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Changing box size to derive targets

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Just as a trader will "roll" their retracement brackets to establish new bullish or bearish targets when a stock breaks to new highs or new lows, a trader/investor can do the something similar with their point and figure charts to ascertain "new" bullish or bearish vertical counts.

However, just as we want to "honor" levels of trading with our retracement brackets that "fit" past levels of trading, a trader that changes the box size on his/her point and figure chart from the conventional scales used, should try and look back historically to try and determine if the "new" box size has some credence to historical trading.

Late Friday night, I was trying to get caught up on some e-mail and a subscriber using the point and figure charts to determine downside risk/reward in the Networking Index (NWX.X) 213 -0.26% found that the conventional $5 box chart had the NWX.X trading well below a bearish vertical count of $280.

The question of establishing further downside is something I looked into years ago. While I never have read anything about how to tackle this issue of establishing other bearish vertical counts, it made sense to me to "imagine" an institution or the MARKET for that matter perhaps trading from a different scale.

As mentioned before, the vertical counts (bullish/bearish) from the point and figure system is really derived from the laws of ballistics (determining travel distance of a projectile). To many investors, this has some interesting comparatives to "gravity." Many have learned that stocks can go down "faster" than they go up.

I digress and will not go into the laws of physics and ballistics, but what I've done in the past is basically say, "What if the MARKET is actually looking at the NWX.X (or any other security) on a different scale? Is there something from the past that can give me a look into the future?"

The subscriber's question on trying to determine further downside in the NWX.X with a bearish vertical count had be changing the "box size" on the NWX.X from the conventional $5 box to $10. What this does is remove noise from the chart. What if the $5 box scale was actually "trying" to point to a much lower price objective than $280, but a brief "market event" or "sector event" had the index actually creating some short-term bullishness that didn't allow the NWX.X to build its "true" bearish count?

By changing the box size to $10, the trader/investor is able to remove some noise from the chart. At the same time though, we need to check to see if this $10 box size (new scale) has any credibility on a historical basis. That is... what good does it do to change box size if it isn't accurate or close to accurate on historical trading?

Here's the $10 box scale that I mentioned in this morning's market monitor.

Networking Index Chart - $10 box

A "back test" of the $10 box size does have some historical significance or correlation. In May of last year, the $10 box would have created a bearish vertical count of $310, which was achieved prior to the early August (red 8) buy signal at $350.

With the CURRENT bearish vertical count of $220 being achieved, the subscriber that "asked the question" of how much downside remains, is alert that the NWX.X may be near a level of near-term support.

This does not necessarily mean current levels are a "buying opportunity." Obviously, the $310 level back in July was not a "buying opportunity."

However, this data may be useful to the bearish trader in his/her account and trade management for stocks with a "networking theme." True, bearish vertical counts can always be exceeded, but the $10 box hints that the NWX.X may be at a level where bears are reducing the risk in their accounts and locking in some gains.

If you're trading some "networking" stocks that have achieved bearish vertical counts on their point and figure charts, then it may be a good idea to snug down stops in the trade, or capture some gains at current level.

Later today, I'll talk about networking giant Cisco Systems (NASDAQ:CSCO) $14.19 +2.01%, which has a bearish vertical count of $10 currently associated with its point and figure chart and how one may look to trade this stock going forward and correlate against what we are looking at in the $10 box of the Networking Index (NWX.X).

Jeff Bailey
Senior Market Technician
Option Investor

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