XOX+..........X.X..........XOXOX.....OXO..XOXO..OXOXO..OXOXO..OXOXOXO..O.OXO+.........XOXOX........XO.OXOX...OXO..XOXO..OXOXO..OXOXO..OXOXO.O....OXOX+........XOXOXO.+.....X+.OXOXO..O.O...O.O..O.O.O....O.O..O.O...O....OXOXO+.......XOXOXO+......X.+O.OXO....O.....O......O......O........O....OXOXO........XOXOXO.......X..+.O.O......................................OXO+O........XOXO+O.......X...+..O......................................OX+.........OXOX+.O.......X....+.O......................................O+..........OXO+................+O......................................+...........OX+..................O.....................................+............O+...................O+.........................................................................
470460450440430420410400390380370360350340330
Which signals really matter?
According to the original Davis study 93% of all trading signals are made up by the formationsS1 to S4 and B1 to B4.B1...B2....B3.....B4.......S1...S2....S3.....S4...............................................................................................................X.....X......X......X.........X.............X.....X.X...X.X..X.X.X....X.X.....X...XOX....X.X...OXOX...XOX..OXOX..XOXOX..X.XOX....OXO..XOXO..OXOXO..OXOXO..XOX..OXOX..XOXOX..XOXOX....OXO..XOXO..OXOXO..OXOXO...O...OXO....O.O...XOXO.....O.O...O.O..O.O.O....O.O.......O.............O.........O.....O......O......O......................................................
Note: We take a highly pragmatic approach to point-and-figure, to make it comprehensive andscientifically correct. We go out of our way to avoid unnecessary complications. So in this bookwe have not included the dozens and dozens of buy and sell formations which, though possible,are very rare.
What is the signal/trade gap?
A crucial concept often forgotten is the gap between the time the trading signal is generated andthe trade taking place.If you look at a chart you can spot the trading signals, but you will not be able to derive theirprofitability. The reason is simple: the signal is generated and then the trading action is initiated.79
The Complete Guide to Point-and-Figure Charting
However, the price may have changed in the meantime. If you have high speed access to themarkets and are continuously watching over the prices, the signal/trade gap is not significant.However, if you do all your charting in the evening and give orders to your broker the next dayto buy or sell on the opening, the signal/trade gap becomes significant. Always make realisticassumptions on your ability to trade on a signal.Discussion of the application of complex signalsBecause of the speed and size of market movements in recent years, there is seldom enoughbacking and filling action to generate the five or more columns within the relatively tight priceranges necessary for the creation of the more complex formations.The most extensive study on point-and-figure reveals the frequency of occurrence of fifteen ofthe sixteen formations for 1100 US stocks for the period 1954 through 1964, and two stocksbetween 1914 and 1964, as computed by Robert E. Davis and discussed in his book Profit andProbability published in 1965. Because there are thousands of stocks actively traded on the USnational and regional exchanges and in the over-the-counter markets, and because the entry feefor a round lot is often considerably higher than the margin required for trading one futurescontract, the stock investor must limit his universe of signals to a favourite few.Bond and stock option traders, and especially common stock traders, have a more difficultproblem. They must find the one or more formations best suited to their financial resources. Ifthey have plenty of investment capital, they have the option of using the more commonlyoccurring signals. If their funds available for investment are severely limited, however, theyhave to use the less common signals.Does it work?Point-and-figure charting is a valuable trading tool. It yields specific prices at which to takelongs and go short, and the location of stop-loss points. It provides order, meaning, rationality,consistency, and forces discipline in the trading world where this most important ingredient isso often lacking. But best of all, it works.True, there are whipsaws and false signals. The system is not perfect. But, as a rule, it cuts lossesshort, lets profits run, and is right a high percentage of the time. It is also always in on the majormoves. These are the components of a good trading system and p&f charting does it in an easyto-understand format.The system can be coupled with fundamentals to comprise a matchless trading team. Thefundamental data will indicate the securities to trade and the long-term trends (i.e. bullish orbearish) and provide some guidance as to whether you should take only buy signals to enter longpositions because the fundamentals are extremely strong, take only sell signals to go short, or
80
Interpreting the Charts
take all signals given weak and deteriorating fundamentals, or take all signals. The chart willprovide the timing of the trades.Alternatively, point-and-figure can be used alone if you subscribe to the philosophy that allfundamentally caused movements will ultimately be reflected on the chart so why bother withfundamentals? But regardless of which method you use, the system will work.The later chapters of this book will discuss more complex point-and figure formations using thecharts to predict price movements, and the actual real-trading profit record for the systemspanning seventy years of history and numerous professional and academic studies ofprofitability.
