O.....................OX 10601040 ___________________________________________X________________________OX 10401020 .........................................X|X........................OX 10201000 .....................................X...XOX........................OX 1000980 .....................................XO..XOX........................O. 980960 .....................................XOX.XOX.......................... 960940 _____________________________________XOXOX1X__________________________ 940920 .....................................XOXOXOX.......................... 920900 .....................................XOXOXO........................... 900880 .....................................XOXOX|........................... 880860 .....................................XO.O.|........................... 860840 ___________________________________X_X________________________________ 840820 ...................................XCX....|........................... 820800 ...................................XOX....|........................... 800780 ...................................XO.....|........................... 780760 ...................................X......|........................... 760740 ___________________________________X__________________________________ 740720 ...................................X......|........................... 720700 ...................................X......|........................... 700680 ...................................X......|........................... 680660 .................................X.X......|........................... 660640 ___________________X_____________XBX__________________________________ 640620 ...................XO..........X.XOX......|........................... 620600 .........X.X.X.X.X.XO......9...AOXOX......|........................... 600590 .........XOXOXOXOXOXOX.8.X.XOX.XOXO.......|........................... 590580 .X.......XOXOXOXO6OXOXOXOXOXOXOXO.........|........................... 580570 _X3X_X_X_XOXO_O_O_OX7XOXOXOXOXOX______________________________________ 570560 .XOXOXOXOXOX......OXOXOXO.O.O.OX..........|........................... 560550 .XOXO4OXOXOX......OXOXO.......OX..........|........................... 550540 .XO.OXO.OXOX......O.O.........OX..........|........................... 540530 .X..OX..O.5...................OX..........|........................... 530520 _X__OX________________________O_______________________________________ 520510 OX..O.....................................|........................... 510500 OX........................................|........................... 500490 O.........................................|........................... 490350 ------------------------------------------0--------------------------- 350340 ------------------------------------------0--------------------------- 340
18
BSKYB [BSY.L]generated a buy at 680in November 1999 andmoved steadily up.
Introduction
Chart 0.8 – Safeway [SFW.L]420410400390380370360350340330320310300290285280275270265260255250245240235230225220215210205200195190185180175150145
.....|..X....|...........................|..X7...|......................______6_XO__________________________.....|XOXO...|...........................|XOXO...|...........................|XO.O...|...........................|X..OB..|......................____X_X__OXO________________________....XO5..8XO.|..........................XOX..9XO.|..........................XOX..OAOX|X.........................XOX..O.OX4X6....................____XCX____OXOXO____________________..X.X2X....C.O5OX...................X.XBX3.......O.OXO7.................XOXOX|.......|.OXOXO................XOXO.|.......|.OXOXOX..............._O_____________O_OXOXO______________.....|.......|...O.OXO...................|.......|.....OXOX..................|.......|.....OXOXO.................|.......|.....O.OXO....X.X....._____________________OXOX_X_XOXO____.....|.......|.......O.OXOX8XOXO.........|.......|.........OXOXOXOXO.........|.......|.........OXOXO.OXO.........|.......|.........OXOX..O.OX..._______________________O_OX____OXO__.....|.......|...........O.....OXOX......|.......|.................9XOXA.....|.......|.................OXOXO.....|.......|.................O.OXO_________________________________OXO.....|.......|...................O.O.....|.......|.....................O.....|.......|.....................O.....|.......|......................-----0-------0--------------------------1-------2----------------------
420410400390380370360350340330320310300290285280275270265260255250245240235230225220215210205200195190185180175150145
As the chart above shows, point-and-figure got you well into a short in the down move ofSafeway [SFW.L] during 2001-2002.And, in particular, all the telecoms, dotcoms and techs generated sell signals and had you shortover the major part of the meltdown – not to forget that p&f had you on the long side during theaggressive up move.This is thus an introduction to point-and-figure charting. It is the beginning set of do-it-yourselfinstructions with the later chapters devoted to more detailed aspects of the process.But for now, let’s learn the tools.
