
Point & Figure Signals
The Bearish Signal ReversedThe succession of lower lows and lower highs in the bearish signal is classic bear market action.It suggests an evolving consensus that the stock is overpriced. You expect the force of sellingwhich is producing persistently lower highs to complete a rout of the buyers at some point. Butwhen the bearish signal suddenly reverses, it has all the hallmarks of a bear squeeze. Whateverthe reason, A.W. Cohen found this to be one of the most reliable point & figure chart formations.I don’t dissent. It is a reliable formation although somewhat rare. A properly constituted bearishsignal reversed has at least 7 columns.In the chart below of the FTSE transport index, the events of September 11th initially produceda rout, but there came a time when, although eager selling was producing lower highs, thebuyers were no longer being routed. Eventually the sellers were overcome. The buy signaloccurs the first time a prior high is breached.
Lower highs
Buy
fig 7.4
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The Bullish Signal ReversedThe market is lulled into a false sense of security by the succession of rising lows and highswhich occurs in the bullish signal. When that sequence is interrupted by a breach of the previouslows it can set off liquidation which feeds on itself driving prices substantially lower. Shell inthe early part of 2001 provides a good example.
Sell
Rising lows
fig 7.5
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TrianglesThe symmetrical triangle usually has at least 5 columns. Its development is often a sign of themarket waiting for some important news like the outcome of a Fed meeting, or annual results.The sellers become more reluctant to push the market down to its old lows and the buyersbecome more reluctant to push the market up to its old highs. Volume often diminishes. Thenthe news breaks. There is usually a swift move.I don’t trust the triangle. In my opinion, it is the most treacherous of the point & figure signals.I have the impression that the whole market is aware that the index or share is winding itselfinto an ever tighter coil. When the news comes for which the market has been waiting, there isoften a knee-jerk reaction which sends the market speeding away from the apex of the triangle,only for second thoughts to prevail, whereupon the market rushes all the way back up to theapex and sometimes beyond. There are fewer treacherous triangles on charts which have biggerbox values i.e. more than 1.5%.But a good example of a triangle formation producing good profits was BP in early 1999. Thefirst triangle is a classic, and note that there were two more irregular triangles thereafter.
Buy
fig7.6The upper edge of the triangle is of course similar to the bearish signal reversed.
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An example of a triangle leading traders astray was EMAP in February 2002.
FalseBuy Signal
ShortlivedSell Signal
fig 7.7
The triangle first produced an upward breakout, which immediately reversed, no doubt causingtraders to operate a stop loss and perhaps to go short, only for the share price to reverse onceagain a few days later.In A.W. Cohen’s book, the bullish triangle (one which breaks upwards) has the lowestpercentage profitability of all, and the bearish triangle (one which breaks downwards) has thefourth lowest percentage profitability of all. The profitability figures used in Cohen’s book stillsuggest that the triangle is a worthwhile formation, but I’m still wary of them. Perhaps it’s nottoo important. They are rare formations. They occur about 2% of the time according to RobertEarl Davis’s study.
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The Triple TopThis formation and its variations are very important. When the market is repelled twice at thesame level it is plain that a level of resistance is established. When it breaks through theresistance on a third (or fourth or subsequent) occasion, you could not wish for a clearerdemonstration of disequilibrium. The clothing group Next gave a fine buy signal in May 2000.
Buy
fig 7.8
Michael Burke is of the view that whilst triple tops used to be the strongest buy signals duringthe period 1950-1970, they can’t now be said to be any better than double tops. I must confessthat is not my experience. I’m still very happy with this formation.
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The Ascending Triple TopThe second rally is repelled at a slightly higher point than the first. On the third (or subsequent)occasion, the sellers are overcome. Two examples of the ascending triple top are seen in thechart of BSkyB. In the first example, the upward run was cut short by the 11th Septembertragedy, but after regrouping BSkyB repeated the formation to continue its run. This secondsignal lead me to recommend a swing trade in the shares in Investors Chronicle of 19th October2001.
Buy
Buy
fig 7.9
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The Spread Triple TopThe name speaks for itself. The points of resistance are spread out, not tightly bunched together.
Buy
fig 7.10
Look at the base which BP formed between 500p and 535p. The disequilibrium which occurswhen the price trades at 545p is as obvious as it could be, which is why I suggested in InvestorsChronicle of 11th January 2002 that readers should buy at that price.