Summary•
There are eight basic buy and eight basic sell signals used in point-and-figure charting.
•
The first two buy signals, referred to as the Simple Buy signals and comprised of threeor four columns, play a dual role of determining the price level at which shorts must becovered as well as signalling the opportunity for the establishment of new long positions.
•
The more complex buy signals, all comprised of five or more columns and all containingone or more of the simple signals within their structure, permit the establishment of longpositions but are not used to close out shorts, since short positions are always covered onsimple signals.
•
The Simple Sell signals covering three or four columns always signal the need for theliquidation of long positions as well as suggest the possibility of a short sale.
•
The more complex sell signals, more correctly termed short-sale signals, contain morecolumns of reversals and one or more of the simple sell formations. These complexformations are not used to close longs, since the simple signals accomplish this, but arestrong indicators that the short side is the correct side of the market.
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The Complete Guide to Point-and-Figure Charting
Trend linesStock prices do not move in totally irregular and unpredictable ways. Instead, their prices tendto rise and fall within channels or trends. Although the use of the buy, sell, and short sellformations can provide excellent returns, it is often wise to view the formations within thecontext of the current trend as a means of avoiding those signals running counter to the trendwhich have high probabilities of being false.
The four basic price channels1.
Accumulation channel: marked by an equilibrium position of supply and demand and ahorizontal price movement normally following a major decline,
2.
Bullish channel: marked by rising demand and thus price increasing,
3.
Distribution channel: indicated by an equilibrium position of supply and demand and ahorizontal price movement normally occurring after a major bullish move,
4.
Bearish channel: as denoted by supply exceeding demand and thus a declining price.
Figure 2.20 – Price channels
82
Interpreting the Charts
Trend lines drawn at 45 degrees
Each channel is defined by trend lines drawn on the point-and-figure chart at 45 degree risingor falling, intersecting the diagonal corners of each square. They are drawn only at 45 degreeangles by convention and because the research of Robert E. Davis, as published in Profit andProbability showed,‘that the selling action points or buy points generated by these diagonaltrend lines have very high probability of successful trading.’You will be amazed at how successful these simple diagonal 45 degree trend lines are at definingprice channels. Their significance will become apparent to you in almost all charts – especiallythose over a longer time horizon – again and again. They will become as indispensable a tool inyour trading as they are in ours.The use of 45 degree trend lines is another unique aspect of point-and-figure charting, and onewhich helps eliminate ambiguity and errors of interpretation. Penetrations through p&f diagonaltrend lines are absolutely clear, either true or false, and involve none of the guessing which youget with bar charts and candlesticks.The four types of trend line
1.2.3.4.
Bullish support – a line upwards and below columnsBullish resistance – a line upwards and above columnsBearish support – a line downwards and below columnsBearish resistance – a line upwards and below columns
Accumulation and distribution channels
The horizontal lines defining accumulation and distribution channels are not drawn in a p&fchart because they are obvious as p&f charts are drawn in a grid structure, and such a grid makeshorizontal levels evident.Example of trend lines
The chart overleaf of the French CAC 40 [.FCHI] includes all of the four types of trend lines.They, as you can easily detect, nicely define the channels of the price moves.
