...|..............850 _________________XOX__OXO__XO_________________________________________840 .................XOX..OXO..XO..........................|..............830 .................XOX..OXOX.XO..........................|..............820 ...............X.XOX..O.OXOXO..........................|..............810 ...............XOXOX....OXOXO..........................|..............800 ___________3___XOXOX____OXO6O_________________________________________790 ...........XOX.XO4OX....O.O.O..........................|..............780 ...........XOXOXOXOX........O........X.................|..............770 ...........XOXOXOXOX........O........XO..........X.....|..............760 ...........XOXOXOXOX........OX.X.....9O..........XO....|..............750 ___________XOXO_OXOX________OXOX7X___XO__________XO___________________740 ...........XO...OXO.........OXOXOXOX.XO..........XO....|.X............730 ...........X....O...........OXOXOXOXOXO..........XO....|.XO...........720 ...........X................OXO.OXOXOXO..........XO....|.XO...........710 ...........X................OX..OXOXOXO..........XO....1.XO...........700 _X_________X________________OX__O_OXOXO__________XO____XOXO___________690 .XO........X................OX....O8OXO..........XO....XOXO...........680 .XO....X.X.X................O.....O.OXO..X.X.X...XO....XOXO...........670 .XO....XOXOX........................OXO..XAXOXOX.XO..X.XOXO...........660 .XO..X.XOXOX........................O.OX.XOXOXOXOXOX.XOXOXO...........650 _XOX_XOXOXOX__________________________OXOXOXOXOXOXOXOXOXOXO___________640 .XOXOXOXOXOX..........................OXOXOXOBOXOXOXOXOXO.O...........630 1.OXOXOXOXO...........................OXOXOXO.OXOXOXOXOX..O...........620 ..OXOXOXOX............................OXO.OX..O.OXO.OXOX..O...........610 ..OXOX2.OX............................O...OX....O...OXOX..O...........600 __O_OX__O_________________________________OX________OXOX__O___________590 ....OX....................................O.........OXOX..O........X..580 ....O................VD.............................OXOX..OX.......XO.570 ....................................................OXOX..OXO......XO.560 ....................................................OCOX..OXO......XOX550 ____________________________________________________O_OX__OXO______XOX540 ......................................................OX..O.O......XOX530 ......................................................O|....O......XOX520 .......................................................|....O......XOX510 .......................................................|....O....X.XOX500 ____________________________________________________________O____XOXOX490 .......................................................|....O..X.XOXO.480 .......................................................|....O..XOXO3..470 .......................................................|....O..XOXO...460 .......................................................|....2..XOX....450 ____________________________________________________________OX_XOX____440 .......................................................|....OXOXO.....430 .......................................................|....OXOX......420 .......................................................|....OXOX......410 .......................................................|....O.O.......400 ______________________________________________________________________-------------------------------------------------------0--------------------------------------------------------------------0--------------
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The formula in words as well as symbols is:Downside VerticalCount PriceObjective
=
Value in Pointsof the Rise
+
Number of Boxes in the FirstDownside Reversal after thePeak or the Downside Reversalafter the Last Level Top xMinimum Reversal Value inBoxes x Box Value in Points
orVd = Vtop - (Rd x Rm x Vbox)KGF: 580= 940 – (12 x 3 x 10)=====Summary: calculation of the vertical count
•
For the vertical upside count: take a relevant low, determine the number of boxes (Xs) inthe following column, multiply that number with the box size times minimum reversal,then add that number to the relevant low.
•
For the vertical downside: take a relevant high, determine the number of boxes (Os) inthe following column, multiply that number with the box size times minimum reversal,then subtract that number from the relevant high.
Change of scale areasExplaining the scaling in a previous chapter we have shown that at some values the box sizeschange. Performing a vertical or horizontal count over such areas of change of scaling couldcause confusion.Horizontal counts
The horizontal count method of calculating a price objective counts the number of columnscomprising a base or a top and multiplies this figure by the reversal value which is defined asthe value of a box times the number of boxes comprising a minimum reversal. This result is thenadded to the low of the base to get an upside price objective, or subtracted from the peak of atop to establish the downside price objective.
