this means that when the share price has been rising and starts to fall,
we will only start to plot O’s when the price has fallen by 3 times 10 cents (or 30 cents).
So even if the share price is at 1200 cents, falls 29 cents to 1171 cents, we will not make any entry on the point and figure chart until it falls the full 30 cents.
Again one is attempting to smooth out minor fluctuations in the graph.
As a technical analyst, you have to decide what is the best “Box” and “Reversal” size required to give you the best picture of the share prices’s trend.
Most chartists prefer to use the 3-point reversal and that will be the best starting point for you.
In the chart shown here, we are using a box size of 5 (each X or O represents a price move of 5 cents) with a three (3) box reversal.
The price of the share has gone up to 100 cents (the first vertical column on the left).
The price may have gone up to 101, 103 or even 104 cents, but it did not reach 105 cents (otherwise you would have plotted another X at 105).
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If the price declines to 85 cents (or lower, but not as low as 80 cents), a 3-box reversal has taken place.
The uptrend that was in place is considered broken.
A downtrend has started and it is denoted by a row of three O’s in the second vertical column.
If the price of the share declined to 80 cents, another O would be added.
The downtrend will remain in force until the price reverses up by at least 3 times the box size (i.e. 3 x 5 = 15 cents in this example).
Assume that the price fell all the way to 75 cents (or lower), but not as far as 70 cents.
Your chart would now resemble the second column with the 5 O’s.
Once the price has risen to 90 cents (ie 15 cents above the plotted low of 75 cents) the downtrend will have stopped.
The chart will now depict the new uptrend with the 3 X’s as shown in the 3rd column.
Interpreting the Point and Figure Chart
There are a variety of formations to look for in a point and figure chart.
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The previous examples of how to plot a Point & Figure chart in themselves demonstrate the simplest of buy and sell signals that can be obtained. We will recap them below along with more complex signals.
All that is required for the simple buy and sell signals is three columns, with the second column of X's moving one box above the previous column of X's to generate the buy signal,
or the second column of O's moving below the previous column of O's to generate the sell signal.
This represents a simple breakout through resistance or support.
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Notice that in the bullish pattern both the tops and the bottoms are ascending, and in the bearish pattern both the tops and bottoms are descending,
making this a stronger pattern than the previous examples.
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Even stronger because here there are seven columns and three columns of X's are exceeded on the upside breakout, three columns of O's are exceeded on the sell.
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This one combines two signals:
First, a simple buy signal must be present.
Then the upper trend line must be cleared - for the buy signal.
For the sell signal the opposite holds true.
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Two things must happen here:
A buy/sell signal must already have been given and the upper channel line must be completely cleared on the upside breakout, and the support line on the downside breakout.
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A simple buy/sell signal must already have been given, combined with the clearing of the bearish resistance or support line.
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Remember!
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The simple bullish buy or sell signal is a part of each complex formation. |
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The formations as they have been shown become increasingly stronger. |
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The wider the base of the formation, the greater its upside or downside potential. |
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There is a difference between how these patterns are applied to commodity markets as opposed to common stocks.
However, the complex patterns are more common to stock market trading. |
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Simple patterns need not be heeded when looking for entry into the market, but when they move in the downward direction should not be ignored. |
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By varying the box and reversal sizes these charts can be adapted to suit almost any need. |
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Drawing Trend lines on P & F Charts
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In intra-day charts trend lines are drawn in the conventional way. However, not so in the three point reversal charts. Here they are drawn at a 45-degree angle and do not necessarily have to connect tops or bottoms. This is due to the condensed nature of these charts. Horizontal lines (ie. 180 degrees) can be used to emphasize double/triple tops and bottoms.
There are two basic types of trend lines, namely the basic bullish Support line and the basic bearish Resistance line.
In an uptrend the bullish support line is drawn at a 45-degree angle upwards to the right from under the lowest column of O's. As long as prices remain above that line, the major trend is in bull territory. A breakout through the bullish support line constitutes a sell signal.
In a downtrend the bearish resistance line is drawn at a 45-degree angle downwards to the right from the top of the highest column of X's. As long as prices remain below that trend line, the major trend is considered bearish. A breakout through this bearish resistance line constitutes a buy signal.
