Point and figure charts

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  1. Point and Figure Charts

Point and Figure (P&F) charts are a type of technical analysis charting method that differs significantly from the traditional candlestick or bar charts most traders are familiar with. Instead of plotting price over time, P&F charts plot price *movements* based on pre-defined box sizes and reversal criteria. This results in a chart that filters out minor price fluctuations and highlights significant trend changes, focusing on price action rather than time. This article will provide a comprehensive introduction to P&F charts, covering their construction, interpretation, advantages, disadvantages, and practical applications.

History and Origins

The origins of Point and Figure charting can be traced back to the late 19th century, developed by exchange trader Henry Osgood. Originally used for tracking commodity prices, P&F charts were primarily a manual process. The charts gained popularity among traders who sought a method to identify significant price levels and potential trading opportunities without being distracted by the "noise" of daily price fluctuations. Before the advent of computers, they were painstakingly created by hand, requiring dedication but offering a clear visual representation of price trends. Today, software and online platforms automate the creation and updating of P&F charts, making them accessible to a wider range of traders.

Core Concepts & Construction

Understanding the basic building blocks of a P&F chart is crucial. There are three primary components:

  • Boxes (or Grids): These are the fundamental units of the chart. Each box represents a specific price increment, determined by the box size. The box size is a critical parameter, discussed in detail below.
  • X's and O's: These symbols are used to plot price movements. Traditionally, 'X's represent rising prices and 'O's represent falling prices.
  • Reversal Criteria: These are the rules that determine when the chart changes from plotting 'X's to 'O's, or vice versa. This is a key element in filtering noise and identifying significant trend changes.

Defining the Box Size

The box size is the most important parameter in creating a P&F chart. It represents the minimum price movement required to add a new box to the chart. Choosing the appropriate box size is critical; too small a box size will result in a cluttered chart with excessive noise, while too large a box size may filter out important price movements.

Here's a guide to selecting a suitable box size:

  • Volatility of the Asset: More volatile assets require larger box sizes. For example, a stock that typically moves $5 per day might use a $1 or $2 box size. A less volatile asset might use a $0.25 or $0.50 box size.
  • Timeframe: Longer timeframes generally require larger box sizes.
  • Trading Style: Swing traders and position traders typically use larger box sizes compared to day traders.
  • Percentage-Based Approach: Some traders use a percentage of the asset's price as the box size (e.g., 1% or 2%).
  • ATR (Average True Range): A common method is to use a multiple of the ATR as the box size. The Average True Range is an indicator that measures volatility.

Reversal Criteria – The Heart of P&F

The reversal criteria determine when the chart switches from plotting 'X's to 'O's, or vice versa. There are several common reversal criteria:

  • Fixed Reversal: This is the simplest method. The chart reverses direction whenever the price moves back through the most recent high (for 'O's) or low (for 'X's). This is a fast-responding criteria but can be prone to whipsaws.
  • Variable Reversal: This criteria requires the price to move back through a specified number of boxes before reversing direction. For example, a 3-box reversal means the price must move back through three boxes before a reversal occurs. Variable reversals are less sensitive to noise and provide stronger signals.
  • Percentage Reversal: This criteria bases the reversal on a percentage change in price.

The choice of reversal criteria depends on the trader's risk tolerance and trading style. Variable reversals are generally preferred for longer-term trading, while fixed reversals can be used for shorter-term trading.

Building a P&F Chart – A Step-by-Step Example

Let's illustrate with an example. Suppose a stock is trading at $50, and we choose a box size of $1 and a 3-box reversal criteria.

1. **Initial Point:** Start with a single 'X' column at $50. 2. **Rising Price:** If the price rises to $51, add another 'X' in the same column. Continue adding 'X's as the price rises, one 'X' per $1 increment. 3. **Falling Price:** If the price falls to $50, it remains in the same column. Continue to add 'X's as long as the price stays above the previous low. 4. **Reversal Triggered:** If the price falls back to $47 (three boxes below the highest 'X' column), reverse the chart and start placing 'O's. 5. **Falling Price (O's):** As the price falls further, add 'O's in a new column, one 'O' per $1 decrement. 6. **Rising Price (Reversal):** If the price rises back to $50 (three boxes above the lowest 'O' column), reverse the chart and start placing 'X's again.

This process continues, building the P&F chart column by column, 'X' by 'X' and 'O' by 'O', based on the price movements and the defined reversal criteria.

Interpreting Point and Figure Charts

Once the P&F chart is constructed, it can be used to identify potential trading signals. Here are some key patterns and interpretations:

  • Double Tops/Bottoms: These patterns are formed when the chart makes two successive highs (double top) or lows (double bottom) at the same price level. They suggest a potential trend reversal.
  • Triple Tops/Bottoms: Similar to double tops/bottoms, but with three successive highs/lows. Triple tops/bottoms are generally considered stronger signals than double tops/bottoms.
  • Breakouts: A breakout occurs when the price moves beyond a significant high or low on the chart. This can signal the start of a new trend. A breakout is more significant if it occurs after a period of consolidation.
  • Horizontal Count: The horizontal count is the number of consecutive 'X's or 'O's in a single column. A higher horizontal count suggests a stronger trend.
  • Vertical Count: The vertical count is the number of consecutive columns of 'X's or 'O's. A higher vertical count also suggests a stronger trend.
  • Bullish Saucer and Bearish Saucer: These patterns resemble saucers and indicate potential trend reversals. A bullish saucer forms after a downtrend, while a bearish saucer forms after an uptrend.
  • Upthrusts and Downthrusts: These are short-term price movements that test the strength of a trend. An upthrust occurs during a downtrend, while a downthrust occurs during an uptrend.