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But if the base develops in the 16 to 22 range of the US-scale where boxes change from halfpoints to whole points, what is the box size to be used for determining the reversal value? Insuch cases the reversal value is the average value of the two-box values crossed, or 0.75.Vertical counts
In the vertical count method of calculating the price objective, the number of boxes filled on thefirst reversal after the final bottom or final top is multiplied by the reversal value (box valuetimes the minimum reversal size in boxes), and this figure is added to the bottom value, orsubtracted from the top to get the appropriate price objective. If the boxes cross a change ofscale area, the boxes above and below the change level are simply treated separately.For example, if the first reversal has filled eight boxes over the change of scale area at 20,meaning the boxes 18.5, 19, 19.5, 20, 21, 22, 23 and 24, it can be said to have filled three halfpoint boxes (18.5, 19, 19.5) and five whole-point boxes (20, 21, 22, 23 and 24). These countsare each multiplied by the appropriate reversal values of 1.5 for the three half-point boxes (0.5point boxes times three-box reversal) and three (one-point boxes times three-box reversal) forthe five whole-point boxes. These results are then added (4.5 + 15) for a total of 19.5 points.
Application of price objectivesPrice objectives work because their users act as if they will work and by their actions in themarket tend to validate the objectives. Therefore, horizontal counts should be used to determineprice objectives only where the base on top is so well defined that all chartists will agree on theformation and thereby act in unison. For only with general agreement among users will theirinfluence be sufficiently strong to affect prices.But conversely, since all chartists can agree after the fact as to peaks, bottoms and first reversalsafter such high and low prices, vertical counts are applicable to all situations.Price objectives derived by:•
horizontal counts: work best in the less volatile investment media of common stocks andbonds, where the magnitude of moves are less severe than in futures;
•
vertical counts: work equally well for stocks, commodities and most other chartablemedia.
Only rough guides
Furthermore, price objectives are rarely hit exactly. Often they are not reached and often theyare exceeded. This does not discredit their usefulness, but only reinforces the fact that they arerough guides which indicate the probable distance of a move without regard to the timenecessary to reach the calculated price level. As such they are but one additional tool to help the116
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sophisticated chartist better analyse his market. All price objectives should be drawn on the chartand the sum total of these points coupled with trend lines present the best picture of the marketas it evolves.Why do we prefer vertical counts?
Vertical counts have less subjectivity inherent, as tops and bottoms are easy to detect and needno judging. As calculating of price objective lacks precision, we like to avoid the problems ofestimating base widths.SummaryPrice objectives calculated from horizontal and vertical counts are tools which present a pictureof the probable distance of a trending move. They are not exact, must be used with care andcomplement the variable price objectives presented by trend lines, for each one reveals auniquely determined objective and when used in concert yields the best presentation.
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The use of stop orders
IntroductionAs the famous market technician and trader Jesse Livermore observed, trading success is based,•••
firstly, on acting decisively on trading signals;secondly, on the use of precise stop-loss orders; andthirdly, on intelligent money management.
We have already explained the point-and-figure trading signals. Money management issues willbe covered later in the book. Right now, we would like to explain the subject of stop orders.Re-cap of stop orders
Stop orders are market orders that need to reach specific price levels to be triggered.To put it simply, stop orders become market orders when the specified levels are touched. In aliquid market you can be fairly confident that you will get your trade at the level specified. Forexample, if you place a sell order with a stop at 80, you would expect in most cases to have thetrade filled at 80. But there's usually no guarantee of this. Problems can arise, especially withilliquid markets or accelerated moves, e.g. crashes.Stops in practice
When using a technical system like point-and-figure to trade, you can use stops to get in and outof positions.If you are day-trading, and thus constantly observing the markets, you set such mental limits foryourself and when the price reaches the set level you proceed with the transaction. If you arenot behind a screen you can give stop instructions to your broker. While liquidating positionsyourself is a straight-forward process, giving stop and other orders to your broker needsinvestigation on your side, because the availability of different orders depends on the markets.The best idea is to talk directly to somebody competent at your brokerage firm. The principlesof stops are always the same – ‘get me out or in at a certain level’ – but different markets orinvestment instruments may have different stop procedures. You should therefore check theposition carefully with your broker.
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Reactive and proactive trading styles
Point-and-figure can be used with two different trading styles or a combination of both.Reactive
You might update your chart, analyse it and if you observe a trading signal you do therequired trade. If you are day-trading, you do this continuously and the trade order isentered into the market immediately after the occurrence of the signal.If you update the charts after the market close then you have no other alternative than totrade the next day. You can give an order to buy or sell at opening or give limit/stop orders.We call this way of trading reactive. This means, you do the chart, analyse and trade.Proactive
More often chartists trade the proactive way. Because you know where the signals willoccur, you place stops at those levels. That means, that when the signal happens you areautomatically in the market. If you are trading proactively you have to be very meticulousabout keeping control of all your open orders. We prefer to use orders that are only validduring the trading day; we have all orders cancelled when the market closes and the nextday, before the markets open, we decide which stops have to be placed and introduce themone after the other.Day-trading is usually done the reactive way. Stocks which cannot be followed real-time areusually traded in the proactive way. But you can also trade reactively, taking positions the dayfollowing the day when the signal was generated.Which trading style is better?
