So far in the series on Point and Figure charts we have covered: The Basics, Support and Resistance and Relative Strength, which is a lot about Point and Figure charts but there is still more. Today we will discuss the granddaddy of P&F charts the Bullish Percentage Index (BPI). If you dont want to use any other P&F chart you and you are an investor in this game called the stock market, you should take heed of this index.
In the last article on Relative strength I mentioned "When using the Relative Strength charts one has to remember the all important part of this analysis is the word 'Relative.' If the whole market is falling a relative strength chart will tell you the stocks that are strong relative to the broader index but they may be falling as well. So it would be wrong to use these charts to position yourself long. You should be using other tools to evaluate the state of the market and position yourself in stocks that reflect your bearishness or bullishness. In other words if you see the market bullish as a whole then start looking for bullish RS candidates but if you see the market bearish as a whole then start looking for bearish RS candidates."
Today will answer the question is the market as a whole bullish or bearish. Or better yet, it will answer the question; is the index I am using for comparison bullish or bearish? We also will answer some other investment questions like:
1. When risk is high or low?
Have you heard that you cannot time the market? Have you heard the age-old argument that if you missed the 10 best days in the last 15 years your returns would have been 140% as opposed to if you were a buy and hold your returns would have been 248%? What these buy and hold proponents do not tell you is that if you missed the 10 worst days your returns would have been 473% as opposed to the 248% with a buy and hold.
Market timing does not have to be perfect. Market timing does not mean you get in and out of the market at the bottoms or tops. It does, however, mean you get out of the market before a major bear market devastates the portfolio and in before or during a bull run. Market timing means you grab as much from the middle as possible. Sometimes that is a huge amount and sometimes it is not.
In 1940s an analyst named Earnest Staby wanted a contrarian indicator that would be bullish at market bottoms and bearish at market tops, just the opposite of conventional price charts and created the concept for Bullish Percent (BPI). A.W. Cohen, the same analyst responsible for the famed Investors Intelligence Sentiment Survey built on the Staby's work and in 1955 created the NYSE BPI.
This indicator is often referred to as the coach for NYSE stocks because it will tell us if the offensive or defensive team is on the field. X's mean offense and O's mean defense. "Based on a University of Chicago study 80% of the risk in any stock is based in the market and the sector." The Bullish Percent will tell you the risk to being bullish and the risk to being bearish and hopefully get you on the right side.
What is Bullish Percent
A BPI is the percent of stocks in a given index or sector that are currently giving P&F buy signals. For example, if 300 of the 500 stocks in the S&P 500 index were exhibiting P&F buy signals, the S&P 500 BPI would read 60%.
A BPI chart uses the same three-box reversal to shift columns as in the normal Point and Figure chart but each box constitutes 2 percent, and the vertical axis runs from 0 to 100 percent. It will, therefore, take a 6% change in order to reverse this chart.
Needless to say that when the BPI is in a column of X's, more stocks are on buy signals and when in a column of Os more stocks are on a sell signal. Changes in the index can only come from "first" buy signals. It is this first buy signal that is recorded. All subsequent buy signals are not counted until the stock gives a sell and then another buy.
The Bullish Percent is a one stock - one vote indicator.
The formula for the S&P would be:
Number of stocks in the S&P on a P&F buy
The formula for the NDX would be
Number of stocks in the NDX on a P&F buy
P&F BPIs are maintained for many major indices including the S&P 500, S&P 100, Dow 30, NASDAQ, and NASDAQ 100 but the mighty patriarch of the BPI world is the NYSE BPI. It documents what percentage of stocks in the entire universe of companies that trade on the New York Stock Exchange are exhibiting P&F buy signals on any given trading day. It is important to note that the Bullish Percent Index is not something that can be applied to a single stock but rather an index that is calculated for a group of stocks.
How do you use BPI charts?
As with your basic P&F chart, the letters and numbers in the columns denote the months of the year but with these charts the time spent in a column of X's or O's is usually measured in months, not weeks. The other significant change is that there are no bullish or bearish resistance lines, something I rely quite heavily on when using P&F charts, however there are levels that we calculate to determine our risk.
What we are trying to do with these charts is determine who has control of the index, the bulls or the bears and who has the greatest risk. Let's say there are 500 stocks in the NYSE and that over the next couple of weeks 20 stocks give a new buy signal and 10 stocks give a new sell signal, which nets out 10 new buys or 2%. Remember that each box on the chart represents 2 percent, so a 2 percent net change in new buy signals puts one X in the column. This, of course, assumes the chart is already in a column of Xs. Also remember the only way to move from one column to the next is through a three-box reversal so you would need a net change of 6% to reverse or 6% new sells to reverse. Reversing from one column to the next is synonymous to losing or gaining control of the index depending on if you are a bull or a bear. If the BPI is in a column of Xs the bulls have control but if the chart is in a column of Os the bears have control.
