.....O.O......|.....X...................O......X.X...X...................O4.6...4OXO..X...................OXOXO..XO56X.A...................2XOXO..3O.OX9X...................OXOXO..X..OXOX...................O3OXO..2..O8OX...................O.5X7..X..7.OX.....................O.O..X....O........................8..1.....|.......................A..X.....|.......................O..X.....|.......................OB.X.....|.......................OXOX.....|.......................OXOX.....|.......................O.O......|..........................|.....|..........................|.....|..........................|.....|................
360350340330320310300290280270260250240230220210200195190185180175170165160
As the name indicates, the non-trailing profit-taking level is set at the entry of the position andis not changed until it is either touched or an opposed signal has occurred.
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ConclusionStop orders are a crucial instrument for the point-and-figure trader. They can be used to:•••
open positionsprotect positionstake profits early
Running a big book of stop orders has to be done in a very orderly way to prevent a situation inwhich you confuse your broker or mess up your own order book and thus create losses due tosimple errors.
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Risk and position sizeYour available capital and your risk appetite should define the size of your trading positions. Inthis chapter we talk about simple methods to estimate risk.Keep it simple
Risk estimates can be calculated at any level of detail, involving analysis of a myriad ofscenarios and with various methodologies. However, we have extensive knowledge of riskmanagement and know that a simple comprehensible risk measure technique is what one needs.We propose that you either simulate or estimate a maximum capital drawdown for eachinstrument you want to trade. Then you sum the values and deduct the diversification benefit.That’s all. We assure you if Long Term Capital Management had used that approach, they wouldstill be around today!Estimating the maximum equity drawdown is straightforward. You estimate the trading risks bylooking at the point-and-figure chart that depicts a long time span of the stock you want to trade,then you make an estimate of a worst-case regarding the potential losses.Where does risk come from?The risks of losing money by trading stocks with point-and-figure are twofold:1.
the series of losing trades, so called ‘whipsawing’, which is shown in the chart overleafand
2.
getting locked into a wrong position during a market discontinuity; for instance, beinglong over a random event like the 9/11 terrorist attack.
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The problem of whipsawingChart 3.14 – The Achilles’ heel, whipsawing!9694929088868482807876747270686664626059585756555453525150494847464544
......................|.X.X..............................|.XOXOX............................|.XOXOXO...........................|.XO.OXO...........................|.X..O.O...........................|.X....O...........................|.X................................|.X.......*........................|.X.......*........................|.X.......*................X.......|.X.......*..______________XO________X_______*__....X.........COX.....|.X.......*......XO........XOXO....|.X.......*......XO......X.XOXO....|.X.......*......XO......XOXOXO....|.X.......*..____XO______XOXO_O______X_______*__....XO..X.X.XO...O....|.X.......*..X.X.XO..XOXOX....OX...|.X.......*..XOXOXO..XOXOX....OXO..|.X.......*..XOXOXOX.XOXOX....OXO..|.X.......*..XOXOXOXOXO_OX____OXO____X_______*__XOXOXOXOX..OX....OXOX.|.X..........XOXOBOXOX..O.....OXOXO|.X..........XO.O.OXOX........OXOXOX.X..........X....OXOX........OXOXOXOX..........X____OXO_________O_OXOXOX__________.....OX............O.OXOX...............OX..............OXOX...............O...............O1OX...............................O|O...........___________________________________......................|..................................|..................................|............
9694929088868482807876747270686664626059585756555453525150494847464544
As you can see, the first trade is long at 62, then short with a loss, then long with a loss, shortwith a loss, and this for a series of five trades. We would have lost about 22 points, plustransaction costs estimated at 3. That corresponds to a crash from 82 to 57, indicated on the rightside with ‘*’, which takes quite a big toll on the overall profit. But this sort of whipsawinghappens quite often until a trending position is finally entered.You can make a fair estimate of that whipsawing-risk by looking at the long-term chart anddoing some paper trading, or doing a computerised analysis.As we mentioned before, you also run the risk of discontinuities, gaps or jumps. Such risk is,however, less important with large companies than small caps. If you trade stocks that are in theFTSE, DAX or other blue-chip index, you do not have to consider that risk, because it willalways be smaller than the risk associated with whipsawing.130
Trading Applications
The most significant risk of p&f trading is whipsawing. This is unlike passive investmentstrategies, which suffer from volatility or market crashes – where point-and-figure worksespecially well. Point-and-figure trading, however, is problematic in sideways markets. In suchmarkets positions are often changed and each time a small loss is taken and those small lossesadd up to a big loss. Therefore, the parameter to consider in assessing risks for p&f trading isthe largest historical draw-down and not the size of the moves of the stocks as such.How to calculate historic draw-downs
The trading strategy is simulated with historic data. The equity – the P&L of the simulatedtrading account – is calculated each day during the simulation. After each new high of the equity,the following low is searched for. The difference between the two is a draw-down. Once alldraw-downs are found, the biggest is determined and used in order to estimate the risks involvedin the trading strategy.
