Construction of the 3 Point Reversal Chart

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 are 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

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-l through S-8, is just a mirror image of column 1, we'll concentrate on the buy side. The first 2 signals, B-l 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-l with one minor difference—there are now 4 columns, with the bottom of the second column of o's higher than the first. B-l 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-l 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-l through B-8 applies equal­ly to patterns S-l through S-8 except that, in the latter case, prices are headed down instead of up.

Figure 11.9

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.