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Trader's Corner

Ballistic Bullish Vertical Count

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Point and figure charts are those funny looking charts with columns of X and O. Charts that Charles Dow used to monitor his extensive portfolio of holdings well before the computer age allowed for other methods of charting price action of securities you and I might trade.

As old as the point and figure methodology is, it is a charting system that simply measures supply (O) and demand (X), where the relationship between the two is reflected in price.

Point and figure charts are about as SIMPLE to read, or understand as any other chart (bar, Japanese Candle, line, etc.), but unlike the bar chart, the Japanese candle, or line chart, the point and figure chart construction pays little attention to measuring security price action as it would relate to a charting system that measures price action one day, then creates a different line, or bar, to measure the next day's price action.

The point and figure chart simply measures price action in a continuous motion.

The only belief a trader or investor must have when reading a point and figure chart is the belief that if demand is greater than supply, then PRICE will rise. The other belief one must hold is that if supply is greater than demand then PRICE will fall.

The following article regarding BULLISH vertical counts may be putting the cart before the horse for those that may not have a complete grasp of just how a point and figure chart is constructed, but just the mentioning of bullish vertical count generates questions on just how a "BVC" is generated, what its implications can be, and how it may help a trader/investor begin to assess not only reward, but risk!

Yes ... RISK!

Only when a trader/investor assesses BOTH risk and reward, can a more educated decision regarding purchase and sale of a security be established.

If somebody asked you to invest $500 in anything (a new business, a stock, a gizmo) and told you that you could potentially make 20% on your money, what might you then ask? I hope you'd ask, "How much could I lose?"

If he/she replied "50% to 100% of your money," you might reassess the investment.

Again, you don't need to be an expert, or have a full grasp of how a point and figure chart is constructed to grasp the concepts of the bullish vertical count.

You don't need to be a ballistics (the science or study of the motion of projectiles, as bullets, shells, or bombs; the art or science of designing projectiles for maximum flight performance.) expert either, though the bullish vertical count incorporates many of the principals of this art.

Now we're going to look at some "real life" examples of securities, identify the bullish vertical count column, see how the vertical count is established and then assess the RISK and the potential longer-term reward of the particular security.

Hold on traders! Don't let "longer-term" have you rolling your eyes and have you thinking the bullish vertical count is only an investment tool.

How the bullish vertical count is calculated.

1) Identify the FIRST reversing higher point and figure buy signal where a column of X exceeds a prior column of X.

2) Once the column of X is identified, multiply the number of X in that column by 3, then multiply that by the scale/box size of the point and figure chart, then add the total to the BASE of the X column.

Here is a point and figure chart of Cummins, Inc. (NYSE:CMI) which achieved its bullish vertical count of $106 on Friday. A textbook example at this point of identifying the bullish vertical count column, seeing how it was constructed, calculated, and then over time, monitoring risk reward as bullishness continued to develop, and most likely, traders and investors accumulated positions.

Cummins Inc, (CMI) - $1 box; $2 box

In the above chart, I'm covering several items, so it is a bit "busy" with text.

Let's first identify the bullish vertical count (BVC) column.

See the "1" on the chart? That's the first entry in January, where CMI generated what ends up being the last sell signal the stock had generated. Remember, the bullish vertical count column is identified when a security first gives a reversing higher point and figure buy signal (when a column of X exceeds a prior column of X).

On 1/29/07, CMI's trade at $63 is the first reversing higher point and figure buy signal, and this would be a point that signals demand is once again starting to outstrip supply.

Remember now, the point and figure chart is measuring continual motion, and over time, demand (X) continues to build and price eventually rises to $73 on 2/14/07. Eventually (pink box at $70) shares of CMI edge back and a 3-box reversal takes place. On a $1 box chart (see box scale to right) the point and figure charting system measures "meaningful" reversals when a 3-box reversal of PRICE is witnessed.

Once a 3-box reversal lower is witnessed, the bullish vertical count column is established. It is at this point that a trader/investor can begin to assess longer-term potential REWARD!

In the upper left corner of the chart, I walk you through the mathematical equation of how the bullish vertical count is tabulated.

In many of the plays you read in your newsletter each night, you will see mention of "bullish vertical counts." Now you can envision what is being described, know where the stock is trading relative to a longer-term potential target of reward.

