Point and figure charting

1. Point and Figure Charting

Point and Figure (P&F) charting is a type of price charting that focuses on significant price movements, filtering out minor fluctuations. Unlike traditional candlestick or line charts that plot price over time, P&F charts plot price changes and volume, represented by ‘X’s and ‘O’s, on a grid. This method is designed to clearly identify support and resistance levels and potential price targets, making it a valuable tool for Technical analysis. It’s particularly favored by traders who prioritize price action over time-based analysis.

1. 1. History and Origins

The origins of Point and Figure charting can be traced back to the 1930s, largely attributed to the work of Henry O. Pruden. Pruden, a stock market analyst, developed this method as a way to visualize price movements in a simplified manner, removing the “noise” of daily price variations. His goal was to identify meaningful patterns and potential trading opportunities based solely on price action. The technique gained popularity among commodity traders and has since evolved, finding application in various financial markets including stocks, forex, and cryptocurrencies.

1. 1. Core Principles and Mechanics

The fundamental principle behind P&F charting is to identify significant reversals in price direction. This is achieved by using a pre-defined “box size” and a “reversal amount.” Let's break down these key components:

• **Box Size:** This represents the minimum price movement required to trigger a new column of X’s or O’s. For example, a box size of $1 means the price must move up or down by at least $1 before a new box is added. Choosing the appropriate box size is crucial. Smaller box sizes are more sensitive to price fluctuations, while larger box sizes filter out more noise. The ideal box size is often determined by the volatility of the asset being traded. Volatility is a key factor to consider.

• **Reversal Amount:** This defines the magnitude of price change needed to reverse the current trend and switch from placing ‘X’s to ‘O’s, or vice versa. The reversal amount is typically expressed as a multiple of the box size. A common setting is a reversal amount of 2 or 3 times the box size. For instance, if the box size is $1 and the reversal amount is 2, the price must move down by at least $2 from the last ‘X’ column to initiate a new column of ‘O’s.

• **X’s and O’s:** ‘X’s represent rising prices, and ‘O’s represent falling prices. A column of ‘X’s is built as the price moves upwards, one box at a time. When the price reverses and falls by the reversal amount, a new column of ‘O’s is started. Similarly, a column of ‘O’s is built as the price moves downwards, and a new column of ‘X’s is started when the price rises by the reversal amount.

• **Grid:** P&F charts are constructed on a grid where the horizontal axis represents price levels and the vertical axis represents time (though time is not explicitly displayed). Each box on the grid represents the box size.

1. 1. Constructing a Point and Figure Chart

Let's illustrate the construction process with an example. Suppose we are charting a stock with the following price data, using a box size of $2 and a reversal amount of 3:

| Day | Price | |---|---| | 1 | $10 | | 2 | $11 | | 3 | $13 | | 4 | $15 | | 5 | $14 | | 6 | $12 | | 7 | $10 | | 8 | $11 | | 9 | $14 | | 10 | $16 |

Here's how the chart would be built:

1. **Start:** Begin with the first price ($10). 2. **First Column:** The price rises to $11 (a $1 increase). This is less than the box size of $2, so no box is placed yet. The price continues to rise to $13 (a $3 increase). This is greater than the box size, so place an 'X' at the $10 price level. The price rises to $15 (a $5 increase). Place another 'X' at the $12 price level. Place a third 'X' at the $14 price level. 3. **Reversal:** The price falls to $14 (a $1 decrease). This is not enough to trigger a reversal. The price falls to $12 (a $2 decrease). This is still not enough. The price falls to $10 (a $4 decrease). This is greater than the reversal amount of 3 ($2 x 3 = $6 – though it’s important to measure the reversal from the *highest* price reached in the X column, which was $15, meaning a $6 drop is needed). Therefore, we start a new column of 'O's at the $14 price level. 4. **Second Column:** The price rises to $11 ( a $1 increase). Place an 'O' at the $12 price level. The price rises to $14 (a $3 increase). Place another 'O' at the $10 price level. 5. **Further Continuation:** The price continues to $16. A new column of X's would begin.

This process continues, building columns of X's and O's based on the price movements and the defined box size and reversal amount. The resulting chart will visually represent significant price changes.

1. 1. Chart Patterns in Point and Figure Charting

P&F charts are particularly effective at identifying specific chart patterns that can signal potential trading opportunities. Some common patterns include:

• **Double Top/Bottom:** Similar to traditional charting, a double top or bottom pattern in P&F can indicate a potential reversal. A double top appears as two distinct peaks, while a double bottom appears as two distinct troughs.
• **Triple Top/Bottom:** A triple top or bottom pattern is a stronger signal than a double top/bottom, suggesting a higher probability of a reversal.
• **Bullish Saucer:** A bullish saucer pattern looks like a rounded bottom, indicating a potential upward trend.
• **Bearish Saucer:** A bearish saucer pattern looks like a rounded top, suggesting a potential downward trend.
• **Ascending Three Methods:** This bullish pattern indicates strong buying pressure.
• **Descending Three Methods:** This bearish pattern indicates strong selling pressure.
• **Breakouts:** A breakout occurs when the price penetrates a key support or resistance level, often signaling the start of a new trend. In P&F charts, breakouts are easily identified when a new column of X’s or O’s is formed beyond a previous high or low. Breakout trading is a popular strategy.

