An oversold condition ispresent when the lines are too far below the zero line. The bestbuy signals are given when prices are well below the zero line(oversold). Crossings above and below the zero line are anotherway to generate buy and sell signals respectively, similar to themomentum technique we discussed previously.
Divergences appear between the trend of the MACD linesand the price line. A negative, or bearish, divergence exists whenthe MACD lines are well above the zero line (overbought) and startto weaken while prices continue to trend higher. That is often awarning of a market top. A positive, or bullish, divergence existswhen the MACD lines are well below the zero line (oversold) andstart to move up ahead of the price line. That is often an early signof a market bottom. Simple trendlines can be drawn on the MACDlines to help identify important trend changes. (See Figure 10.19b.)
 
(‘OTC) Nasdaq Composite Index
 
 
 
 
 
 
 
Figure 10.19b =The MACD lines fluctuate around a zero line, giving itthe quality of an oscillator. The best buy signals occur below the zero line.The best sell signals come from above. Notice the negative divergence givenin October (see down arrow).Oscillators and Contrary Opinion 255
MACD HISTOGRAM
We showed you earlier in the chapter how a histogram could beconstructed that plots the difference between two moving averagelines. Using that same technique, the two MACD lines can beturned into an MACD histogram. The histogram consists of verti-cal bars that show the difference between the two MACD lines.The histogram has a zero line of its own. When the MACD linesare in positive alignment (faster line over the slower), the his-togram is above its zero line. Crossings by the histogram aboveand below its zero line coincide with actual MACD crossover buyand sell signals.
The real value of the histogram is spotting when thespread between the two lines is widening or narrowing. Whenthe histogram is over its zero line (positive) but starts to falltoward the zero line, the uptrend is weakening. Conversely,when the histogram is below its zero line (negative) and startsto move upward toward the zero line, the downtrend is losingits momentum. Although no actual buy or sell signal is givenuntil the histogram crosses its zero line, the histogram turnsprovide earlier warnings that the current trend is losingmomentum. Turns in the histogram back toward the zero linealways precede the actual crossover signals. Histogram turns arebest used for spotting early exit signals from existing positions.It’s much more dangerous to use the histogram turns as anexcuse to initiate new positions against the prevailing trend.(See Figure 10.20a.)256 Chapter 10
 
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Figure 10.20a The MACD histogram plots the difference between thetwo MACD lines. Signals are given on the zero line crossings. Notice that thehistogram turns earlier than the crossover signals, giving the trader someadvanced warning.
COMBINE WEEKLIESAND DAILIES
As with all technical indicators, signals on weekly charts arealways more important than those on daily charts. The best wayto combine them is to use weekly signals to determine marketdirection and the daily signals to fine-tune entry and exitpoints. A daily signal is followed only when it agrees with theweekly signal. Used in that fashion, the weekly signals becometrend filters for daily signals. That prevents using daily signals totrade against the prevailing trend. Two crossover systems inwhich this principle is especially true are MACD and Stochastics.(See Figure 10.20b.)Oscillators and Contrary Opinion 257
 
