Last week we talked about double tops and double bottoms, triple tops and triple bottoms, bullish catapults and bearish catapults and triangles. Today I would like to continue our discussion of Point and Figure charts and discuss how to use them to calculate a price objective.
I would like to add a caveat here; the price objectives we will calculate here should only be used as a guide for how much you could make out of a trade or a place where you should be thinking about taking profits. Frequently stocks will trade past these projections and also frequently not make it all the way to the projection. P&F charts are not crystal balls they are just very handy tools.
There are two ways of calculating a price objective; the Vertical Price Objective (VPO) and Horizontal Price Objective (HPO). With each type you can determine a bullish and bearish price objective.
Let's start with the Vertical Price Objective.
Bullish Vertical Count
In these examples I will be using the double top and bottom formations I talked about in my last article but you can use anyone of the other P&F formations for the first step.
1. Find a sell signal, which most times will be a double bottom because they are so prevalent, however, not all the time.
Easy as pie - not!
Lets do an example.
1. The double bottom at 35 was a sell signal.
This stock has a price projection of 57.
Bearish Vertical Count
1. Find a buy signal, which most times will be a double top because they are so prevalent, however, not all the time.
1. The double top at 40 was a buy signal.
This stock has a price projection of 26.
Horizontal Price Objective
The second way of determining a price projection is using a Horizontal Price Objective (HPO). You should use the HPO for stocks that have formed a large base otherwise use a vertical count.
When calculating a HPO, measure the base a stock has created and broken. The break tells you the formation has completed and you can start your calculation. Sort of like the when doing the VPO, you have to wait for the bullish count to form a column of Os to confirm that the column of X's had completed or the bearish count you have to wait for the column of Xs.
To measure, count the horizontal columns filled with X's and O's without any spaces in between. Find the widest part of the base that is unbroken to count. The number of columns to count can very often be a judgment call.
There are no minimum columns required in the calculation.
The charts with the most powerful moves will be the on that have a large area of accumulation before the chart breaks out. These are considered powder kegs. The more it builds up the more explosive the breakout can be.
Bullish Horizontal Count
1. Find a buy signal
1. Buy signal at $40
Bullish Horizontal count is 55.
Bearish Horizontal count
1. Sell signal at $33
Bearish Horizontal count is 25.
Up to this point we have used a box size of 1, which begs the question "How do you calculate the Price Objective when the box size changes." Simply, if the box size was $5 then you would use a multiplier of 5 in step #4 instead of 1 or if the box size was $0.50 then you would multiple by 0.50 instead of 1.
Obviously a box size change affects the price objectives of the chart because we are measuring the strength of the move off the bottom or top and that is measured by the box size. However, when a chart crosses over two different box sizes you have to do the calculations twice and add them together. This is where the vertical counts can be confusing but as long as you understand the different calculations for the box sizes, you should be able to do this easily. You will not have this problem with the Horizontal count because it typically will not cross different box sizes so you should only run into this issue with the Vertical count. Let's start out with a review of the box sizes.
Let's take an example of a stock that moves from $18.00 to $23.00. Under $20 the box size is $0.50 but $20 and over it is $1.00.
In the above example we will assume the column of X's from $18 to $23 is the column we have determined to be the one to use for a Bullish Vertical Count. Firstly, you take the count from $18 to $20 = 5 and you do the calculations using a box size of $0.50. That would be 5 * 3 * 0.50 = 7.5. Then you take count from $21 to the top of the column at 23, which is 3. Now you do your calculation using a box size of 1. That would be 3 * 3 * 1 = 9. Now you add the two together 7.5 + 9 = 16.5. Add this number to the bottom X at $18 + 16.5 = 34.5 is your bullish vertical count.
So is your brain just about mush. You have just learned about all there is to learn on how to create a point and figure price objective horizontally and vertically. Next week we will continue on with this series and talk about some really cool ways to use P&F charts using relative strength.
Until then plan your trade and trade your plan.