1. 1. Using Point and Figure Charts for Trading

P&F charts can be used for a variety of trading purposes:

• **Identifying Support and Resistance:** The horizontal lines formed by the tops and bottoms of columns of X’s and O’s represent key support and resistance levels.
• **Setting Price Targets:** Once a pattern is identified, P&F charting can be used to project potential price targets. For example, measure the vertical distance between the top and bottom of a bullish saucer pattern and project that distance upwards from the breakout point to estimate a price target.
• **Trend Identification:** The direction of the columns (X’s or O’s) indicates the prevailing trend. A series of consecutive X columns suggests an uptrend, while a series of consecutive O columns suggests a downtrend. Trend following is well suited to P&F charting.
• **Confirmation of Signals:** P&F charts can be used to confirm signals generated by other technical indicators. For example, if a moving average crossover signals a buy opportunity, a P&F chart can be used to confirm that the price is also exhibiting bullish behavior. Consider using MACD as a confirming indicator.
• **Risk Management:** P&F charts can assist in setting stop-loss orders. Placing a stop-loss order just below a key support level identified on the chart can help limit potential losses.

1. 1. Advantages and Disadvantages of Point and Figure Charting

• • Advantages:**

• **Filters Noise:** P&F charts eliminate minor price fluctuations, focusing on significant movements.
• **Simple and Clear:** The visual representation is easy to understand, even for beginners.
• **Identifies Key Levels:** Clearly highlights support and resistance levels.
• **Objective:** The rules for constructing the chart are objective, reducing subjective interpretation.
• **Pattern Recognition:** Facilitates the identification of important chart patterns.

• • Disadvantages:**

• **Lagging Indicator:** P&F charts are lagging indicators, meaning they react to price movements rather than predicting them.
• **Parameter Sensitivity:** The choice of box size and reversal amount can significantly impact the chart's appearance and the signals it generates. Selecting optimal parameters requires experimentation and understanding of the asset's volatility.
• **Time Disregard:** The omission of time can be a disadvantage for some traders who believe time is a critical factor in analysis. Elliott Wave Theory, for example, relies heavily on time cycles.
• **Requires Practice:** Mastering the interpretation of P&F charts requires practice and experience.

1. 1. Combining Point and Figure Charting with Other Tools

P&F charting is most effective when used in conjunction with other technical analysis tools. Consider combining it with:

• **Moving Averages:** Use moving averages to confirm trends identified on the P&F chart. Simple Moving Average and Exponential Moving Average are popular choices.
• **Fibonacci Retracements:** Apply Fibonacci retracements to P&F charts to identify potential support and resistance levels.
• **Volume Analysis:** Although P&F charts don't directly display volume, incorporating volume analysis can provide additional confirmation of price movements. On Balance Volume (OBV) can be useful.
• **Relative Strength Index (RSI):** Use RSI to identify overbought and oversold conditions.
• **Bollinger Bands:** Utilize Bollinger Bands to assess volatility and potential breakout points.
• **Ichimoku Cloud:** Integrate the Ichimoku Cloud to understand support, resistance, and trend direction.
• **Candlestick patterns:** Confirm signals generated by P&F charts with candlestick patterns.
• **Harmonic Patterns:** Look for harmonic patterns in conjunction with P&F signals.
• **Gann Theory:** Apply Gann levels and angles to P&F charts for potential price targets.
• **Support and Resistance Levels:** Corroborate P&F levels with classic support and resistance identification.
• **Trend Lines:** Draw trend lines on P&F charts to visualize trend direction.
• **Chart Patterns:** Look for confluence with other chart patterns like head and shoulders or flags.
• **Market Sentiment:** Assess overall market sentiment alongside P&F signals.
• **Economic Calendar:** Consider economic events that might influence price movements.
• **News Analysis:** Stay informed about news events that could impact the asset.
• **Intermarket Analysis:** Analyze correlations between different markets.
• **Price Action:** Focus on price action confirmation alongside P&F signals.
• **Elliott Wave Analysis:** Combine P&F with Elliott Wave principles.
• **Wyckoff Method:** Integrate Wyckoff’s principles of accumulation and distribution.
• **Seasonality:** Consider seasonal trends alongside P&F signals.
• **Correlation Analysis:** Analyze correlations with other assets.
• **Sector Rotation:** Identify sector rotation opportunities.
• **Mean Reversion:** Look for mean reversion opportunities confirmed by P&F.
• **Algorithmic Trading:** Develop algorithms based on P&F patterns.

By combining P&F charting with other analytical tools, traders can increase the accuracy of their trading decisions and improve their overall profitability.

1. 1. Conclusion

Point and Figure charting is a unique and powerful tool for technical analysis. Its ability to filter noise and focus on significant price movements makes it a valuable addition to any trader's arsenal. While it has its limitations, when used correctly and in combination with other analytical techniques, P&F charting can significantly enhance trading performance. Remember to experiment with different box sizes and reversal amounts to find the settings that work best for your trading style and the assets you are trading. Trading psychology is also vital for success.

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