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Wednesday, December 2, 2009

Lesson 6 - Point-and-Figure Charts

You know what point-and-figure charts look like: an elongated version of tic-tac-toe. Yet, they provide another means of determining a trend. In fact, their advantage over a bar chart is the specific buy and sell signals — no personal interpretation is needed.

The pork belly chart is shown for the same time period in both bar chart and point-and-figure form. The differences in appearance are striking. This is due mainly to the lack of a time scale on the point-and-figure chart. Time is irrelevant; price movements are charted only when they occur. On days when no new high or low is made, no additional entries are made on the chart.

Also, on a point-and-figure chart, the price scale marks the space between the lines rather than on the lines as bar charts are marked.

Pork Bellies Pork Bellies Point and Figure

Upward price action in a point-and-figure chart is indicated by X's; downward movement by 0's.

The point-and-figure chart gives a simple buy signal when an X in the latest column has filled a box that is one box higher than the preceding column of X's. A simple sell signal appears when the latest column is in 0's, and the 0's fill the box below the previous column of 0's. These simple signals are marked on the pork belly point-and-figure chart on this page.

Each point-and-figure chart you see will have a box size and reversal number. In this case, it is 40 x 6, which means each box is worth 40 points, and it takes a price change of six full boxes in the opposite direction to start a new column. When beginning a new column, the box adjacent to the last entry is always left empty.

Rules for plotting

  • When plotting X's, wait for the price to rise to fill the entire box before adding another X to the current column. Likewise, when working with a down trending column of 0's, wait for prices to drop to fill the whole box before adding another 0 to the column.
  • Based on a single day's price action, you don't add to the current column and then plot a reversal. If you continued the current column of X's or 0's, don't start a new column based on one day's price action.

For example, if the most recent column is X's, look at the daily high first. If the high is high enough to require drawing one or more additional X's in the current column, the daily low is ignored, regardless of how low it might be. If the trend has truly reversed, it will be revealed the following day Only if you can't add an X do you check the low to see if you can fill the required number of boxes for a reversal.

A similar procedure is used when the current column is 0's. Look at the daily low first and ignore the high if you can add to the 0 column. As before, only if you can't add an 0 do you check the high to determine if you can add enough X's for a reversal. A flow chart for plotting a 3-box reversal chart is below.

Point and Figure Flow Chart

Each vertical column will always have at least the number of X's or Os needed for a reversal. For example, the pork belly illustration of a 40 by 6 box size and reversal will always have at lease six X's or 0's in each column.

There are many formations on point-and-figure charts, but breakouts of double or triple tops or bottoms are probably the most reliable ones. The last rally (the June rally) on the pork belly point-and-figure chart to just over the 70 f level was a breakout of a triple top.

Trendlines can also be used on point-and-figure charts. Most traders agree that the 45-degree trendline, which cuts each box diagonally, is more useful than connecting highs or lows as you do on a bar chart.

An uptrend line is started at the lower right hand comer of the box with an 0 and drawn up to the right at a 45-degree angle. A downtrend line begins at the upper right hand comer of a box with an X and is drawn down at a 45-degree angle to the right.

Advanced Point and Figure

Selective use

Breakouts of point-and-figure formations must completely clear the 45-degree line, and, if applicable, move one box higher or lower than the previous column of like letters.

The disadvantage of point-and-figure charts is that they may be slow to signal trend changes. Since point-and-figure traders are buying and selling breakouts, follow through is needed for a profitable trade. Similar to moving averages, they don't work well in sideways markets.

One way to use the point-and-figure selectively is to ignore minor trend reversals when a new column is started. Some whipsaws may be reduced by ignoring minor signals unless they are in tune with the major trendline on the point-and-figure chart.

Source

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