Some
readers might think I’ve taken some old book down from the shelf
and blown the dust off it to write this lesson, but the truth is Point and
Figure charting is alive and well. In my opinion, this method of technical
analysis is a great way to stay focused on the markets. The basic idea behind
Point and Figure charting is to eliminate insignificant movement in the market
and expose the real battle between
the bulls and the bears. If you take the time to understand the concepts behind
the system, it can be a tool to keep your judgment clear of the "noise"
that builds up from constant analysis.
This
lesson will cover the basics of creating Point and Figure charts.
When
I told someone in the office I was doing a lesson on Point and Figure charting,
they said, “Aha! Point and figure out where your money went!” The truth is:
Nothing is a sure thing in the world of trading. A surprising number of
successful professionals use this tool for exactly what it is -- a logical and
organized way to understand supply and demand. Only significant price movements
are accounted for, filtering out the irrelevant jives and jukes of the market.
For this reason, less subjectivity is involved in identifying patterns.
Like
every strategy trying to conquer the enigma of the markets, Point and Figure
charting has its limits. There is no volume accounted for and the element of
time is not represented in linear fashion. This shouldn’t be an issue, if you
use traditional bar and candlestick charts as well. I like Point and Figure
charting for following sectors. By keeping a steady handle on where the indexes
are, I am able to base my other strategies.
It
is not certain as to exactly when Point and Figure charting came about. Charles
Dow called it the “book method” in 1901, claiming it had been around for 15
years -- giving it a birth date of 1886. Victor deVilliers gave the method its
modern name in his 1933 classic The Point
and Figure Method of Anticipating Stock Price Movements. It is also rumored
that in 1901, legendary trader James R. Keene used the charts to promote the
stock for Andrew Carnegie who hired him to sell huge amounts of equity, without
crashing the price. Point and Figure charting is the oldest form of Western
technical analysis.
The
Basics
The
best way to learn Point and Figure charting is to actually make them yourself.
At first the concepts may seem a little obscure, but with practice, you will
find them to be extremely logical. The main components of the system are X’s
and O’s:
Either
an X or an O will be put in a “box” to designate the appropriate price
action. Each column represents either bullish or bearish action, so X’s and
O’s will always remain in their own column.
Each
“box” represents a price range. The range is decided upon by the creator of
the chart. The smaller the “box size,” the more sensitive and suitable the
signals will be for shorter-term trading. In general, these guidelines are
followed for the traditional method:
| Price
Range |
Box
Size |
| 5
- 20 |
.50
|
| 20
- 100 |
1
|
| 100
- 200 |
2
|
| 200
- 500 |
4
|
The
price values are never rounded, in other words 4.95 would be a 4, not a 5.
The
last component of the system is the “reversal number.” This is also decided
upon by the chart creator. This number designates the number of boxes the price
action must reverse in a column to confirm a shift to the next column, which
will be the opposite direction. Traditionally the reversal number is 3. So if in
a bullish column of X’s, the
price action must hit a new low by 3 points to merit a move over to a new column,
which will be bearish. The smaller the reversal number, the more sensitive the
chart will be. Someone working with a shorter trading time frame may want to
adjust this technique for his or her own needs. Although this may seem a little
confusing at first, the following flow chart maps out the process:
Now
let's go through the process with the example below:
