Introduction: Point And Figure Charting

INTRODUCTION

The first charting technique used by stock market traders before the turn of the century was point and figure charting. The actual name "point and figure" has been attributed to Victor deVilliers in his 1933 classic, The Point and Figure Method of Anticipating Stock Price Movements. The technique has had various names over the years. In the 1880s and 1890s, it was known as the "book method." This was the name Charles Dow gave it in a July 20, 1901 editorial of The Wall Street Journal.

Dow indicated that the book method had been used for about 15 years, giving it a starting date of 1886. The name "figure charts" was used from the 1920s until 1933 when "point and fig­ure" became the accepted name for this technique of tracking market movement. R.D. Wyckoff also published several works dealing with the point and figure method in the early 1930s.

The Wall Street Journal started publishing daily high, low, and closing stock prices in 1896, which is the first reference to the more commonly known bar chart. Therefore, it appears that the point and figure method predates bar charting by at least 10 years.

We're going to approach point and figure charting in two steps. We'll look at the original method that relies on intraday price moves. Then we'll show you a simpler version of point and figure charting that can be constructed by using only the high and low prices for any market.

THE POINT AND FIGURE VERSUS THE BAR 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, the 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 on point and figure charts.

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

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).

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 5x3 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 11.4 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 10x3 chart (Figure 11.3) shows the last column as a series of x's with no o columns. The 5x3 chart (Figure 11.2) shows the last upleg in 5 columns—3 x columns and 2 o columns. The 3x3 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.