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Figure 10.20b = The MACD histogram works well on weekly charts. At
the middle peak, the histogram turned down 10 weeks before the sell signal(down arrow). At the two upturns, the histogram turned up 2 and 4 weeks
before the buy signals (up arrows).
THE PRINCIPLE OF CONTRARYOPINION IN FUTURES
Oscillator analysis is the study of market extremes. One of themost widely followed theories in measuring those marketextremes is the principle of Contrary Opinion. At the beginningof the book, two principal philosophies of market analysis wereidentified—fundamental and technical analysis. ContraryOpinion, although it is generally listed under the category oftechnical analysis, is more aptly described as a form of psycho-logical analysis. Contrary Opinion adds the important thirddimension to market analysis—the psychological—by determin-ing the degree of bullishness or bearishness among participants inthe various financial markets.258 Chapter 10
The principle of Contrary Opinion holds that when thevast majority of people agree on anything, they are generallywrong. A true contrarian, therefore, will first try to determinewhat the majority are doing and then will act in the oppositedirection.
Humphrey B. Neill, considered the dean of contrarythinking, described his theories in a 1954 book entitled, The Artof Contrary Thinking. Ten years later, in 1964, James H. Sibbetbegan to apply Neill’s principles to commodity futures tradingby creating the Market Vane advisory service, which includesthe Bullish Consensus numbers (Market Vane, P.O. Box 90490,Pasadena, CA 91109). Each week a poll of market letters is takento determine the degree of bullishness or bearishness amongcommodity professionals. The purpose of the poll is to quantifymarket sentiment into a set of numbers that can be analyzedand used in the market forecasting process. The rationale behindthis approach is that most futures traders are influenced to agreat extent by market advisory services. By monitoring theviews of the professional market letters, therefore, a reasonablyaccurate gauge of the attitudes of the trading public can beobtained.
Another service that provides an indication of market sen-timent is the “Consensus Index of Bullish Market Opinion,” pub-lished by Consensus National Commodity Futures Weekly(Consensus, Inc., 1735 McGee Street, Kansas City, MO 64108).These numbers are published each Friday and use 75% as an over-bought and 25% as an oversold measurement.
Interpreting Bullish Consensus Numbers
Most traders seem to employ a fairly simple method of analyzingthese weekly numbers. If the numbers are above 75%, the marketis considered to be overbought and means that a top may be near.A reading below 25% is interpreted to warn of an oversold condi-tion and the increased likelihood that a market bottom is near.Oscillators and Contrary Opinion 259
Contrary Opinion Measures RemainingBuying or Selling Power
Consider the case of an individual speculator. Assume that spec-ulator reads his or her favorite newsletter and becomes con-vinced that a market is about to move substantially higher. Themore bullish the forecast, the more aggressively that trader willapproach the market. Once that individual speculator’s fundsare fully committed to that particular market, however, he orshe is overbought—meaning there are no more funds to committo the market.
Expanding this situation to include all market partici-pants, if 80-90% of market traders are bullish on a market, it isassumed that they have already taken their market positions.Who is left to buy and push the market higher? This then is oneof the keys to understanding Contrary Opinion. If the over-whelming sentiment of market traders is on one side of the mar-ket, there simply isn’t enough buying or selling pressure left tocontinue the present trend.
Contrary Opinion Measures Strong VersusWeak Hands
A second feature of this philosophy is its ability to compare strongversus weak hands. Futures trading is a zero sum game. For everylong there is also a short. If 80% of the traders are on the long sideof a market, then the remaining 20% (who are holding short posi-tions) must be well financed enough to absorb the longs held bythe other 80%. The shorts, therefore, must be holding much larg-er positions than the longs (in this case, 4 to 1).
This means further that the shorts must be well capitalizedand are considered to be strong hands. The 80%, who are holdingmuch smaller positions per trader, are considered to be weakerhands who will be forced to liquidate those longs on any suddenturn in prices.260 Chapter 10
Some Additional Features of the BullishConsensus Numbers
Let’s consider a few additional points that should be kept in mindwhen using these numbers. The norm or equilibrium point is at55%. This allows for a built-in bullish bias on the part of the gen-eral public. The upper extreme is considered to be 90% and thelower extreme, 20%. Here again, the numbers are shifted upwardslightly to allow for the bullish bias.
A contrarian position can usually be considered when thebullish consensus numbers are above 90% or under 20%.Readings over 75% or under 25% are also considered warningzones and suggest that a turn may be near. However, it is general-ly advisable to await a change in the trend of the numbers beforetaking action against the trend. A change in the direction of theBullish Consensus numbers, especially if it occurs from one of thedanger zones, should be watched closely.
The Importance of Open Interest (Futures)
Open interest also plays a role in the use of Bullish Consensus num-bers. In general, the higher the open interest figures are, the better thechance that the contrarian positions will prove profitable. A contrar-ian position should not be taken, however, while open interest is stillincreasing. A continued rise in open interest numbers increases theodds that the present trend will continue. Wait for the open interestnumbers to begin to flatten out or to decline before taking action.
Study the Commitments of Traders Report to ensure thathedgers hold less than 50% of the open interest. Contrary Opinionworks better when most of the open interest is held by speculators,who are considered to be weaker hands. It is not advisable to tradeagainst large hedging interests.
Watch the Market’s Reaction toFundamental News
Watch the market’s reaction to fundamental news very closely.The failure of prices to react to bullish news in an overboughtOscillators and Contrary Opinion 261
area is a clear warning that a turn may be near. The firstadverse news is usually enough to quickly push prices in theother direction. Correspondingly, the failure of prices in anoversold area (under 25%) to react to bearish news can betaken as a warning that all the bad news has been fully dis-counted in the current low price. Any bullish news will pushprices higher.
Combine Contrarian Opinion with OtherTechnical Tools
As a general rule, trade in the same direction as the trend of theconsensus numbers until an extreme is reached, at which time thenumbers should be monitored for a sign of a change in trend. Itgoes without saying that standard technical analytical tools canand should also be employed to help identify market turns atthese critical times. The breaking of support or resistance levels,trendlines, or moving averages can be utilized to help confirmthat the trend is in fact turning. Divergences on oscillator chartsare especially useful when the Bullish Consensus numbers areoverbought or oversold.
INVESTOR SENTIMENT READINGS
Each weekend Barron’s includes in its Market Laboratory section aset of numbers under the heading “Investor Sentiment Readings.”In that space, four different investor polls are included to gaugethe degree of bullishness and bearishness in the stock market. Thefigures are given for the latest week and the period two and threeweeks back for comparison purposes. Here’s a random sample ofwhat the latest week’s figures might look like. Remember thatthese numbers are contrary indicators. Too much bullishness isbad. Too much bearishness is good.262 Chapter 10
 