19
Chapter
1
Drawingpoint-and-figure charts
•
Background
•
How to draw the charts
•
Computerised charting
The Complete Guide to Point-and-Figure Charting
BackgroundPoint-and-figure charting has long been associated with images of serious-minded men hunchedover notebooks in dark corners of brokerage offices and trading floors, making cryptic markson box-ruled paper. Part-time speculators usually think of it as a valuable tool that is beyondtheir grasp, either because it demands too much time, or is too complicated, or requires accessto time and sales data that isn’t always available.Hopefully, this book will correct these misconceptions. Anyone can keep p&f charts just as hecan the more common bar graphs. All that’s needed is a pencil and eraser, graph paper, dailyhigh-low prices for each stock or contract to be plotted, and an understanding of a few simplerules. The result is a trading tool that is more useful than the standard bar chart, and that presentsclearer pictures of what prices are doing, more precise indications of where to get in and out ofa market, and more reliable predictions of how far price moves are likely to go.The underlying philosophy: supply and demandThe basic premise of p&f charting and trading is that the Laws of Supply and Demand, andnothing else, govern the price of a security or commodity.•••
When demand is stronger than supply, the stock’s price rises;When supply exceeds demand, the price falls;When supply and demand are contesting for supremacy, the price moves sideways.
Point-and-figure extracts the essence of that battle for equilibrium between supply and demandby creating an interpretable graphic, the p&f chart. The chart is used to determine investmentor trading strategy.Representing the forces of supply and demand
Every p&f chart contains the following elements:Long columns of Xs
Long columns of Os
Short alternating columnsof Xs and Os
Signify greater demandthan supply and thereforea rising price.
Signify greater supplythan demand and thereforea falling price.
Signify a contest for supremacybetween supply and demandfrom a relatively equal position.
The p&f chart is a pictorial record of the contest between the forces of supply and demand.22
Drawing Point-and-Figure Charts
Chart 1.1 – Supply and demand in the case of Aegon [AEGN.AS]
The long columnof Xs – risingprices – meansthat demand atthat time wasgreater thansupply.
The longcolumn of Os –falling prices –means that atthat time supplywas greater thandemand.
General principlesPoint-and-figure charts are unique in three ways:1. Only large significant moves are noted, and minor fluctuations are ignored as having norelevance to the overall trend.2. P&F charts ignore the passage of time. Dates may be indicated on the chart, but this is donesolely as a matter of convenience, and has no relevance to decision making or to signaldescriptions.3. P&F charts denote movements by the letters “X” and “O” and not by lines, as in themore commonly seen line/bar charts.23
The Complete Guide to Point-and-Figure Charting
How to draw the chartsThe toolsPencil and paper
As already mentioned, the only things necessary for successful p&f charting of stocks,commodity future contracts, options or any other investment are a pencil and paper, daily highand low prices for each investment being monitored, and an understanding of a few simple rules.The pencil should be soft lead type which can be easily erased. The eraser should leave the papersmudge-free and the paper should have either the US ten squares to the inch with heavy rulingsevery five boxes, or the European 4mm grid. The 1mm engineering grid is, however, too tiny.Graph paper of the appropriate type is readily available at most office supply stores.Pencil and paper in the computer age? In the modern world of computers and the internet, thereference to pencil and paper may seem rather old-fashioned. But we firmly believe that tothoroughly understand p&f charts, you have to spend some time manually drawing them. Onlyby doing this will you properly appreciate the subtleties of p&f. Once you have drawn chartsmanually, you may well decide to move on to using a computer. However, be aware that manyof the most accomplished traders still prefer to maintain their p&f charts by hand.Computer
Even if you take our advice and start by drawing charts manually, you will probably end upusing a computer for p&f charting. Point-and-figure programs work on any standard PC. Belowis a short description of the equipment that we use:•
Reasonable hardware (at the time of writing, we use as a desktop a Pentium IV, 2GHz,512MB, 100GB Hard disk, and as a portable a Pentium IV, 2.66GHz, 256 MB Ram, 30GB Hard disk). Because hardware gets cheaper and cheaper we recommend, the biggerthe better. However, a reasonable PC should not cost a fortune.
•
A reliable and fast back-up device; we use an IOMEGA Zip drive and a CD-Burner.
•
Good p&f software. We recommend MetaStock, PFScan and Updata.
•
A very good screen. Because p&f is so fascinating, you will spend a lot of time lookingat the screen!
•
Fast access to the data providers, especially for downloading prices of a large numberof stocks. We use broadband internet.
Remember the most important task in computing is: back up!Chapter 6 details the use of computers and the programming of p&f charting in more detail.24
Drawing Point-and-Figure Charts
Learning by doingThe best way to learn how to draw a p&f chart is to work through an example. This is what wewill do in this section.The table below should be considered an excerpt of stock data. It is shown in the most widelyused format, namely:1.2.3.4.5.6.