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The Triple Top with Long TailA.W. Cohen said that the existence of a long tail causes the move to be particularly dynamicwhen the triple top is breached. I agree, provided that it is understood that I am referring to ashort-term move.
Buy
Long Tail
fig 7.11
The reason for this dynamism is probably that the formation has some resemblance to a trap.Bears are being squeezed as a perceived downtrend fails to emerge after the earlier breach of atriple bottom.
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The Bull TrapMichael Burke attributes this formation to the huge popularity of triple tops. Effectively, thechartist is paying a penalty for his buying point being known well in advance. The share pricebreaches a triple top by one box but there is no follow-through buying. The share price advancesno further. Indeed, sellers, who may have been waiting on the sidelines for the chart-basedbuying to come in, start driving down prices. It is a bull trap. The share then executes a 3 boxreversal. The assumed disequilbrium was an illusion.It is important to note that Michael Burke regards it as a sell signal once the 3 box reversal isexecuted because there will be a number of bulls trapped who will be forced to liquidate.
Bull TrapSell
fig 7.12A good example is provided by Diageo in September 1999. The bullish looking triple topbreakout was a trap, and if traders had regarded it not simply as a failed buy signal but also asa sell signal when the shares made a 3 box reversal, they would have made back their losses andmore. But I don’t like trading this formation much. It is difficult to distinguish from the catapult.111
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The CatapultThe catapult, in contrast to the bull trap, is a bullish formation, which means that its similarityto and potential confusion with the bull trap is most unhelpful. A.W. Cohen was of the view thatthis formation occurred about 50% of the time after a triple top breakout. That statistic isprobably not true of today’s markets. Just like the bull trap, the market breaches a triple top andthen has a pullback. The breach may advance by between 1 and 3 boxes, usually (although A.W.Cohen says up to 7 boxes). There is then a pullback, usually into the base from which the sharehas just broken out. In other words, it looks just like the bull trap at that point. In the past I havetried to distinguish between the two by calling a formation a bull trap if the share advances justone box and reverses, and by assuming that it is a catapult if it advances 2 or more boxes beforepulling back. Unfortunately that distinction doesn’t always work. I’ve seen bull traps that haveadvanced 2 boxes and catapults which have started after 1 box.It’s all a bit muddled and a recipe for losing money so it seems to me. Look at the chart on thenext page of NASDAQ before it made its final break to the 2001 lows.
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Bear trap orcatapult ?
fig 7.13This was a classic breach of a triple bottom, immediately followed by a 3 box reversal. Youwould have been a little annoyed to have bought it at that point, reading it as a bear trap. On theother hand it would have cost you only 4 boxes because a stop loss would have taken you shortagain when the formation proved to be a catapult.In general, I attach no weight to the 3 box reversal at this point. Since it could be either a beartrap (bullish) or a bearish catapult (bearish), I make no assumptions and I let the market unfold.Eventually it tells me.
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The Triple BottomAfter this sell signal at 600p was noted in the Evening Standard of July 2001, Enterprise Oilformed another base at the lower level of 570p to 610p before declining to 460p.
Sell
fig 7.14
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The Descending Triple BottomThe sell signal given by Rio Tinto on 11th June 2001 was a fine example of the descending triplebottom. Note the early similarity between the descending triple bottom and the bearish signal.The difference is the downward acceleration in the former pattern and the absence of it in thelatter.
Sell
fig 7.15
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The Spread Triple BottomAfter this spread triple bottom sell signal in February 2001 at 1240p, noted in the EveningStandard, Shire declined quickly to 840p before staging a recovery. I made the point in Chapter2 about markets falling much faster than they rise. You won’t be surprised to learn that I like thetriple bottom and its variations.
.
fig 7.16
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Point & Figure Signals
The Triple Bottom with Long Tail
Sell
fig 7.17The short-term dynamism of the long tail is well illustrated here. After the FTSE gave its triplebottom sell signal on 20 February 2001, the market fell over 700 points in 22 trading days.
