Getting Started with Points and Figures Charting
Point and Figure charts aren't your typical stock chart; they are useful, easy to interpret, and can quickly be used to track and analyze asset prices. For these reasons, many traders and investors would benefit from using P&F charts. Point and Figure charts were more popular before computers, because P&F charts could (and still can) be quickly plotted by hand. These charts have been used since the late 1800s, although one of the most popular methods for using them was developed by A. W. Cohen in the mid 1900s.
What Is Unique About P&F Charts?
The first difference is that price moves are marked with X’s and O’s. An X marks a rising price, while an O represents a falling price.
The price must also move a set amount (called “box size”) before an X or O can be drawn. This means insignificant price moves are ignored. Because of this, it’s possible that traders will get fewer false breakouts, and will be able to more clearly see support and resistance areas.
Time is not considered in a P&F chart, only how the price is moving. Unless a price move occurs that matches or exceeds the box size, the chart is not updated.
Figure 1 shows a common candlestick chart, while Figure 2 shows the stock, over the same period, using a Point and Figure charting technique.
All charts courtesy of StockCharts.com
Trendlines are also included, these will be discussed shortly.
How Are P&F Charts Made?
In order to construct a P&F chart, a box size must be established. The box size chosen should be at least partially determined by the price of the stock. Beyond this, the trader can choose any size they like; more price data is filtered out with a larger box size, while less data is filtered out with a smaller box size.
For a stock in the $30 to $100 range the box size may be $1, and the box size can always be increased as the stock rises by simply changing the scale on the right (change the Box Size on StockCharts).
For a $10 stock the box size may be $0.25 or $0.50. Only when the price moves by that amount is an X or O marked.
Also note how every column has at least three X’s or three O’s. This is the method developed by A. W. Cohen, called the 3-box reversal. In order to start a new column, and indicate a shift in direction, the price must reverse three box sizes. When this occurs the new column will drawn with three boxes (X’s or O’S) to reflect the price change. This is why every column will have at least three symbols.
For example, assume stock ZYZYZ has fallen from $50 to $45. This creates a column of five O’s moving down to $45, using a $1 box size. The price stops falling and moves up to $48. This is a three box-size reversal, so three X’s are plotted moving up to $48.
If the price only reaches $47 on the rally, we wait. Either the price eventually reaches $48 and we create our X column with three X’s, or we wait until it does before making an entry.
How Do You Read a P&F Chart?
Just like candlestick charts or other charting methods, Point and Figure Charts have their own patterns, forms of analysis and trade signals.
Support and resistance are levels the price has had a hard time getting through. When two or more X columns reach the same spot but can’t proceed higher, that is a resistance level. When two or more O columns reach the same spot but can’t proceed lower, that is a support level.
A buy signal is generated when an X column exceeds a prior X column by one box. A sell signal is generated when an O column exceeds a prior O column by one box. Knowing that prices can move in a choppy fashion, traders are encouraged to use other analysis techniques to filter out some of these signals, and not follow them blindly.
Figure 2 also shows trendlines; bearish trendlines in red and bullish trendlines in blue. A bullish trendline is created following a buy signal (see above), starting at a significant low (O column). Unlike trendlines on traditional charts, P&F trendlines don’t connect high or low points, but rather simply angle out at 45 degrees for an uptrend, or 135 degrees for a downtrend.
Even P&F charts, which filter out a lot of insignificant price movements, can get cluttered looking and hard to interpret. Trendlines can help pick out the dominant trend and keep you trading in the right direction. Just like traditional charts, uptrends are created by higher price highs and higher price lows. Downtrends are created by lower swing lows and lower swing highs. These guidelines still apply to P&F charts; during a downtrend, O columns should be making lower lows than prior O columns and the X columns (pullbacks) should be making lower highs than prior X columns.
The Bottom Line
Point and Figure charts filter out a lot of insignificant price movements, making trends and support and resistance levels easier to spot for some traders. These charts are a viable alternative for many investors who aren’t worried about minor fluctuations in stock price. P&F charts don’t have a time element, which means money can be tied up in a stock waiting for it to makes it move. The annotations StockCharts uses for labeling months help give some concept of time on the charts. There are many ways to apply P&F charting techniques, which include analysis and trade signals. The best thing you can do is play around with P&F charts, and study them, to see if they can help you with your trading.
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Quotes of the Day:
- "The stock market is a giant distraction to the business of investing." - Irving Kahn
- "The best investors are those who are able to stay calm and rational in the face of market volatility." - Louis Bacon
- "Investing is not a get-rich-quick scheme, it's a get-rich-slowly scheme." - Leon Cooperman
- "The key to successful investing is to focus on the fundamentals of the companies you invest in." - Ron Baron
- "Investing is not about being right or wrong, it's about making money." - Jeffrey Gundlach
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