Advantages of Point and Figure Charts

  • Noise Reduction: P&F charts filter out minor price fluctuations, focusing on significant price movements.
  • Clear Visual Representation: They provide a clear and concise visual representation of price trends.
  • Objective Signals: The reversal criteria provide objective signals, reducing subjective interpretation.
  • Identification of Support and Resistance: Horizontal lines on the chart represent potential support and resistance levels.
  • Simple to Understand: The basic concepts are relatively easy to grasp, even for beginners.
  • Focus on Price Action: P&F charts emphasize price action, a fundamental aspect of technical analysis.

Disadvantages of Point and Figure Charts

  • Lagging Indicator: P&F charts are lagging indicators, meaning they react to price movements rather than predicting them.
  • Subjectivity in Parameter Selection: Choosing the appropriate box size and reversal criteria can be subjective.
  • Time Insensitivity: P&F charts do not consider time, which can be a disadvantage in certain trading situations.
  • Not Suitable for All Assets: P&F charts are most effective for assets that exhibit clear trending behavior. They may be less useful for choppy or range-bound markets.
  • Requires Practice: Mastering the interpretation of P&F charts requires practice and experience.

P&F Charts vs. Other Chart Types

| Feature | Point and Figure | Candlestick Charts | Bar Charts | |---|---|---|---| | **Axis** | Price | Time & Price | Time & Price | | **Focus** | Price movements | Price movements over time | Price movements over time | | **Noise** | Filtered | Present | Present | | **Time Sensitivity** | Insensitive | Sensitive | Sensitive | | **Signal Generation** | Reversal criteria | Patterns, indicators | Patterns, indicators | | **Complexity** | Moderate | Moderate | Moderate |

Practical Applications and Strategies

P&F charts can be integrated into various trading strategies. Here are a few examples:

  • Breakout Trading: Buy when the price breaks above a significant high on the chart.
  • Trend Following: Identify the prevailing trend and trade in the direction of the trend.
  • Support and Resistance Trading: Buy at support levels and sell at resistance levels.
  • Pattern Recognition: Identify patterns such as double tops/bottoms, triple tops/bottoms, and saucers to anticipate trend reversals.
  • Combining with Indicators: Use P&F charts in conjunction with other technical indicators, such as Moving Averages, MACD, RSI, and Bollinger Bands, to confirm signals. Fibonacci retracements can also be applied to P&F charts.
  • Using P&F for Target Setting: Measure the vertical distance between significant points on the chart to project potential price targets. Elliott Wave Theory can sometimes be visually approximated on P&F charts.
  • Applying Ichimoku Cloud principles to P&F: While not a direct overlay, understanding the concepts of the Ichimoku Cloud can help interpret P&F signals.
  • Combining with Volume Analysis: Confirm P&F signals with volume analysis to assess the strength of the trend. On Balance Volume (OBV) can be useful here.
  • Using P&F with Japanese Candlestick Patterns recognition: Identifying candlestick patterns within the P&F framework can provide additional confirmation.
  • Employing Gann Theory principles: Gann angles and levels can be applied to P&F charts for potential support and resistance.
  • Utilizing Harmonic Patterns on P&F: While challenging, identifying harmonic patterns within the P&F structure can offer high-probability trading opportunities.

Resources for Further Learning

  • **Books:**
   * *Point and Figure Charting* by Tom Dorsey
   * *Trading with Point and Figure Charts* by Marty Chen
  • **Websites:**
   * Investopedia: [1]
   * TradingView: [2] (Offers P&F charting functionality)
  • **Software:**
   * MetaTrader 5 (with custom P&F indicator)
   * TradingView
   * AmiBroker
  • **Online Courses:** Search for "Point and Figure Charting" on platforms like Udemy and Coursera.
  • **YouTube Channels:** Search for "Point and Figure Charting" for numerous tutorial videos.
  • **Blogs and Forums:** Explore trading blogs and forums dedicated to technical analysis.

Conclusion

Point and Figure charts offer a unique and powerful approach to technical analysis. By filtering out noise and focusing on significant price movements, they provide a clear visual representation of price trends. While they have their limitations, P&F charts can be a valuable tool for traders of all levels, especially when used in conjunction with other technical indicators and trading strategies. Mastering P&F charting requires practice and a thorough understanding of its core concepts, but the potential rewards can be significant. Remember to always practice proper risk management and to backtest your strategies before risking real capital. Understanding Risk Management is paramount, alongside Position Sizing.


Technical Analysis Chart Patterns Trading Strategies Support and Resistance Trend Following Market Trends Candlestick Charts Bar Charts Trading Indicators Volatility

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