We have run long-term computer simulations and can state that there is no huge advantage ofone trading style over the other. Trading the proactive way generates slightly better results, butreally the difference is not such that one should discard the reactive trading style.
Where to place stopsThe beauty of point-and-figure is that it indicates very clearly where stops have to be placed.You place the stop at the level where the reversal or the double top/bottom would actually occur.The proactive trader places the stop where the next signal would take place. In chart 3.5overleaf, we have indicated where we went short, where long and where you would place thestop.====
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Example 3.5 – Placing a sell-stop orderChart 3.5 – A sell-stop order example360350340330320310300290280270260250240230220210200195190185180175170165160
..........|.....C..........................|.....X..................X.......|.....X................X.XO......|.....B................XOXO......|.....X................1OXO......|.....X.................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
In the chart above we go short at 290 (red), go long at 195 (green) and at the same time place astop at 170. 170 is the level where a sell-signal would be generated, namely a triple-bottombreakout.If our position had the size of 1,000 shares, then we would have to give sell-stop for 2000 shares.The first 1,000 sold would liquidate the position, and the second 1000 would initiate a new shortposition.In the continuation of our trading we sell and go short at 250. And we simultaneously introducea buy stop at 280, which is the level a double-top breakout would happen (and eventually doeshappen).
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Example 3.6 – Placing a buy-stop orderChart 3.7 – A buy-stop-order example360350340330320310300290280270260250240230220210200195190185180175170165160
..........|.....C..........................|.....X..................X.......|.....X................X.XO......|.....B................XOXO......|.....X................1OXO......|.....X.................O.O......|.....X<-1................O......X.X...X...................O4.6...4OXO..X<-2................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
When we go short at 250 we know that a buy signal would be generated at 300 (triple topbreakout) and put therefore a buy-stop at that level. Later, after that the following X-columnreverses at 270, we can lower the stop to 280, as this is now the level where a buy would begenerated, and eventually is.=====
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Taking profits early by using stopsThe most frustrating formation for the p&f chartist is the pole. The pole is the symbol of lostopportunity, as it represents a nice price move without an exit point at which you are promptedto realize your open profit. The open profit or loss is the amount of money you would make orlose if the position were liquidated immediately. It is unnerving because your portfolio can bemaking good open profits but, if no exit signal is generated, you may fail to take them.Chart 3.8 – Unnerving poles on Friends Provident [FP.L]FP.L / 3 box rev, 2001.07.09 to 2003.01.10215210205200195190185180175170165160155150145140138136134132130128126124122120118116114112110108106104102100
.|.................................................................|..OX.................................................................|..OX2................................................................|..O1O................................................................|..O_O__X________________________________________________________________.|OX.X4............................................................|...|OXOXO............................................................|...|OXO3O............................................................|...|O.O.5............................................................|..______6_______________________________________________________________.|....O............................................................|...|....O..................X.........................................|...|....O........X.........XO........X...............................|...|....O..7.....XO8.......XO........XO........................C.....|..______O__XO____XOXO______XO________XO______________________X_XO_______.|....OX.XOX.X.XOXO..X...X9X.......XO............X...X.....XOXOX...|...|....OXOXOXOXOXOXO..XO..XOXOX.....XO........X...XOX.XO..X.XOXOXO..|...|....OXOXOXOXOXOXOX.XOX.XOXOXO....XO........XO..XOXBXO..XOXOXOXO..|...|....OXOXOXOXOXOXOXOXOXOXOXOXO....XO........XOX.XOXOXO..XOXO.OXO..|..______OXOXOXOXOXOXOXOXOXOXOXOXOX_X_XO________XOXOXOXOXOX_XOX__OXO_____.|....OXOXOXO.OXOXO.OXOXOXOXOXOXOXOXO......X.XOXOXOXOXOXOXOX..OXO..|...|....OXO.OX..O.OX..OXOXO.OXOXOXOXOXO......XOXOXOXO.OXOXOXO...O.O..|...|....O...O.....OX..OXOX..O.OXOXOXOXO......XOXOXOX..OXOXOX......OX.1...|..............OX..OXO.....OXO.OXOXO......XO.OXO...O.OXOX......OXOXO.________________OX__O_______OX__O_OXO______X__O_______OXOX______OXOXO_.|..............OX..........OX....OXO......X..........OXO.......O.OXO..|..............OX..........OX....OXOX.....X..........OX..........OXO..|..............OX..........OX....OXOXO....X..........OX..........O|O..|..............O...........O.....OXOXOX.X.X..........OX...........|OX__________________________________OXOXOXOXOX__________O_____________OX.|................................OXOXOXOXOX.......................|OX.|................................OXOXOXOXOX.......................|OX.|................................OXOXOXOXOX.......................|O..|................................OXOXOXOXOX.......................|..-0--------------------------------O-OXOAO-OX-----------------------0--2----------------------------------O-O---OX-----------------------3--