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The Complete Guide to Point-and-Figure Charting
Chart 2.7 – Price channels in the French marketFCHI / 3 box rev, log1/ 1997.01.02 to 2003.01.16
7000680066006400620060005900580057005600550054005300520051005000490048004700460045004400430042004100400039003800370036003500340033003200310030002900285028002750270026502600255025002450240023502300225022002150
___________________________+______________________________________ 7000...........|.....|.....|...9+.|........|.......................... 6800...........|.....|.....|...6O+|........|.......................... 6600...........|.....|.....|.3.XOX+........|.......................... 6400...........|.....|.....|.X4XOXB+.......|.......................... 6200_______________________1_XOXAXO_+_________________________________ 6000...........|.....|.....XO2OXO.O..+.....|.......................... 5900...........|.....|.....XOXO...C...+....|.......................... 5800...........|.....|.....XOX....O..5.+...|.......................... 5700...........|.....|.....XOX....2..X6.+..|.......................... 5600_______________________COX____O__XO__+____________________________ 5500...........|.....|.....XO.....O..XO...+|.......................... 5400...........|.....|.....X+.....3..XO....+.......................... 5300...........|.....|.....X.+....OX.XOX...|+......................... 5200...........|.....|....+X..+...OX4XOXO..|.+........................ 5100_____________________+_B___+__OXOXOXO_____+_______________________ 5000...........|.....|..+..X....+.O.O.78O..|...+...................... 4900...........|.....|.+...A.....+|...O.O..|....+..................... 4800...........|.....|+..X.9......+....+OC.X.....+.................... 4700...........|.....+...7OX......|+..+.9BOXOX....+................... 4600________________+____6OX________++__OXO1OX5____+__________________ 4500...........X...+.|...XOX......|.++..OXO|O3O.....+................. 4400...........7O.+..X.X.XOX......|+..+.OX.|2.O......+................ 4300...........6O+...XOX2X8|......+....+OA.|..6.......+............... 4200...........XOX...XOXO4.|.....+|.....OX.|..O........+.............. 4100___________58XO__1OXO_______+_______OX____O_________+_____________ 4000...........4OXOX.XO....|...+..|.....OX+|..OX.........+............ 3900...........XO.OXCX.....|..+...|.....OX.+..OXO.........+........... 3800...........X..OXOX.....|.+....|.....OX.|+.O7O..........+.......... 3700...........X..OBO|.....|+.....|.....OX.|.+O.O....X......+......... 3600___________3__9X_______+____________O_____+_OX_X_X9______+________ 3500...........X..OX.|....+|......|........|...+OXOX8XOX......+....... 3400...........X..OX.|...+.|......|........|....OXOXOXOXO....B.+...... 3300...........2..OX.|..+..|......|........|....O+OXOXOXO....XOX+..... 3200.....X.A...1..AX.|.+...|......|........|......OXO.O.O....XOXO+.... 3100_____78XO__X__OX__+___________________________OX____O____XO_O_+___ 3000.....XOXO..C..O..+.....|......|........|......O.+...OX.X.X.....+.. 2900.....XO9OB.X....+|.....|......|........|.........+..OXOXOX......+. 2850...X.XO.OXOX...+.|.....|......|........|..........+.OXOAOX.......+ 2800...XOX..OXOX..+..|.....|......|........|...........+OXO.OX........ 2750_3_XOX__OXOX_+______________________________________O___OX________ 2700.XOXOX..OXO|+....|.....|......|........|.............+..O......... 2650.XOXOX..OX.+.....|.....|......|........|..............+........... 2600.2O5OX..OX+|.....|.....|......|........|...............+.......... 2550.X4.6...O+.|.....|.....|......|........|................+......... 2500_X______+________________________________________________+________ 2450.X.........|.....|.....|......|........|..................+....... 2400.X.........|.....|.....|......|........|...................+...... 2350.X.........|.....|.....|......|........|....................+..... 23001..........|.....|.....|......|........|.......................... 2250-----------9-----9-----0------0--------0-------------------------- 2200-----------8-----9-----0------1--------2-------------------------- 2150
No ambiguity
Note how well the trend lines in the above chart work. Point-and-figure only uses 45 degree trendlines and it is therefore absolutely clear where to trace them. All trend lines in this book are drawnby computer. That means no guessing and no tinkering. Just clearly defined trend lines.84
Interpreting the Charts