DateOpening priceHighest price of the dayLowest price of the dayClosing priceNumber of stocks traded
Table 1.1 – Figures for P&F drawing example
Date
Open
High
Low
Close
Vol
1-Jan-01
37.25
38.25
35.75
37.50
1234000
2-Jan-01
39.50
40.12
39.25
40.00
1567000
3-Jan-01
37.50
38.50
37.00
37.25
1456000
4-Jan-01
37.00
37.50
36.50
37.00
1789000
5-Jan-01
37.00
40.25
37.00
39.00
2345000
Please read through the instructions overleaf, then roll your sleeves up, take a piece of paper anda pencil, and try to do the chart yourself.
25
The Complete Guide to Point-and-Figure Charting
Scaling the chart
As the prices are in the 29 to 60 range the box size of 1 is used (explained in the How to scalethe chart section on page 31).
41...............40...............39...............38...............37...............36...............35...............Day 1 - Starting the chart
Once the chart is scaled for the stock, the next step is to enter price movements. This isaccomplished by observing the daily highs and lows for the stock.If we start a new chart manually on blank paper we have to decide whether to put Xs or Os inthe first column of the chart. Since there are no entries yet on the chart, the spread between thefirst day’s high and low is important.If the spread spans the value of three or more boxes and the price closes above the centreof the range, draw the appropriate number of Xs.How does this work in practice?In our example, Day 1, 1st January 2001, had a high of 38.25, a low of 35.75, and closed at37.50. Because the high and low spans 3 boxes (36, 37, 38), with our pencil we would place adot in the 36, 37 and 38 boxes, as shown in the chart below.
41...............40...............39...............38...*...........37...*...........36...*...........35...............Since the closing price (37.50) is above the middle of the range (37.0), we would change thedots to Xs in the 36, 37, and 38 boxes, as shown below.26
Drawing Point-and-Figure Charts
41...............40...............39...............38...X...........37...X...........36...X...........35...............Had the close been below the centre of the range, the entries would have been Os.Note that if the range between the high and low had failed to span three boxes, dots would beplaced in the boxes that were spanned, as temporary markers. For example, had the high on Day1 been 37.50 and the low 35.75, dots would be placed only in the 36 and 37 boxes. The dotswould serve as reminders of which boxes have been crossed until more days’ price data becameavailable.If, on Day 2, the stock had a high of 38.25 and a low of 36.75, a third, and higher box (38) wouldhave been reached, so the two dots in the 36 and 37 boxes would be replaced with Xs and a thirdX drawn at 38.If, on Day 2, the range had been 37.25 to 34.75, a lower box (35) would have been crossed. Thedots in boxes 36 and 37 would be replaced with Os, and a third O drawn at 35.Once the first column of Xs or Os has been entered in the chart, closing prices are no longerused in the charting process. From now on, only high and low prices play a role.Rising prices
On Day 1 in our example, the price advanced from box levels 36 to 38. Accordingly, we have acolumn of Xs in the 36, 37, and 38 boxes. Now that the first column has been drawn, thecontinuation becomes considerably easier.The technique is as follows:•
If the current or most recent column is composed of Xs, look at the high for the dayunder consideration (the ‘daily high’). If it is at least one box higher than the highest X inthe current column, draw in the appropriate number of additional Xs.
For instance, if the current column has Xs at 36, 37, and 38 and the daily high is 39.25, you woulddraw a new X at 39. If the daily high was 40.125, you would draw new Xs at 39 and 40. Notethat a box is considered crossed if the price hits the exact price point of the box. For example, ifthe daily high was 40 you would draw an X in the 40 box, just as you would if the high was40.875. The 41 box could not be filled with an X until the price reached at least 41.
27
The Complete Guide to Point-and-Figure Charting
Day 2 - A new high
In our example, because on Day 2, 2nd January 01, there was a high of 40.12, two extra Xs aremarked in boxes 39 and 40. The updated chart is shown below.
41...............40...X...........39...X...........38...X...........37...X...........36...X...........35...............If the daily high is high enough to require the drawing of one or more additional Xs in thecurrent column, the daily low is totally ignored. This procedure of looking first at the highs anddrawing more Xs continues as long as each succeeding daily high is one or more boxes higherthan the last X drawn in the current column.Price reversal
At some point, there will come a time when the daily high does not permit the drawing of new Xs.Only when this occurs is the daily low of interest. If the daily high is not at least one box higherthan the highest X, the daily low is reviewed to determine whether the price advance has reversed.If the low is lower than the highest X by the value of three boxes, the price advance is consideredtemporally broken. In this case we look at the daily low to see if we have a price reversal andshould thus draw three Os. If we can draw three Os, the new column is drawn with the first O beingplaced one column to the right of the X column and one box below the highest X.Day 3 - A price reversal from up to down
On Day 3, since the 40.25 is not high enough to permit the entry of a new X, attention is focusedon the daily low: 37. Because the low of 37 allows for three boxes (39, 38 and 37) below thehighest marked box (40) to be filled, the trend is considered in the p&f chart as reversed, andOs are drawn downwards beginning one column to the right of the X column and with thehighest O one box below the highest X. The chart at the top of the next page shows this pricereversal.