215210205200195190185180175170165160155150145140138136134132130128126124122120118116114112110108106104102100
In the above chart two poles are highlighted, the first 114 to 150 (32% from low to high) and thesecond from 100 to 155 (55% from low to high). Both are tremendous moves which are notexploited by the traditional point-and-figure method. The preceding and following signals of eachof the two poles are indicated as usual and fully explain how such poles frustrate the chartist.You have various options to realize such open profits, which in the case of poles would vaporizeif you simply wait for a new signal. You can use either trailing stops or profit targets, and in thefollowing pages we show you how.122
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Trailing stops
One strategy is to use trailing stops, which means that you always maintain a profit-taking orderat the price level where a reversal would occur. That strategy is best described by the followingcharts.Chart 3.9 – Pole 1, initial situation
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....X.......X.....X.X...X.XOX...XOXOX...XOXOX....O.OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......OX......O....
360350340330320310300290280270260250240230220210200190180170160150140130
First we show the chart formation over the entire period. You can see a good open profit duringthe decline towards 130 in the short position taken at 290, which, however, is never realised.Even worse, the position would be closed with a small loss when the double-top break-outoccurs around 350.In the chart over the page we show you the same pole but this time from a couple of weeksearlier when we decided to protect our open profit with the use of a trailing stop.123
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Chart 3.10 – Pole 2, protecting the open profit with a trailing stop
360350340330320310300290280270260250240230220210200190180170160150140130
..................X.....X.XO....XOXO....XOXO.....O.O.......O.......O.......O.......O.......O.......O.......O.......O............................................................................
360350340330320310300290280270260250240230220210200190180170160150140130
Assume the stock made a new low and is trading around 220. Obviously we could liquidate theposition and take the profits immediately, but as we believe that there is more downsidepotential, we put a buy-stop at the hypothetical reversal value of 250, with the intention to lowerit when new Os are added to the column. Should the stock move to 250, a reversal wouldhappen, and therefore we call it a hypothetical reversal level.
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Chart 3.11 – Pole 3, lowering the trailing stop
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..................X.....X.XO....XOXO....XOXO.....O.O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O....................................
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On the next day the stock has a new low at 170. We lower the stop to 200 where the reversalwould occur for that situation.
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Chart 3.12 – Pole 4, realizing the open profit
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..................X.....X.XO....XOXO....XOXO.....O.O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......O.......OX......OX......OX......OX......O....
360350340330320310300290280270260250240230220210200190180170160150140130
During the next week the stock goes as far down as 130 and reverses. With a low at 130 we hadlowered the trailing stop to 170, where it is eventually executed. With this strategy we havesuccessfully protected an open profit. We have bought back the short position at 170, we haveno position at all now, but just wait for the next signal, which, as we know from the first chart,is a buy at 360.
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Non-trailing profit targets
Employing some statistical or simply visual studies on your favoured stocks will help you todefine a price target after which you can take profits early. For example, for swing trading wehave found that taking profits after 8 to 12 boxes increases profitability.In our optimised trading strategies we also use variable non-trailing price targets similar to amoving average of price moves. We base the price targets on a series of preceding columns. Avalue which works well is taking 1.5 times the average size in boxes of the last 3 columns as aprice target for liquidatation of a position. This is explained in the chart below.The preceding 3 columns prior to the buy signal (280) are highlighted. They have the sizes (inboxes) of 6, 4 and 3 respectively and average 4.33. Taking 1.5 times the average of their sizesequals 6.5, which we round to 7 and determine the profit target 7 boxes higher, namely at 350.Hence, we will cover our long position, taken at 280, in full or in part at 350.Chart 3.13 – Variable price target (moving average type)360350340330320310300290280270260250240230220210200195190185180175170165160
..........|.....C..........................|.....X..................X.......|.....X................X.XO......|.....B................XOXO......|.....X................1OXO......|.....X............