Size of positionsTo be prudent is a virtue. On the other hand, with tiny positions, you can’t make big money. Ona winning position, you always think bigger positions should have been taken, and on the losingtrades you always have too big a position! Therefore a simple way of calculating levels of risksand sizes of positions is required. We’ll give you a simple way of calculating your own levelsof risk and capital requirements.First you have to quantify your risk appetite. A good starting point is to establish the maximumamount of capital you are willing to lose in adverse circumstances and the number ofinstruments you want to trade. The amount of capital that you have at your disposition is anumber we can unfortunately not change, and it does not need to be estimated. It is what it is!For each instrument you estimate a possible worst case scenario. The easiest way is to base suchestimations on historical data, i.e. long-term charts. If a certain strategy applied to a given stockhad a maximum draw-down of 40%, it is reasonable to use that value for an estimate. Obviouslyit is conceivable that the stock will take a bigger hit than the historic maximum, though theprobability is low. Such a risk should be compensated for by diversification, i.e. trading morethan one security.Then if you trade two or more low-correlated instruments, you have to calculate thediversification benefits which lowers the risk-value below the aggregate of the estimated drawdowns; or put the other way round, you can trade bigger positions. If you trade:•••
2 instruments (stocks, bonds, futures), decreases total risk by 33%5 instruments, decreases total risk by 50%10 instruments, decreases total risk by 80%
with the value of risk referring to the aggregate of simulated draw-downs.131
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Example 3.7 – Calculating maximum drawdown
You decide to trade Siemens [SIEGn.DE] and Repsol [REP.MC] with a simple p&f strategy,1,000 shares each. You estimated the maximum drawdown at 15,000 for Siemens and 9,000for Repsol. Therefore, you would sum the two draw-down figures – equals 24,000 – andsubtract the diversification benefit of 33% – equals 8,000 – resulting in the capital-at-risknumber of 16,000. To be safe and responsible in running your strategy, you have to put aside16,000. If this number is greater than the margin requirements set by your broker, it isimperative to put it aside anyway.Looked at from a different point of view, you want to put 20,000 in trading Repsol andSiemens with equal amounts of shares. You have estimated the maximum drawdown forSiemens to be 15 per share and 9 for Repsol. So a portfolio with 1 Repsol and 1 Siemenswould incur a risk of 24 minus the diversification benefit of 33%, resulting in a risk numberof 16. Therefore, you could trade 20,000 divided by 16 equals 1,250 shares, and so itwould be advisable to trade not more than 1,250 shares of each company.
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Pyramiding made simple and profitable
IntroductionMuch has been written concerning the pros and cons of pyramiding and the right and wrongways to do it. But unfortunately while the concept of adding to positions which are trendingseems so logical and correct, its implementation usually becomes cumbersome, complicated,inexact, and more of an art than a science. And thus generally not worth the trouble.Naturally, all traders would like the greatest concentration of positions in those stocks showingthe largest positive moves, but the employment of a pyramiding strategy usually degeneratesinto a finger-crossing, seat-of-the-pants exercise of guesses.But now all that can change. Pyramiding can become a simple, exact and easily-implementedmarket tool capable of substantially increasing overall portfolio returns.What is point-and-figure pyramiding?