Bullish support linesBullish support lines are drawn from the lower right corner of a low O - or exposed O - at a 45degree angle from lower left to upper right when the chart has rising bottoms.The 15 year FTSE 100 [.FTSE] chart shows a bullish support line which is defined by 4 columns– or 2 exposed Os with the subsequent higher Xs – and holds for 10 years.Chart 2.8 – FTSE [.FTSE] 15 year, with bullish support lineFTSE / 3 box rev, log2/ 1988.01.11 to 2003.01.107199705769196783665065206392626761446023590557905676556554565349524451415040494148444749465645654475438843024217413540543974389638203745367135993529346033923325326031963134307230122953289528382783272826742622257125202471242223752328228322382194215121092067202719871948191018731836180017651730
......|.|.....|.|.....|.|.....|.|...........|........|.......|......|...................... 7199......|.|.....|.|.....|.|.....|.|...........|........|.......|......|...................... 7057......|.|.....|.|.....|.|.....|.|...........|.......X|.......|......|...................... 6919......|.|.....|.|.....|.|.....|.|...........|.......C1....X..|......|...................... 6783______________________________________________5_____XOX___9O.______________________________ 6650......|.|.....|.|.....|.|.....|.|...........|.XOX...XOX4..6O........|...................... 6520......|.|.....|.|.....|.|.....|.|...........|.4OX7X.BOXOX.XOX|......|...................... 6392......|.|.....|.|.....|.|.....|.|...........|.XO6OX9XOXOXOXOX2......|...................... 6267......|.|.....|.|.....|.|.....|.4.X.........X.XO.OXOX23O5OXOXO......|...................... 6144________________________________XOXO________1OX__8_OAO_O_O_A_O___._________________________ 6023......|.|.....|.|.....|.|.....|.3OXO........XO2....O.|.......OX.....+...................... 5905......|.|.....|.|.....|.|.....|.XO7O......X.XO.......|.......346...+|...................... 5790......|.|.....|.|.....|.|.....|.X6.8......XCX........|.......OXO..+........................ 5676......|.|.....|.|.....|.|.....|.2..O......XOX........|.......OXO.+..|...................... 5565________________________________X__O______BO_________________OX7+_____.____________________ 5456......|.|.....|.|.....|.|.....A.1..OX.....X.|........|.......O.O..B.X...................... 5349......|.|.....|.|.....|.|.....XOX..OXOX...X.|........|.......|+9..XCX2..................... 5244......|.|.....|.|.....|.|.....9OX..OXOXA..X.|........|.......+.O..XO1O..................... 5141......|.|.....|.|.....|.|.....8OC..9.OXO..X.|........|......+|.O..XO|O..................... 5040______________________________XOB____O_OX_X________________+___OX_A__6_____._______________ 4941......|.|.....|.|.....|.|.....7OX......OXOX.|........|....+..|.OXOX.|O..................... 4844......|.|.....|.|.....|.|.....6OX......OXOX.|........|...+...|.OXOX.|O..................... 4749......|.|.....|.|.....|.|.....XOX......O.O..|........|..+....|.O.OX.|O..................... 4656......|.|.....|.|.....|.|.....XOX...........|........|.+.....|...OX.|O..................... 4565______________________________5OX_____________________+__________OX__O__________.__________ 4475......|.|.....|.|.....|.|.....3O|...........|........+.......|...OX.|7....X................ 4388......|.|.....|.|.....|.|.....2.|...........|.......+|.......|...O..|O..X.X9............... 4302......|.|.....|.|.....|.|.....X.|...........|......+.|.......|......|OX.X8XOX......+B...... 4217......|.|.....|.|.....|.|.....1.|...........|.....+..|.......|......|OXOXOXOXO......XC..... 4135______________________________A__________________+___________________OXOXOXOXOX_____XO_____ 4054......|.|.....|.|.....|.|.....9.|...........|...+....|.......|......|OXOXO.O.OXO....XO..... 3974......|.|.....|.|.....|.|.....8.|...........|..+.....|.......|......|O.OX....OXOX.X.XO..... 3896......|.|.....|.|.....|.|.....4.|...........|.+......|.......|......|..OX....O.OXOXOXO..... 3820......|.|.....|.|.....|.|.....1.|...........|+.......|.......|......|..OX......OXOAOX...... 3745______________________________C_____________+__________________________O_______O_O_O_______ 3671......|.|.....|.|.....|.|.....B.|..........+|........|.......|......|...................... 3599......|.|.....|.|.....|.2.....8.|.........+.|........|.......|......|...................... 3529......|.|.....|.|.....|.XO....7.|........+..|........|.......|......|...................... 3460......|.|.....|.|.....|.XO....6.|.......+...|........|.......|......|...................... 3392________________________XO____X________+___________________________________________________ 3325......|.|.....|.|.....|.COX...5.|.....