Point-and-Figure Charting

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  1. Point-and-Figure Charting

Point-and-Figure (P&F) charting is a unique type of technical analysis used to forecast price movements. Unlike traditional candlestick or bar charts that plot price over time, P&F charts filter out minor price fluctuations and focus solely on significant price *changes*. This makes them particularly useful for identifying key support and resistance levels, and potential price targets. This article will provide a comprehensive introduction to P&F charting, covering its history, construction, interpretation, advantages, disadvantages, and how it compares to other charting methods.

History and Origins

The origins of Point-and-Figure charting are somewhat obscure, but it is generally credited to a Japanese rice trader in the early 20th century. The method spread to the West through the writings of George Schade in the 1930s. Schade's work popularized the technique, emphasizing its ability to distill market noise and reveal underlying trends. Initially, P&F charts were hand-drawn, requiring significant time and effort. However, with the advent of computer software and Technical Analysis Software, creating and analyzing P&F charts has become much easier. It remains a popular tool among traders who value a clear, uncluttered view of price action.

Basic Principles and Construction

P&F charts are constructed using two key elements:

  • **Boxes:** These represent price levels. A standard P&F chart uses boxes of equal size, representing a predetermined price increment. For example, a box size of $1 means each box represents a $1 change in price. The choice of box size is critical and should be tailored to the specific asset being traded and its typical volatility. Larger box sizes filter out more noise but may miss important short-term movements. Smaller box sizes capture more detail but can become cluttered and prone to false signals.
  • **Xs and Os:** These are placed within the boxes to indicate price movement. An 'X' is placed in a box when the price rises to a new high, and an 'O' is placed in a box when the price falls to a new low. Crucially, a new column of Xs or Os is *not* started until the price has moved by at least the predetermined box size. This is the core principle of filtering out minor price fluctuations.

Here's a step-by-step guide to constructing a P&F chart:

1. **Determine the Box Size:** This is the first and most important step. A common approach is to use a percentage of the average true range (ATR) of the asset. The Average True Range is a volatility indicator that measures the average price range over a specified period. A box size of 1-2% of the ATR is often a good starting point. 2. **Establish the Initial Price Level:** Start with a price level and draw a single box. 3. **Plot Xs and Os:** 

   *   If the price rises, place an 'X' in the box. Continue adding Xs to the *same column* until the price rises by a full box size.  Only then do you move to a new column, one box higher.
   *   If the price falls, place an 'O' in the box. Continue adding Os to the *same column* until the price falls by a full box size. Only then do you move to a new column, one box lower.

4. **Ignore Minor Fluctuations:** If the price moves up or down but doesn't reach a full box size, it's ignored. The chart remains unchanged. 5. **Continue Plotting:** Repeat steps 3 and 4 until the chart is complete.

Key Patterns and Interpretations

P&F charts reveal several key patterns that traders use to identify potential trading opportunities.

  • **Double Top/Bottom:** These patterns are similar to those found in traditional charts. A double top occurs when the price fails to break through a resistance level twice, forming an 'M' shape. A double bottom occurs when the price fails to break through a support level twice, forming a 'W' shape. These patterns often signal a potential reversal.
  • **Triple Top/Bottom:** Similar to double tops/bottoms, but with three attempts to break through a level. These are generally considered stronger signals.
  • **Breakouts:** A breakout occurs when the price moves decisively through a horizontal line of Xs or Os. Breakouts can signal the start of a new trend. However, it's important to confirm breakouts with volume or other indicators. A strong breakout will typically be accompanied by a significant increase in volume.
  • **Bullish Saucer:** This pattern resembles a saucer or bowl. It starts with a downtrend, followed by a period of consolidation (a horizontal line of Os), and then a breakout to the upside with a series of Xs. This pattern suggests a potential bullish reversal.
  • **Bearish Saucer:** The inverse of the bullish saucer. It starts with an uptrend, followed by consolidation (a horizontal line of Xs), and then a breakout to the downside with a series of Os. This pattern suggests a potential bearish reversal.
  • **Up Trend:** Characterized by a series of higher highs and higher lows, represented by consecutive columns of Xs.
  • **Down Trend:** Characterized by a series of lower highs and lower lows, represented by consecutive columns of Os.
  • **Support and Resistance:** Horizontal lines of Xs or Os often act as support and resistance levels. These levels can be used to identify potential entry and exit points.