Point-and-figure pyramiding refers to the trading of consecutive chart signals of the samecategory (i.e. buys or sells), whereby on each additional signal of the same category the positionis increased. The purpose of pyramiding is to concentrate the invested capital in the trending,and therefore profitable positions.The systemThe pyramiding system requires just a slight modification of the point-and-figure technique.A quick review of non-pyramiding point-and-figure
In the non-pyramiding p&f method, only the first signal is considered. Thus, after a string of sellsignals, the first buy signal would trigger a long. Once taken, the long would be held throughoutthe entire series of additional buy signals, with no additional positions added, and finallyliquidated on the very first sell signal.Simultaneous with the closing out of the long, a short sale would be executed which wouldremain on the books without additional short positions added on new sell formations, until thefirst buy signal where the short would be covered and a new long taken.Pyramiding means all signals are taken
With pyramiding, the technique is changed so that positions are taken on every signal, not juston the first signal after a reversal. Thus on the first buy formation after a sell signal, a long istaken. On each subsequent buy signal an additional position is taken until a sell signal occurs,at which time all longs are immediately liquidated and a short taken. On each subsequent sell133
The Complete Guide to Point-and-Figure Charting
formation an additional short position is added until a buy signal occurs, at which time all shortsare covered and a long taken. The result is a large accumulation of positions in stocks orcontracts which are showing substantial trends, with small commitments in non-trendingor whippy situations.Chart 3.15 – Pyramiding, ARM [ARM.L]ARM.L /58057056055054053052051050049048047046045044043042041040039038037036035034033032031030029028528027527026526025525024524023523022522021521020520019519018518017517016516015515014514013813613413213012812612412212011811611411211010810610410210098969492908886848280787674727068666462605958575655545352515049484746454443424140393837
134
1998.04.17 to 1999.12.16..............................|...................................................X.....................................|...................................................X.......______________________________________________________________________________X___X_______..............................|...............................................XO..X.....................................|...............................................XO..X.....................................|...............................................XOX.X.....................................|...............................................XOXOX.......______________________________________________________________________________XOXOX_______..............................|...............................................XO.OX.....................................|...............................................X..OX.....................................|...............................................X..OX.....................................|...............................................X..OX.......______________________________________________________________________________X__OX_______..............................|.............................................X.X..O......................................|.............................................XOX.........................................|.............................................XOX.........................................|.............................................XOX...........____________________________________________________________________________XOX___________..............................|...........................................X.XOX.........................................|...........................................XOXOX.........................................|...........................................XOXO..........................................|...........................................XO..............__________________________________________________________________________B_______________..............................|...........................................X.............................................|...........................................X.............................................|...........................................X.............................................|...........................................X...............__________________________________________________________________________X_______________..............................|...........................................X.............................................|...........................................X.............................................|...........................................X.............................................|...........................................X...............__________________________________________________________________________X_______________..............................|...........................................X.............................................|...........................................X.............................................|...........................................X.............................................|...........................................X...............________________________________________________________________________X_X_______________..............................|.........................................XOX.............................................|.........................................XOX.............................................|.........................................XOX.............................................|.........................................XO................________________________________________________________________________X_________________..............................|.........................................X...............................................|...............................X.........X...............................................|.............................X.XO........X...............................................|.............................XOXO....X...X.................____________________________________________________________XOXOX___XO__A_________________..............................|.............................XOXO8OX.XOX.X...............................................|.............................XO.OXOXOXOXOX...............................................|.............................X..OXOXOXOXOX...............................................|.............................X..OXOXO9OXOX.................____________________________________________________________X__O_O_O_O_O__________________..............................|.............................X...........................................................|.............................X...........................................................|.........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........X.X............OXO..X.|...........................................................________XOX____________O_O__X_____________________________________________________________4.......XOX..............OX.B.|............................................................O......XOX..............OXOX.|............................................................O....X.XO...............OXOX.|............................................................OX...XOX................AXOX.|..........................................................._OXOX_XOX________________OXOX_____________________________________________________________.OXOXOXOX................OXOX.|............................................................O.OXOXO.................OXO..|..............................................................5XO6..................OX...|...........................................................---OXO-------------------O----9-------------------------------------------------------------O--------------------------9-----------------------------------------------------------
58057056055054053052051050049048047046045044043042041040039038037036035034033032031030029028528027527026526025525024524023523022522021521020520019519018518017517016516015515014514013813613413213012812612412212011811611411211010810610410210098969492908886848280787674727068666462605958575655545352515049484746454443424140393837
However, you only start a new positionwhen the nature of the chart changes. Ifyou are neutral, you do not go short on thesecond or a later sell signal. If you havemissed the first sell, you patiently waituntil a buy is generated and start yourpyramiding from there.In the chart of ARM Holdings on the left,pyramiding is demonstrated during theforceful up move in 1999. As you can see,there are up to 5 consecutive buy signalswithout a sell signal occurring. In thepyramiding approach to trading you wouldincrease at each buy or long position. Atthe first sell formation you liquidate theentire position and go one short.We have indicated the liquidation of thelongs with a red bar of the length equal tothe accumulated position.The chart on the right shows the oppositesituation, namely the pyramiding ofpositions is triggered during a down move.Specifically, in the case of Cable andWireless, one unit was sold short at 210,the market continued down and anotherunit sold short at 185, then the marketrallied a bit (but no buy signal was given),however the rally died and the stockstarted falling again given another sellsignal at 190 – where another unit wassold – and a final unit of shares was sold at155. After that, there was a short rally anda buy signal at 180 indicated to close outthe 4 short units, and open a long position.
Trading Applications
Chart 3.16 – Pyramiding, Cable and Wireless [CW.L]CW.L / 3 box rev, log1/ 2002.03.12 to 2003.01.1025024524023523022522021521020520019519018518017517016516015515014514013813613413213012812612412212011811611411211010810610410210098969492908886848280787674727068666462605958575655545352515049484746454443424140393837
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