Now let's cover how a trader/investor can begin to assess RISK and over time, while measuring against the longer-term bullish vertical count, constantly measure a stock's RISK/REWARD.

For the purposes of this article, I'm going to be defining RISK as how much dollar decline to a "sell signal" (where O would fall below a prior column of O) can be measured.

See the "brown box" on 3/19/07 at $71.00? That was a double top buy signal. For you more experienced point and figure chartists, you'll also recognize that as a bullish triangle pattern.

On 3/19/07 a trader/investor may have been assessing longer-term reward to $106, but what was the RISK to a sell signal? At $71, the RISK to a sell signal (red box with "R") would have been to $66.

Immediately a trader/investor could have assess RISK as being equivalent to $5, with REWARD being assessed as $106 - $71 = $35.

I don't know about you, but risking $5 to potentially make $35 is pretty good!

Option traders may well use that type of RISK/REWARD analysis to buy one (1) option contract that costs $5.00 or less, then begin to tabulate what that option might be worth should the stock ever trade $106 over time.

As we follow the chart of CMI, we see price continue to rise to $75, then a 3-box reversal back down to $72, then in April (after blue 4) CMI's point and figure chart gives another double top buy signal at on 4/20/07 at $76.

Once again a trader/investor can assess RISK/REWARD. Once you have the bullish vertical count, that's the potential REWARD you are constantly measuring against.

Institutions build positions over time, and traders/investors should take note, but understand how to constantly be measure risk/reward in the trade.

On 4/20/07 we could once again measure RISK = $5 with REWARD being equivalent to $106 - $76 = $30.

Risking $5 to potentially make $30 is still pretty darned good in my book. That's a risk/reward ratio of 1:6.

Boom! Now CMI is really on the move and price ramps to $91 by 4/24/07.

Then pulls back to $84 before seeing a 3-box reversal back higher to $87 by 4/26/07.

If a trader/investor had purchased addition shares on the 3-box reversal higher at $87, their RISK could have been identified as $4, with REWARD of $106 - $87 = $19.

There we would have assessed risk as $4 and potential reward as $19.

See what's happening here? As a stock nears its bullish vertical count, the point and figure charting methodology, even on 3-box reversal higher, has risk/reward starting to diminish a bit.

Still pretty good risk/reward though at roughly 2:9.

Then boom! Earnings come in much "stronger-than-expected" and stock surges as high as $107.23 on Friday, before closing back at $96.14, where I've placed blue "?."

See the brown box at $93? That's where CMI opened for trade on Friday, before it jumped to $107.23, or $106 and its bullish vertical count.

Now, at $93, RISK/REWARD for a new long/bullish entry would have been terrible, if measuring potential longer-term reward to $106.

While bullish vertical counts may NEVER be reached, we've seen many stocks EXCEED their bullish vertical counts, and not by just a dollar or two. There are some stocks that are more than DOUBLE the price of the previously established bullish vertical counts.

Hopefully, you can begin to appreciate how the bullish vertical count can be helpful in assessing longer-term reward for a bull, and equally important to a bear that may be considering shorting a stock that has bullish vertical count, regardless of just how "unreasonable" that bullish vertical count appears to be.

A diesel engine manufacturer signaling, "I'm going to $106, even though I'm trading in the $70s!"

Whenever a stock achieves a bullish vertical count, I strongly suggest traders/investors long the stock take profits.

I mentioned that the bullish vertical count is partially derived by the science/art of ballistics. When you look at the chart of CMI, and its bullish vertical count column, a trader/investor should see the length of a gun barrel.

Think about it. If you've ever seen a target shooter's rifle, the barrel of the gun is usually rather long. Depending on the distance the target shooter's target is (100 yards, or 1,000 yards) the amount of powder that explodes and moves the projectile is also important.

Look at some of those "X" columns on the CMI chart, with the bullish vertical count column being a focus. It takes some "explosion" to get a stock's price rising from $58 to $73 in one continual push higher without so much as a 3-box reversal having taken place in-between.

Do you believe that there weren't some trader/investors that "knew" CMI's earnings were going to be bullish enough to get the stock to $106 by Friday's earnings? Maybe, just maybe, the bulk of market participants following the stock knew it earlier this year?