Investor's Intelligence
Bulls 48%
Bears 27
Correction 24
Consensus IndexBullish Opinion 77%
 
AAll Index
(American Association ofIndividual Investors
625 N. Michigan Ave.Chicago, tL 60611)
Bullish 53%
 
Bearish 13Neutral 34Market Vane
Bullish Consensus 66%
NUMBE
Investors Intelligence (30 Church Street, New Rochelle, NY10801) takes a weekly poll of investment advisors and producesthree numbers—the percent of investment advisors that are bull-ish, those that are bearish, and those that are expecting a marketcorrection. Bullish readings over 55% warn of too much optimismand are potentially negative for the market. Bullish readingsbelow 35% reflect too much pessimism and are considered posi-tive for the market. The correction figure represents advisers whoare bullish but expecting short term weakness.
Investors Intelligence also publishes figures each week thatmeasure the number of stocks that are above their 10 and 30 week
INN ESTORS INTELLIGENCEOscillators and Contrary Opinion 263
 
moving averages. Those numbers can also be used in a contraryfashion. Readings above 70% suggest an overbought stock market.Readings below 30% suggest an oversold market. The 10 weekreadings are useful for measuring short to intermediate marketturns. The 30 week numbers are more useful for measuring majormarket turns. The actual signal of a potential change in trendtakes place when the numbers rise back above 30 or fall backbelow 70. 
INTRODUCTION
The first charting technique used by stock market traders beforethe turn of the century was point and figure charting. The actualname “point and figure” has been attributed to Victor deVilliersin his 1933 classic, The Point and Figure Method of Anticipating StockPrice Movements. The technique has had various names over theyears. In the 1880s and 1890s, it was known as the “bookmethod.” This was the name Charles Dow gave it in a July 20,1901 editorial of The Wall Street Journal.
Dow indicated that the book method had been used forabout 15 years, giving it a starting date of 1886. The name “figurecharts” was used from the 1920s until 1933 when “point and fig-ure” became the accepted name for this technique of trackingmarket movement. R.D. Wyckoff also published several worksdealing with the point and figure method in the early 1930s.
265266 Chapter 17
 