As with conventional trend line analysis, this trend line can, at times, be redrawn. A correction in an uptrend can sometimes break below the rising support line and whip around to resume the uptrend. The 45-degree angle line is then redrawn from that reaction low. Sometimes the uptrend is so strong that the price moves too far from the 45-degree line. In that case it is advised to redraw a tighter line to achieve a best fit situation. Either way the 45-degree angle is not a rigid rule, but rather to be used as a guideline.
Point & Figure Channel Lines
Channel lines are lines drawn parallel to the basic bullish support line or the bearish resistance line. In an uptrend the channel line is called the bullish resistance line and in a downtrend it is called the bearish support line. These lines are considered much less reliable than the basic trend lines, so it is important that these channel lines are completely cleared in order for a penetration to occur. An X or an O that lands right on the trend line does not constitute a penetration.
Channel lines are used mainly as timing aids. They can be helpful in knowing when to take some profits, but should never be used to take a position against the prevailing trend.
The Horizontal Count
The three point reversal method allows for two different measuring techniques - the horizontal and the vertical. The horizontal method works best when the upside breakout has been preceded by a long period of accumulation of shares, in which supply and demand have been battling one another. This gives rise to a “horizontal base” consisting of a number of vertical columns of X’s and O’s. Usually, the greater the number of columns in this base, the higher the share can be expected to rise after the breakout.
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First add the number of columns that form the base that the reversal broke out of.
In the chart opposite a triple bottom at 750 was broken through.
This base was made up of 8 columns.
We are using a 3 x 15 reversal and box size so we multiply this by the number of columns.
Thus, we have 3 x 15 x 8 = 360.
Next we subtract this value from the highest value (840) in the base to get the downside target.
We thus have 840 - 360 = 480 as the target.
In this example the market actually went down to 420.
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The same concepts apply in the reverse to locate an upside target.
Here there is a base of 12 columns on a 2 x 3 Point & Figure chart.
This gives a potential move of 72.
The low in the base was 210 and thus the upside target is 282.
The market reached 280 before consolidating.
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The Vertical Count
A vertical count is based on the general principle that the higher the first vertical row of Xs in an upside breakout, the higher the ultimate target.
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Again you want to look for a breakout.
Add the number of X’s (or O’s) in the first column and multiply by box size and reversal.
In this example of a 2 x 3 chart, the first column of the downside breakout started at 248 and is 10 blocks.
Thus the initial downside move is 10 x 2 x 3 = 60
Subtract this value from the highest value (start) of the column to get the target.
Thus the target is 248 - 60 = 188. In reality a bottom of 210 was reached.
Subtract this value from the highest value of the column to get the downside target
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Similarly, on the upside a break occurred in the opposite 3 x 3 chart after the first column which started at 213 rose 11 blocks.
Thus, we add this initial move of 3 x 3 x 11 = 99 to the start of 213 to get a target of 312.
In reality the market moved to 318.
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There are several important points that need to be made in respect of both horizontal and vertical calculations.
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Upside target calculations are more dependable when the general trend of the market is up. |
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Downside calculations are more accurate when the general trend of the market is down. |
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Investment decisions based purely on Point and Figure calculations are risky. |
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The calculated target must be considered along with other technical and fundamental information. |
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If both a vertical and a horizontal count can be done, and if both project a similar target, this is clearly more dependable.. |
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There is no time-limit for the target to be attained./td>
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| Wave Theory |
The idea that history repeats itself has itself recurred throughout history and it is hardly surprising as man is surrounded by evidence of cycles; the 24-hour cycle of the sun, the 28-day cycle of the moon and the tides, the annual cycle of seasons and so forth.
Obviously the cycles of the seasons have had a marked influence upon agricultural economies from very ancient times and so it is hardly surprising that many people have tried to impose cyclic, or wave theory upon other, far more complex economic models.
One of the first modern observers to try and apply cycles to economic events was a US farmer named Arthur Brenner who published his “Prophecies of Future Ups and Dows in Prices” in 1875.