One of the toughest things about being a chartist, is grasping the concept, or the belief, that the market is all knowing, and that it looks ahead, and knows what the future holds.

Often-times, our "beliefs" overrule what we actually see happening, and for a multitude of reasons, we can't surmise just what is driving a stock's price action, up or down.

Here's another stock to practice on. I'm not disclosing its name right now, but let's practice identifying the bullish vertical count column, and I want to show you how to calculate a bullish vertical count when a stock's box size/scale has the bullish vertical count being built between a $1 and $2 box size.

Mystery Stock - $1 and $2 box size

Here's a stock that many of us have heard of. In early April (blue 4) the stock generated a reversing lower double bottom sell signal at $94, and fell to $93.

Then reversed back up to $100.

A point and figure chartist would see that column of X from $94 to $100 being observed as a "low pole warning." This is a pattern that sometimes indicates a stock is "sold out" as it reverses more than 1/2 of a rather long column of "O."

You can see the stock begins working sideways as supply and demand come to some type equilibrium.

Then on 4/24/07 the stock gives a triple top buy signal at $102 and a trader/investor would begin calculating the bullish vertical count.

One thing that is different here, than with CMI's chart, is that the bullish vertical count column is being constructed when the box size/scale (right of chart) is now measured in not just $1 increments, but also in $2 increments.

You see, the point and figure charting system wants to measure prices as it would related to a more "meaningful" amount of price action.

When stocks get above $100, a $1 move in the stock price isn't as meaningful as a $1 move in a $30 stock. So, for stock's priced above $100 to as high as $200, the point and figure charting systems changes to $2 increments.

When we calculate a bullish vertical count that spans this type of transition, we need to calculate the bullish vertical count in two different formulas.

Actually, the ONLY difference is that the "multiply by scale" number is changed.

The Mystery Stock's bullish vertical count has us counting the X's from $98 to $100, for the $1-box. Then we count the X's from $102 to $110 for the $2-box scale.

See? We're still counting X's, and then multiplying by 3, but for the scale change, we need to separate things a bit. Once we get our sums 9 for the $1-box and 30 for the $2-box by the end of 4/26/07 trade (remember that the bullish vertical count is still being constructed) we can then continually add that to the base of the X column, which is $98.

Traders are you ready!

The Mystery Stock has generated a triple top buy signal, it is now above trend (bearish resistance trend), where usually, the first time a stock trades such trend is "painful for a bull."

Baidu.com (BIDU) - $1 and $2 box

Wow!

In Thursday's extended session, BIDU did trade as high as $143 and in the OptionInvestor.com Market Monitor I suggested that traders long take profits if their initial target was $137.

Regular session trade, when all market participants are able to cast their votes, did see shares of BIDU trading as high as $132.80 before finishing out at $124.57 +13.89%.

What's a bullish trader's current RISK/REWARD assessment for a new long entry should the stock open at $126.00 Monday morning?

I come up with RISK to a sell signal, which would currently be viewed as $96 as being equivalent to $126 - $96 = $30 of risk.

Reward, using the still building bullish vertical count to $203 would be $203 - $126 = $77.

That's roughly better than 1 risk for 2 potential reward.

Dorsey/Wright and Associates posts the tabulation for us at 2.75 reward for every dollar of risk.

If you're interested in viewing some FREE point and figure charts, a great website is www.stockcharts.com

Here's there point and figure chart of Baidu.com and they too post the bullish vertical count.

Now you know what the bullish vertical count is. You know how to identify where it began. You also have learned one technique of how to assess RISK/REWARD in a security, based on what the longer-term bullish price objective is.

A bullish vertical count is "good" as long as the stock does not give a reversing lower point and figure sell signal. That means, as long as the stock doesn't give a "sell signal," a trader/investor can continually assess a longer-term price objective, which the market may have in mind for a stock, to its bullish vertical count.

Yes! There is also a BEARISH vertical count, which will be addressed in another Trader's Corner.

A great book I'd suggest ANY trader/investor read, is Point and Figure Charting, by Thomas J. Dorsey.

I don't recommend the book just to learn how point and figure charts are constructed, but to really drive home the "point" of how important it is to understand the simple laws of supply and demand, and the impact on price.
 

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