The Wall Street Journal started publishing daily high, low,and closing stock prices in 1896, which is the first reference to themore commonly known bar chart. Therefore, it appears that thepoint and figure method predates bar charting by at least 10 years.
We're going to approach point and figure charting in twosteps. We'll look at the original method that relies on intradayprice moves. Then we’ll show you a simpler version of point andfigure charting that can be constructed by using only the highand low prices for any market.
THE POINT AND FIGURE VERSUSTHE BAR CHART
Let’s begin with some of the basic differences between point andfigure charting and bar charting and look at a couple of chartexamples.
The point and figure chart is a study of pure price movement.That is to say, it does not take time into consideration while plot-ting the price action. A bar chart, by contrast, combines bothprice and time. Because of the way the bar chart is constructed,the vertical axis is the price scale and the horizontal axis, a timescale. On a daily chart, for example, each successive day’s priceaction moves one space or bar to the right. This happens even ifprices saw little or no change for that day. Something must alwaysbe placed in the next space. On the point and figure chart, onlythe price changes are recorded. If no price change occurs, thechart is Jeft untouched. During active market periods, a consider-able amount of plotting may be required. During quiet marketconditions, little or no plotting will be needed.
An important difference is the treatment of volume. Bar chartsrecord volume bars under the day’s price action. Point and figurecharts ignore volume numbers, as a separate entity. This lastphrase, “as a separate entity,” is an important one. Although thevolume numbers are not recorded on the point and figure chart,it does not necessarily follow that volume, or trading activity, istotally lost. On the contrary, since intraday point and figurecharts record all price change activity, the heavier or lighter vol-ume is reflected in the amount of price changes recorded on thePoint and Figure Charting 267
 
chart. Because volume is one of the more important ingredientsin determining the potency of support and resistance levels, pointand figure charts become especially useful in determining atwhich price levels most of the trading activity took place and,hence, where the important support and resistance numbers are.
Figure 11.1 compares a bar chart and a point and figurechart covering the same time span. In one sense, the charts looksimilar, but, in another sense, quite different. The general priceand trend picture is captured on both charts, but the method ofrecording prices is different. Notice in Figure 11.2 the alternatingcolumns of x’s and o’s. The x columns represent rising prices, whilethe o columns show declining prices. Each time a column of x’smoves one box above a previous column of x’s, an upside break-out occurs. (See arrows in Figure 11.2.)
F Daily Bar Chart Point & Figure Chart
 
 
 
Figure 11.1 A comparison of a daily bar chart for the S&P 500 Index(left) and a point and figure chart (right) for the same time period. The pointand figure chart uses x columns for rising prices and o columns for decliningprices.268 Chapter 11
 
 
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Point & Figure Chart (5x3)
 
 
 
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Figure 11.2 A buy signal is given when one x column rises above the topof a previous x column (see up arrows). A sell signal is given when a columnof 0’s falls below a previous o column (see down arrows). Signals are moreprecise on point and figure charts.
Correspondingly, when a column of o’s declines one boxunder a previous column of o’s, a downside breakout occurs.Notice how much more precise these breakouts are than those onthe bar chart. These breakouts can, of course, be used as buy andsell signals. We'll have more to say on buy and sell signals a bitlater. But the charts demonstrate one of the advantages of thepoint and figure chart, mainly the greater precision and ease inrecognizing trend signals.
Figures 11.3 and 11.4 reveal another major advantage of thepoint and figure chart: flexibility. While all three of the p&f chartscover the same price action, we can make them look very differentto serve different purposes. One way to change the p&f chart is tovary the reversal criteria (let’s say from a 3 box reversal to a 5 boxreversal). The larger the number of boxes required for a reversal, the 
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Figure 11.3 Increasing the box size from 5 points to 10 makes the pointand figure chart less sensitive and fewer signals are given. This is more suit-able for a long term investor.
 