28
Drawing Point-and-Figure Charts
41...............40...X...........39...XO..........38...XO..........37...XO..........36...X...........35...............Had the low been 36, four Os would have been drawn (39, 38, 37, and 36). Had the low been35, five Os would have been drawn (39, 38, 37, 36 and 35). And so on.But if the low had been 37.50, only two boxes would have been penetrated, and, since the threebox reversal method of p&f does not consider a trend to have been reversed until three boxesare spanned, no entries would be made for the day and the price would be regarded as still onthe advance.If neither one new X nor three new Os can be drawn, no entry would be made and the procedurewould begin anew on the following day.On the following and each succeeding day and as long as the trend is still up (meaning thecurrent column is an X column) the high is reviewed first for new entries and only if no new Xscan be drawn is the low analysed for a three-box reversal. Regardless of how low the low maybe, if the high permits the drawing of at least one new X, the trend is still up and the low mustbe disregarded. If the trend has truly reversed, even though a new X was drawn, the directionalchange will be revealed the following day when a higher high is lacking and the low is three ormore boxes below the highest X.Falling prices
If the current column is a declining column or a column of Os, the daily procedures are reversed.The daily low is analysed first. If the low is one or more boxes below the lowest O in the currentcolumn, the appropriate number of additional Os are drawn and the daily high is ignored.For instance, if the current column runs from 39 down to 37 and the day’s low is 35.75, a newO is entered at 36, and the high price for the day is of no concern. If, on the other hand, the lowfails to permit the entry of one or more additional Os, as in a low of 36.50, the high would beanalysed to determine if a three-box reversal had occurred. If the high were 40 or above, areversal has occurred and a new column of Xs is drawn immediately to the right of the Os withthe lowest X being entered one row higher than the lowest O in the most current of O columns.If no new Os can be added and a reversal has failed to occur, no entries are made for the dayand the procedure begins again the following day.
29
The Complete Guide to Point-and-Figure Charting
Day 4 - No new lower low and no price reversal, wait for the next day
On Day 4, the low price is 36.50, but would have to have been 36, lower, to add another zero.As a new lower low is not recorded, and the day’s high is not high enough to signal a three-boxreversal, we do nothing and wait for the next day’s prices.Day 5 - Subsequent reversal, this time from down to up
On Day 5, 5th January 3001, a reversal is made, as no new lower low is made, and the high of thatday is above 40 – signalling a three-box reversal. The chart now looks as follows:
41...............40...X_X.........39...XOX.........38...XOX.........37...XO..........36...X...........35...............The simple example above, using prices over 5 days, demonstrates nearly all the major featuresof a point-and-figure chart.
30
Drawing Point-and-Figure Charts
The basic elements of constructionFrom the previous example, we learnt that the major elements of p&f chart construction are:1.2.3.4.