Using a football analogy the "field" is 0 to 100 percent and where you are on this "field" determines your "field" position. The column you are in tells you who has football and the field position tells you how much room you have to run.
Let's now talk about the levels of overbought and oversold or, sticking to the football analogy, the end zones. BPI rules say overbought at 70% and oversold at 30%. If the chart was 30% or below and in a column of X's the bulls have a lot of room to run the ball and the most risk is for the bears. Supply is starting to dry up and there is not many sellers (demand increasing) left to push the market lower. On the other hand, if the chart is 70% or above and in a column of O's the bears have a lot of room to run the ball. Supply is plentiful and there are not many buyers (demand decreasing) left to push the market higher.
Six Risk Levels for the NYSE BPI
1. Bull Alert - This risk level can only happen when the index is below 30 percent and reverses into a column of Xs. This is your most bullish signal; bulls have the least risk (good field position) and have taken control of the index (in possession of the ball).
2. Bull Confirmed - Occurs when a BPI chart gives a buy signal such as a double top or triple top break just like the basic P&F chart. However, it is important to note that a buy signal below the 30% level is quite different from a buy signal at 70%. Remember your "field position."
3. Bull Correction - When a BPI chart is in a bull confirmed state but the market takes a rest and reverses into a column of Os. If the BPI reverses back to a column of Xs, the bull confirmed state resumes.
4. Bear Alert - This risk level can only happen when the index is above 70% and reverses into a column of Os. This is probably your most bearish signal; bears have the least risk (good field position) and have taken control of the index (in possession of the ball).
5. Bear Confirmed - Occurs when a BPI chart gives a sell signal such as a double bottom or triple bottom break just like the basic P&F chart. However, it is important to note that a sell signal above the 70% level is quite different from a sell signal at 30%. Remember your "field position."
6. Bear Correction - When a BPI chart is in a bear confirmed state but the market takes a rest and reverses into a column of Xs. If the BPI reverses back to a column of Os, the Bear Confirmed state resumes.
Let's look at an example.
First question - without looking at anything else, would you be long, short or flat here? The column of Xs or Os determines who has the ball. And the 70% or 30% helps to determine field position and who has the most risk.
The chart is in a column of Os so the bears have the ball and field position says the bulls have the most risk so you would definitely not be long and I can't see any reason to be flat. The only position left is to be short.
Let's look at the annotated chart.
Starting in 2001, the BPI got below the 30% and the risk is for the bears. Then sometime in October 2001 it reversed to a column of Xs, this was a Bull Alert, " Bull Alert occurs when the BPI chart is below 30% and it reverses into a column of Xs."
The BPI did not give a Bull Confirmed until November of 2003, "Bull Confirmed occurs when a BPI chart gives a buy signal such as a double top or triple top break." This is the point where investors would want their portfolios into long positions or where you would start using your relative strength P&F charts to look for long candidates.
Then next signal you have is a column of Os that is a Bull Correction, "Bull Correction occurs when a BPI is in a bull confirmed state but the market takes a rest and reverses into a column of Os. If the BPI reverses back to a column of Xs, the bull confirmed state resumes. "
The Bull Confirmed resumed with the next column of Xs.
Now we get above the 70% level and risk is for the bulls and now we exit any long positions and await a short signal.
Sometime in March of 2004 we get the next signal, a Bear Alert, "A Bear Alert occurs when you are above the 70% level and the chart reverses to a column of Os."
Then in May of 2004 the BPI chart gives a Bear Confirmed, "A Bear Confirmed occurs when a BPI chart gives a sell signal such as a double top or triple bottom break." This is the point where investors would want their portfolios into short positions or where you would start using your relative strength P&F charts to look for short candidates.
Then next signal you have is column of Xs that is a Bear Correction, "Bear Correction occurs when a BPI is in a bear confirmed state but the market takes a rest and reverses into a column of Xs. If the BPI reverses back to a column of Os, the bear confirmed state resumes. "The BPI chart as now reversed back into a column of Os so the bear confirmed resumes.
The BPI is not a market predictor, just a very good way to measure your risk. When the risk is high we become less offensive. When the risk is low we become more offensive. In many cases, the truth lies somewhere in between. With that said I think this is an extremely good case for not been long this market and that now is the time to use your relative strength P&F charts to find your weakest stocks and think about short positions.