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Figure 11.4 Reducing the box size to 3 points produces more signals.This is better for shorter term trading. The last rally from 920 to 1060 pro-duced 6 different buy signals. Protective sell stops can be placed under thehighest column of 0’s (see S1-SS).270 Chapter 11
less sensitive the chart becomes. The second way to vary the chart isto change the box size . Figure 2 uses a box size of 5 points. Figure11.3 changes the box size from 5 points to 10 points. The numberof columns has been reduced from 44 in the 5x3 chart in Figure 11.2to only 16 columns in Figure 11.3. By using the larger box size inFigure 11.3, fewer signals are given. That allows the investor to con-centrate on the major trend of a market by avoiding all the shortterm sell signals that are eliminated from the less sensitive chart.
Figure 11.4 reduces the box size from 5 to 3. That increasesthe sensitivity of the chart. Why would anyone want to do that?Because it’s better for shorter term trading. Compare the last rallyfrom 920 to 1060 in all three charts. The 10x3 chart (Figure 11.3)shows the last column as a series of x’s with no o columns. The 5x3chart (Figure 11.2) shows the last upleg in 5 columns—3 x columnsand 2 o columns. The 3x3 chart (Figure 11.4) breaks the last upleginto 11 columns—6 x columns and 5 o columns. By increasing thenumber of corrections during the uptrend (by increasing the num-ber of o columns), more repeat buy signals are given either for laterentry or for adding to winning positions. It also allows the traderto raise protective sell stops below the latest columns of o’s. Thebottom line is that you can alter the look of the point and figurechart to adjust its sensitivity to suit your own needs.
CONSTRUCTION OF THE INTRA-DAY POINT AND FIGURE CHART
We've already stated that the intraday chart was the original typeused by point and figure chartists. The technique was originallyused to track stock market movement. The intent was to captureand record on paper each one point move of the stocks underconsideration. It was felt that accumulation (buying) and distrib-ution (selling) could be better detected in this manner. Onlywhole numbers were employed. Each box was given a value ofone point and each one point move in either direction wasrecorded. Fractions were largely ignored. When the technique waslater adopted to commodity markets, the value of the box had tobe adjusted to fit each different commodity market. Let’s con-struct an intraday chart using some actual price data.Point and Figure Charting 271
 
The following numbers describe 9 actual days of trading ina Swiss franc futures contract. The box size is 5 points. Therefore,every 5 point swing in either direction is plotted. We’ll start witha 1 box reversal chart.
4/29 4875 4880 4860 4865 4850 4860 4855
5/2 4870 4860 4865 4855 4860 4855 4860 4855 4860 4855 4865 4855
5/3 4870 4865 4870 4860 4865 4860 4870 4865
5/4 4885 4880 4890 4885 4890 4875
5/5 4905 4900 4905 4900 4905
5/6 4885 4900 4890 4930 4920 4930 4925 4930 4925
5/9 4950 4925 4930 4925 4930 4925 4935 4925 4930 4925 4935 4930 4940 49355/10 4940 4915 4920 4905 4925 4920 4930 4925 4935 4930 4940 4935 4940
5/11 4935 4950 4945 4950 4935 4940 4935 4945 4940 4965 4960 4965 4955 4960 4955 4965 4960 4970
 
Figure 11.5a is what the previously listed numbers wouldlook like on the chart. Let’s begin on the left side of the chart. Firstthe chart is scaled to reflect a 5 point increment for every box.
Column 1: Put a dot at 4875. Because the next number—4880—is higher, fill in the next box up to 4880.
Column 2: The next number is 4860. Move 1 column to thetight, go down 1 box, and fill in all the o’s down to4860.
Column 3: The next number is 4865. Move 1 column to thetight, move up 1 box and put an x at 4865. Stophere. So far you have only 1 x marked in column 3because prices have only moved up 1 box. Ona 1box reversal chart, there must always be at least 2boxes filled in each column. Notice that the nextnumber is 4850, calling for o’s down to that num-ber. Do you go to the next column to record the col-umn of declining o’s? The answer is no because thatwould leave only 1 mark, the x, in column 3.Therefore, in the column with the lone x (column 3)fill in o’s down to 4850.272 Chapter 11
 