+.....|........|.......|......|...................... 3260......|.|.....|.|.....|.X3X9..4.|....+......|........|.......|......|...................... 3196......|.|.....|.|.....|.AO8OX.X.|...+.......|........|.......|......|...................... 3134......|.|.....|.|.....|.XOXOXCX.|..+........|........|.......|......|...................... 3072________________________X5XOXO3___+________________________________________________________ 3012......|.|.....|.|.....3.XO7A.O|.|+..........|........|.......|......|...................... 2953......|.|.....|.|.....24X6....|.+...........|........|.......|......|...................... 2895......|.|.....|.|.....CO8.....|+|...........|........|.......|......|...................... 2838......|.|.....|.|.....XO|.....+.|...........|........|.......|......|...................... 2783__________________X___B______+_____________________________________________________________ 2728......|.|.....9.|.56..X.|...+.|.|...........|........|.......|......|...................... 2674......|.|.....8A|.XOX.X.|..+..|.|...........|........|.......|......|...................... 2622......|.|.....7OX.XOXAX.|.+...|.|...........|........|.......|......|...................... 2571......|.|.....XO14XOXOX.|+....|.|...........|........|.......|......|...................... 2520________1_____XBXOX7XO__+__________________________________________________________________ 2471......9.XOX...3OXOXOX.|+|.....|.|...........|........|.......|......|...................... 2422......XOXO68..XCXO.OX.+.|.....|.|...........|........|.......|......|...................... 2375......8OXOXO..XO|..89+|.|.....|.|...........|........|.......|......|...................... 2328......XOCOXOX.X.|..O+.|.|.....|.|...........|........|.......|......|...................... 2283______7AB2XOXOX____+_______________________________________________________________________ 2238......XOX4XOXO2.|.+...|.|.....|.|...........|........|.......|......|...................... 2194......5OXO5OXOX.|+....|.|.....|.|...........|........|.......|......|...................... 2151......3OXO.OXOX.+.....|.|.....|.|...........|........|.......|......|...................... 2109......XO|..OXOX+|.....|.|.....|.|...........|........|.......|......|...................... 2067______X____9AB+____________________________________________________________________________ 2027......X.|..O.+|.|.....|.|.....|.|...........|........|.......|......|...................... 1987......X.|...+.|.|.....|.|.....|.|...........|........|.......|......|...................... 1948......X.|..+..|.|.....|.|.....|.|...........|........|.......|......|...................... 1910....X.1.|.+...|.|.....|.|.....|.|...........|........|.......|......|...................... 1873__X_X8X__+_________________________________________________________________________________ 1836X.X4XOX.+.....|.|.....|.|.....|.|...........|........|.......|......|...................... 1800X2XO6O8-9-----9-9-----9-9-----9-9-----------9--------0-------0------0---------------------- 17651O3O-99-0-----1-2-----3-4-----7-8-----------9--------0-------1------2---------------------- 1730
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The Complete Guide to Point-and-Figure Charting
The more times the support line has held price declines in check, the stronger the supportbecomes.As long as the price remains above the bullish support line, the position is said to be long-termbullish.In such cases there are three legitimate ways to trade the market:1.
Take all signals and thereby ignore the long-term trend.
2.
Take long positions with stop-loss orders placed at sell signals, yet all short sell signalsare ignored due to the long-term bullish nature of the price.
3.
Ignore all sell signals occurring above the bullish support line and thereby continue tohold the longs until a sell signal occurs below the support line. In this way trading islessened, commissions are reduced and the possibility of obtaining a long-term capitalgain is increased. The disadvantage is that this third tactic is the least sensitive of thethree to current market patterns.
The selection of the trading tactic to be employed is solely up to the individual and should be afunction of his analysis of the fundamental prospects of the position and his personal desire fortransactional action.
86
Interpreting the Charts
Chart 2.9 – Bullish support of Shire Pharmaceuticals [SHP.L]SHP.L 3box rev, / 2000.01.04 to 2001.02.151480146014401420140013801360134013201300128012601240122012001180116011401120110