At the turn of the century an American mathematician, W D Gann, was one of the first men on record to successfully apply cyclic theory to the stock market. However, perhaps the best-known advocate of “Wave Theory”, as the subject has become known, was a Russian economist named Nicolai Kontratieff who plotted economic history going back centuries to come up with a pattern of super-cycles of boom and depression that most of us have seen reproduced somewhere sometime.
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Ralph Nelson Elliott was the first, however, to promote a cult that has nagged at investors ever since.
He found that the stock market moved in a series of natural waves or rhythms.
He found that there were 5 waves in the direction of the main trend (impulse waves 1, 3, 5) with corrective waves 2 and 4, followed by 3 waves in a counter direction (the correction).
This pattern was found to occur on a minute to minute basis or on a year to year basis.
Note that the five graph points are always those where the graph line changes direction - the troughs and crests of minor waves within one big wave - a minor crest followed by a minor trough, another minor crest and another minor trough followed by a crest which is itself the peak of a bigger wave. Then there follows three downward moves within the down phase of the bigger wave.
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He identified two types of waves, namely Impulse (the one going in the direction of the trend) and Corrective (going opposite to the current trend).
In the five wave move there are three Impulse waves and two Corrective waves.
He also established that there are relationships between the sizes of these waves and thus once you have identified a wave pattern and are part way through it,
you can accurately determine the extent of future moves.
He noted that of the Impulse waves, Wave 3 would usually be about 1.618 or 2.618 times the size of Wave 1.
Also Wave 5 would either equal or be about 1.618 times the size of Wave 1.
There are exceptions to these general rules, but usually these relative sizes would apply.
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With the two Corrective Waves,
Wave 2 cannot be longer than wave 1.
Usually Wave 2 will be either 0.618, 0.5 or 0.382 times the size of Wave 1
Wave 4 cannot return such that it overlaps into Wave 1.
Usually Wave 4 will be 0.382 or 0.236 times the size of Wave 3
With the Corrective Waves, Wave C will either be equal to Wave A in size. Alternatively Wave C will be 1.618 or 0.618 times the size of Wave A
Normally Wave C will end about 0.618 times the size of wave A past Wave A.
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It is also possible for Wave A to Equal Wave B which equals Wave C.
The Elliott wave need not always be a uniform 5 wave bull formation. Elliott noted that “extensions” sometimes happened at crests 1, 3 or 5. These, he said, lacked the elongated sub wave evident in the diagram, but tended to break down into nine waves of approximately the same length.
Wave 2 often turns out to be a protracted sideways market but the downside will usually be where the highest support level is found. By the end of Wave 2, many investors have been weeded out. Wave 3 is usually the longest wave in the formation, and the most profitable bull phase. Volume and price movements are strong and you will usually find several extension at this stage of the market. Where the third wave is extended, you will usually find that Wave 1 and 5 are equal in time and size.
The ABC correction can take place during a bear or bull trend. It simply corrects the previous trend. Wave A is often considered to be a “minor correction” and the market will ignore. Wave B’s are “bull/bear traps” where investors believe the primary trend is again bullish. Wave C’s often turn out to be sustained bear trends where investors off-load their shares to protect whatever is left of their capital.
Joseph Granville noted that the three up-waves tend usually to be of about the same time duration, followed by two down-waves of relatively short duration. Furthermore, he noted that the time taken from the very beginning of one bull market to the very beginning of the next, on Wall Street, is on average between four and four-and-a-half years. Roughly speaking that is an up-cycle of three years followed by a down lasting between a year and 18 months. Experience of the South African market suggests, however, that our cycles tend to be of varying length.
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As a final chart to keep Wave Analysis as one of the technical Analysis tools you will do well to consider, note how based on the above thory,
and just using the data up to the end of December 2022!
The first wave which started in October 2022 and went up to end November was initially identified.
Then it’s retracement (wave 2) to the last week of December was identified.
Then, based on just this and no future knowledge, Wave Analysis at the end of December identified the top of wave 3 in February 2023,
the level of pull-back of Wave 4 in March 2023, and the top the Market moved to (Wave 5) at the end of July 2023.
Happy Investing and always consider your Charts, especially those Waves!
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(You can also obtain this Lesson as a PDF document from our Services Menu, or click here)
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