How to scale the chartHow to start a new chartWhen the box can be filledWhen a reversal occurs
We’ll now look at these elements in more detail.1. How to scale the chart
The first task in drawing a p&f chart is to scale it properly. This means assigning a value-range tothe boxes. We say value-range because each box has an upper limit and a lower limit.Definition of a box
The following figure explains what is referred to as a box. Manual p&f charts are always drawn onpaper with a pre-printed grid, which is either filled with Xs or Os. Nowadays with computergenerated charts the grid is not explicitly present, as you will see throughout this book.The figure below shows an excerpt from a typical computer-drawn p&f chart with a grid putover it. The grid that is put over the chart divides it into boxes. These are the boxes we refer toin the context of point-and-figure.Figure 1.1 – Scaling for the Dow at 40 - 1897 and again in 193243424140
Box 40
3938373635
XXXXXX O XX OX O XX O X OX O XX OX
Price ScaleYou can see on the figure that the numbers on the left refer to the box itself. Box 40 is box 40,and not the continuous area between 39 and 40 or 39.5 and 40.5, just simply box 40. This31
The Complete Guide to Point-and-Figure Charting
follows from the ‘discretizing’ of price and it differs from continuous scales like the one foundon a ruler, where between 39 and 40, 39.5 can be found or estimated.In point-and-figure only 39 and 40 exist, nothing in-between.=====
Why is discretization of price far superior to discretization of time?Discretization means the division into small individual elements. In technical analysis– other than point-and-figure – the information is sliced into individual elementsaccording to the time axis. The data or information is partitioned into weeks, days ormultiples of minutes, and hence the horizontal time-axis or time-line is equally spaced.That is discretization of time.But does time matter for a long or short position?No, or only to a minimal extent. In point-and-figure the data is divided according toprice; that is discretization of price. Does price matter? You bet! Point-and-figure hasan advantage over other technical analysis methods through this fundamentaldifference in discretization of the information.Think of it. It does really not matter if the Dow moves to 10,000 over 1 or 4 weeks.What matters is that it does move to 10,000. Does it matter if your favourite stockmoves to a new high on a Tuesday or a Thursday? In bar-charts, yes, because it alterstrend lines. In p&f it does not, and hence especially avoids fuzziness of such trendlines. The new high on Tuesday is treated like the new-high on Thursday in p&f, anda year with little price move action takes little room on a chart and a year like 1987 or2001 with a lot of movement takes considerably more room; and that is what webelieve is the correct representation of a market. Like in a history book where the eraof the Neanderthals should occupy fewer pages than the 20th Century. In the bar-chartworld, the 20th Century would be described in the same number of pages as 100 yearsof our ancestors fighting the sabre-tooth tigers and catching mammoths!A final commentSure, if you trade options or derivatives for benefiting from the decay in time-valuethings are different and time obviously matters. However, for the great majority oftraders out there in the markets what matters most are price moves. Only point-andfigure treats the importance of price moves in a way that we think is adequate - hencethe superiority, in our view, of point-and-figure.=====
32
Drawing Point-and-Figure Charts
What constitutes Box 40 (or any other particular box) depends on your perspective:1.
If you are coming from above with falling prices, i.e. you are testing whether you canfill box 40 with an O, then the low has to be equal or smaller than 40.
2.
If you are coming from below with rising prices, i.e. you are testing whether thebox can be filled with an X, then the high has to be equal or greater than 40.
It is as simple as that.Variable box sizes
The p&f chart tracks price moves. Price moves are relative, which means that the absolute levelof the price matters. That is why a 200-point down move on the Dow at a level of 10,000 istotally different from a 200-point down move at 1,200. At the lower level of 1,200 such a moveis a crash whereas at the higher level of 10,000 it is only a slightly bigger-than-average move.The crash should be represented by a column of many Os, as Os mean descending prices,whereas the slightly bigger-than-average move should be depicted by only one or two boxesfilled with Os. In order to achieve this sense of proportion, you have to use variable box-sizes.As a general principle: the higher the absolute price, the bigger the box.We propose – again, generally speaking – that a box should represent about 2% of a price move.On that basis, the box for the Dow at a level of 1,200 would be of the size of 25 and at the levelof 10,000 it would be 200. If you adopted these box sizes:••
with the Dow at 1,200, the 200-point ‘crash’ move would be marked by filling 8 boxes;with the Dow at 10,000, the 200-point slightly bigger-than-average move would be markedby filling only 1 box.
The chart below scales the Dow around a level of 10,000. The differences between the boxesare 200, and therefore we say that the box size is 200.Figure 1.2 – Scaling for the Dow at 10,00010600104001020010000
Box 10000
98009600940092009000
XXXXXX O XX OX O XX O X OX O XX OX
Price Scale33
The Complete Guide to Point-and-Figure Charting
We will give some more details on scaling stock indices in a later chapter. But we would like tomention already at this point that a box size of 200 for the Dow between 6000 and 14000 wouldbe chosen if a high level of compression were desired, e.g. for a long-term chart spanningseveral decades. For shorter time spans, box sizes for the Dow at that level of 100 or even 50are more common. Intraday charts would be drawn with a box size of 20.Standard box sizes
What you should keep in mind is that the box sizes become bigger as price increases. However,they can easily be found in the following table, where you see which box size you have to applyfor which price range.Table 1.2 – Standard box sizes
Price
Box Size
from
to
6
14
0.2
14
29
0.5
29
60
1
60
140
2
140
290
5
290
600
10
600
1400
20
As an example, if a stock has a price history in the range of 30 to 40, from the table you can seethat a box size of 1 is appropriate, because the price range lies within the 29 to 60 bracket.As a rule of thumb, the box size is 2% of the value of the middle of the price range. For example,the mid-value of the range 600 to 1,400 is 1,000, which gives a box size of 20 (2% of 1,000).However,