Point and Figure charting has been around for many many years. But it still works and still offers some advantages other types of charting do not. Point and Figure charts are only concerned with price, unlike candlesticks or bar charts, where the vertical coordinates are based on price and the horizontal coordinates are based on time. If you have been studying charts for any length of time, this concept may be hard to grasp. Point and Figure charts don't care if the price action covered one day, one week, one month or one year, to the P&F chartist time is irrelevant. The point and figure chart is concerned only with price movement and time is not taken into consideration while plotting the price action. Since only price changes are recorded, if no price change occurs then the chart is left untouched.
You have probably heard the term 'noise' when referring to charts. Noise is all the fluctuations and gyrations price action can make when it is not trending. And since stocks only trend 30% of the time there is a lot of noise on price charts. Wouldn't it be nice if you could take most the 'noise' out of the chart? Since time is not a factor in P&F, the disturbances caused by small fluctuations in price (noise) are removed and, therefore, trends become easier to spot.
So how do P&F charts remove the noise from charts? P&F chart's prices are in vertical columns of Xs and Os. The Xs represent demand or increasing prices and Os represent supply or decreasing prices. Each X and O in turn represents a change in a price increment called the box size. There are two attributes that affect the appearance of a P&F chart: box size and reversal amount.
First of all let's talk about the box size. This is the minimum price increment that will be drawn on the chart. So if the price changes by less than the box size, no box is drawn and the chart remains unchanged. The price can bounce around within this price increment all it wants but unless it moves greater than the box size the P&F chart will not change. All the 'noise' inside this increment is removed. Increasing the box size filters smaller price movements and decreasing the box size adds more 'noise.'
All of the examples I will use in this and subsequent articles on P&F will use a $1.00 box size. However, it should be obvious that a $3.00 reversal in a $50 stock is much different than a $3.00 reversal in a $5.00 stock or a $150.00 stock. To compensate, we adjust the box size for different price levels.
Traditional box size values are listed in this table:
This system was designed long before the Dow crossed the 1,000 point mark, much less 10,000 so when plotting the DOW, some use a box size of 50 and a box size of 25 for the S&P 500 and the NASDAQ indexes.
When choosing a box size it is important to remember your goal is to highlight significant price moves while filtering noise. If you were to play with various box sizes, you would find that small changes in box size have little effect on the chart or the signals generated. Each X or O is a box.
The second attribute that affects the appearance of the P&F chart is the reversal amount. The reversal amount is the number of boxes that need to be retraced to cause the P&F chart to reverse from a column of X's to a column of O's or vice versa. When the reversal amount is small, reversals will be more frequent and longer-term price trends will be more difficult to identify. Increasing the reversal amount makes longer term trends to appear more readily but the short-term ones disappear. Everything is a trade-off isn't it?
So how many boxes do you use for a reversal? Well another name for Point and Figure Charting is "The Three Box Reversal Method." While I don't know how it was originally decided, there is a visual appeal to using the three boxes to designate a change in direction.
Making a Column of Os
P&F charts are only concerned with high and low prices, the closing price is irrelevant and as long as the price action continues in the same direction you stay in the current column.
For example if you're in a column of Os, and the low today forces one box to be added to the chart then add an O to the column. Of course, if the low is more than one box lower, then fill in all of the boxes to match that low price.
Continue marking Os in the current column as long as the stock continues to make lower lows. That is to say continue in the current column of Os, regardless of any other price action, disregarding the highs during the trading session. This is an important point so let me say it another way: as long as the low for the stock adds one box to the column of Os, ignore the highs. Or as long as the high for the stock adds one box to the column of Xs, ignore the lows.
Moving to a Column of Xs
To move from a column of Os to a column of Xs, two things must occur. First, the stock must not move down one box during the trading session, in other words the stock may not make a lower low. Second, the high price for the stock must be at least three boxes higher than the lowest O. If these two conditions do not take place, then the P&F chart is not updated.
Let's find a P&F chart to follow to see how this works. If you really want to get a handle on P&F charting it would be worth your while to get a sheet of graph paper and draw the chart yourself.
To build a chart, you have to start somewhere. I've chosen INTC whose price back in 2001 moved from $27 to $31 over several trading days. The box size is $1.
Here is what the P&F chart for INTC looks like. For now start with the left hand column. (This is a P&F Chart from Stockcharts.com)
Here is the left most column:
The first column from $27 to $31 is filled with Os, telling you that sellers are in control of the stock.
To move to the second column and start a column of Xs, two things must occur. First, the stock cannot touch $26 during the trading session for this would add another O to the column. And second, the high for the day must be $30 or higher (3 boxes higher than the lowest O). In our example, that is exactly what has occurred. INTC printed a price of $30 but not to $31 and did not touch $26 (a lower low) so a column of Xs is drawn.
So we mark a column of Xs, telling us that demand is overcoming supply. When marking the column of Xs, start one row above the last O, and fill at least 3 boxes with Xs. In this case, start at $28, and fill in the boxes for $28, $29, and $30 with an X.
One day (you don't know the date) INTC fell to $27 but not to $26 and did not touch $31 so a column of Os is drawn.
Then on another day INTC trades up to $31 but does not trade down to $26 so a new column of Xs is drawn. But do you see something different here? Notice the 6 on the 28 row. This is the only indication of time and tells you the P&F chart has now moved to the 6th month of the year. We are now in the month of June 2001.
Let's move forward 6 columns and take note of the 7 in the 7th column of Os? That tells us we have moved to July and look at how much 'noise' you see on the chart. From the 6 (June) to the 7 (July) a whole months worth of trading and there is only 2 or maybe 3 updates to the P&F chart. Now look at a daily bar or candlestick chart of INTC and see how much noise you see. The number of updates from July (7) to August (8) was even less. (P&F denotes the 10th month October with an "A", November with at "B" and December with a "C")
Let's stop here and do another example. The more you practice and draw these charts the better you become. However, that may be a moot point since there are many websites that will draw P&F charts for you so you don't have to actually draw them yourself. However, you should know how they are constructed.
Let's start with a look at a BAR chart of GE from August 2004 to now. A yearly high was made on December 14th at 37.75. Let's see if we can identify this high on the P&F chart.
Here is the P&F chart for GE and once again, I got this chart from StockCharts.com.
Let's "read" the last column of Xs. The column started in the month of June (6) when first of all GE did not move down one box during the trading session, or did not make a lower low. Secondly, GE's high for the day was at least $32, three boxes higher than the lowest O at 29. These two conditions took place so a new row of Xs was created. Then in September (the 9 on the chart) GE reached higher than $34 but did not reach $35 until November (the B on the chart). And then it was not until December that GE reached over $37 but not to $38.
Since June GE has never fulfilled the conditions for a reversal to a column of Os and since December GE has not been able to make a higher high to add another X. Take a look at the bar chart and see how much noise has been eliminated and how the P&F chart gives you a much clearer picture of how GE has traded over the last 8 months.
P&F charts can take out most of the gyrations and fluctuations you see in bar or candlestick charts but we have only touched the surface of how useful these charts can be. Next week we will address how to draw support and resistance lines on the charts. So see you then.
Remember plan you trade and trade your plan.