 
 
Figure 11.5a A 5x1 point and figure chart of a Deutsche mark contractis shown in the upper chart. The blackened boxes show the end of each day’strading. Figure 11.5b shows the same price data with a 3 box reversal.Notice the compression. Figure 11.5c shows a 5 box reversal.
Column 4: The next number is 4860. Move to the next column,move 1 box up, and plot in the x’s up to 4860.
Column 5: The next number is 4855. Because this is a movedown, go to the next column, move down a box, andfill the o at 4860. Notice on the table that this is thelast price of the day. Let’s do one more.
Column 6: The first number on 5/2 is 4870. So far, you only haveone o in column 5S. You must have at least 2 marks ineach column. Therefore, fill in x’s (because prices areadvancing) up to 4870. But notice that the last priceon the previous day is blacked out. This is to helpkeep track of time. By blacking in the last price eachday, it’s much easier to keep track of the separate days’trading.
Feel free to continue through the remainder of the chart tosharpen your understanding of the plotting process. Notice thatPoint and Figure Charting 273
this chart has several columns where both x’s and o’s are present.This situation will only develop on the 1 point reversal chart andis caused by the necessity of having at least 2 boxes filled in eachcolumn. Some purists might argue with combining the x’s and o’s.Experience will show, however, that this method of plotting pricesmakes it much easier to follow the order of the transactions.
Figure 11.5b takes the same data from Figure 11.5a and trans-forms it into a 3 box reversal chart. Notice that the chart is con-densed and a lot of data is lost. Figure 11.5¢ shows a 5 box reversal.These are the 3 reversal criteria that have traditionally been used—the 1, 3, and 5 box reversal. The 1 box reversal is generally used forvery short term activity and the 3 box for the study of the interme-diate trend. The 5 box reversal, because of its severe condensation, isgenerally used for the study of long term trends. The correct order touse is the one shown here, that is, begin with the 1 point reversalchart. The 3 and 5 box reversals can then be constructed right off thefirst chart. For obvious reasons, a 1 point reversal chart could notpossibly be constructed from a 3 or 5 box reversal.
 
Figure 11.5b Figure 11.5c274 Chapter 11
THE HORIZONTAL COUNT
One principal advantage of the intraday 1 box reversal chart is theability to obtain price objectives through use of the horizontalcount. If you think back to our coverage of bar charts and pricepatterns, the question of price objectives was discussed. However,virtually all methods of obtaining price objectives off bar chartswere based on what we call vertical measurements. This meant mea-suring the height of a pattern (the volatility) and projecting thatdistance upward or downward. For example, the head and shoul-ders pattern measured the distance from the head to the necklineand swung that objective from the break of that neckline.
Point and Figure Charts AllowHorizontal Measurement
The principle of the horizontal count is based on the premise thatthere is a direct relationship between the width of a congestionarea and the subsequent move once a breakout occurs. If the con-gestion area represents a basing pattern, some estimate can bemade of the upside potential once the base is completed. Oncethe uptrend has begun, subsequent congestion areas can be usedto obtain additional counts which can be utilized to confirm theoriginal counts from the base. (See Figure 11.6.)
The intent is to measure the width of the pattern.Remember we're talking here of intraday 1 box reversal charts.The technique requires some modifications for other types ofcharts that we’ll come back to later. Once a topping or basing areahas been identified, simply count the number of columns in thattop or base. If there are 20 columns, for example, the upside ordownside target would be 20 boxes from the measuring point.The key is to determine which line to measure from. Sometimesthis is easy and, at other times, more difficult.
Usually, the horizontal line to count across is near the mid-dle of the congestion area. A more precise rule is to use the linethat has the least number of empty boxes in it. Or put the otherway, the line with the most number of filled in x’s and o’s. Onceyou find the correct line to count across, it’s important that youinclude every column in your count, even the ones that arePoint and Figure Charting 275
 
Figure 11.6 By counting the number of colurmns across the horizontalcongestion area, price objectives can be determined. The wider the congestionarea, the greater the