Using P&F Charts with Other Technical Indicators

While P&F charts are powerful on their own, they can be enhanced by combining them with other Technical Indicators.

  • **Moving Averages:** Applying Moving Averages to P&F charts can help confirm trends and identify potential support and resistance levels.
  • **Relative Strength Index (RSI):** The Relative Strength Index can be used to identify overbought and oversold conditions, which can help refine entry and exit points.
  • **Volume:** Analyzing volume in conjunction with P&F charts can help confirm breakouts and identify the strength of a trend. A breakout accompanied by high volume is considered more reliable.
  • **Fibonacci Retracements:** Applying Fibonacci Retracements to P&F charts can help identify potential pullback levels.
  • **MACD:** The Moving Average Convergence Divergence can be used to confirm trend direction and identify potential reversal signals.

Advantages of Point-and-Figure Charting

  • **Noise Reduction:** P&F charts effectively filter out minor price fluctuations, providing a clearer view of underlying trends.
  • **Clear Support and Resistance:** Horizontal lines of Xs and Os clearly identify key support and resistance levels.
  • **Easy Pattern Recognition:** P&F charts make it easier to identify classic chart patterns like double tops/bottoms and saucers.
  • **Objective:** The rules for constructing and interpreting P&F charts are relatively objective, reducing the influence of subjective bias.
  • **Focus on Price Action:** P&F charts focus solely on price movement, ignoring time as a factor. This can be beneficial for traders who believe that price is the primary driver of market movements.

Disadvantages of Point-and-Figure Charting

  • **Lagging Indicator:** Because P&F charts filter out noise, they can be lagging indicators, meaning they may not react quickly to sudden price changes.
  • **Box Size Sensitivity:** The choice of box size is critical and can significantly impact the chart's appearance and the signals it generates. Finding the optimal box size can require experimentation.
  • **Time Independence:** While some view time independence as an advantage, it can also be a disadvantage. P&F charts don't provide information about the *duration* of a trend, which can be important for some traders.
  • **Subjectivity in Pattern Interpretation:** While the construction of P&F charts is objective, the interpretation of patterns can still be subjective.
  • **Not Suitable for Short-Term Trading:** Due to their lagging nature, P&F charts are generally better suited for medium- to long-term trading than for short-term scalping or day trading.

P&F Charting vs. Other Charting Methods

Here's a comparison of P&F charting with other common charting methods:

  • **Candlestick Charts:** Candlestick charts provide more detailed information about price movement, including open, high, low, and close prices. They are more sensitive to short-term fluctuations than P&F charts. Candlestick Patterns are a core component of many trading strategies.
  • **Bar Charts:** Similar to candlestick charts, bar charts also display open, high, low, and close prices. They are less visually appealing than candlestick charts but convey the same information.
  • **Line Charts:** Line charts connect closing prices, providing a simple representation of price movement. They are less detailed than candlestick or bar charts and P&F charts.
  • **Renko Charts:** Renko Charts are similar to P&F charts in that they filter out noise. However, Renko charts use bricks of fixed size, while P&F charts use boxes. Renko charts are based on price movement, while P&F charts are based on percentage changes.

Practical Applications and Trading Strategies

Several trading strategies can be implemented using P&F charts:

  • **Breakout Trading:** Buy when the price breaks above a horizontal line of Xs and sell when the price breaks below a horizontal line of Os.
  • **Pattern Trading:** Identify and trade classic chart patterns like double tops/bottoms and saucers.
  • **Trend Following:** Identify and follow established trends, buying during pullbacks in an uptrend and selling during rallies in a downtrend. Combine with Trend Lines for confirmation.
  • **Support and Resistance Trading:** Buy near support levels and sell near resistance levels.
  • **Price Target Calculation:** Measure the height of a chart pattern and project it from the breakout point to determine a potential price target. For example, the height of a bullish saucer can be used to estimate the potential upside target.

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