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The Long Tail DownThis occurs when a share has an unusually long or unusually steep fall without any of the minorrallies which one typically sees. Tom Dorsey says that the share must fall about 20 boxes (unitsof price movement). The buy signal occurs on the first 3 box reversal. I must say I have neverbeen convinced that this is a safe chart formation. I don’t see how it portrays an enduringalteration in the equilibrium between buyers and sellers in favour of the buyers. To me it simplyrepresents a highly risky form of bottom fishing. It works on the supposition that the first rallywill be the start of a durable upward move, or at any rate a profitable bounce, which seems adangerous stance.However, I have to report that it did in fact work (!) with Kingfisher in October 2000.
BuySupport Holds
fig 7.18118
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Tom Dorsey wisely advises operating a stop loss immediately if the buy signal fails and themarket makes a lower low. He also makes a convincing case for not using the long tail up as asell signal. But whilst I consider this formation too dangerous for swing traders to use, it can beused, in conjunction with options, by long-term buy and hold investors, as I explain in Chapter11.Michael Burke also uses a variation of the long tail down (or up) principle in his analysis ofbullish percent charts which are a composite of the number of bullish charts in a sector ormarket. Since there is an underlying change in equilibrium in this respect, one can see the forceof using the principle with such charts.
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The High PoleEarl Blumenthal, another famous point & figure chartist, developed this signal. The pattern isformed when a column of Xs exceeds the previous column of Xs by at least 3Xs and then givesup more than half of its total gains in the next column of Os. This is less of an actual sell signalthan a warning signal. I do not pay much attention to it when the trend is up, but in a downtrendit can be very effective in picking up bear market rallies on the point or during the course offailure, as the chart below of Standard Chartered demonstrates. The first high pole in November1999 occurs in the middle of an uptrend and can’t really be considered a success, but the nexthigh pole, also in an uptrend, is successful, as are the three which occur in a downtrend in theearly months of 2000. With minor variations, signals 3, 4 and 5 below represented EarlBlumenthal’s favourite signal to sell short.
2
31
4
5
fig 7.19120
Point & Figure Signals
Another superb example of the high pole in a bear market was the NASDAQ Comp in April2002.
Sell
fig 7.20
Count the number of Xs in the substantial bear market rally from late February to 12th March2002. It was 12. The sell signal occurs on the sixth O (1820), at which point the market has givenup 7 out of the 12 Xs. Thereafter the NASDAQ plunges to new lows for the year.
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My evaluationI deal with the reliability of point & figure charting as a whole in Chapter 8. So far as I am awarethere has only been one study into the reliability of individual point & figure patterns. It wasdone by Professor Robert Earl Davis, and the results for each signal are published in A.W.Cohen’s original book as well as in the books by Kermit Zieg and Tom Dorsey noted at thebeginning of this chapter. Not all the above signals were studied by Davis - those such as thehigh pole and long tail down were not considered. The study covered the period 1954-1964,apart from two stocks which were analysed from 1914 to 1964. It was found, for example, thatduring a bull market, with proper use of trend lines and price objectives, the triple top formationwould be profitable 87.9% of the time for an average gain of 28.7% over 6.8 months. It wasunprofitable 12.1% of the time for an average loss of 8.3% over 2.2 months. All of theformations examined had reliability rates of at least 80% except the bullish triangle which hada reliability rate of 71%. These reliability rates are simply unachievable in today’s markets. Itwould be a license to print a money. This is my personal opinion, but look at the charts and theywill prove it to you. The more recent work by Dr Kermit Zieg also proves the point.My opinion of the individual point & figure formations is as follows:Double top/Double bottomIt is not worth trading this signal, on the whole. It simply describes a single countertrendrally or dip, which may have lasted just one day, before the trend continues. If you thinkyou can make money trading such minor corrections, it may be the signal for you. Good luck.Bullish signal/ Bearish signalUsually you don’t have to consider this signal, it is so rare. If it only has 3 columns, thenit is effectively just a double top or double bottom with a rising low/falling high. You’dbest advised to ignore it. If it has 5 columns or more, it is broadly indistinguishable froman ascending triple top formation/descending triple bottom formation, and as such it isreliable.Bullish Signal reversed/Bearish Signal reversedThey are reliable formations because they usually describe a squeeze of the bears or panicliquidation by the bulls. But as buy/sell signals they are often shortlived, either becausethe panic subsides or because a new equilibrium forms from which a fresh point & figuresignal is generated.TrianglesThe most treacherous of all. You need to be a day trader, watching the price action like ahawk to see if this formation is going to turn against you. Don’t trust it.122
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Triple Top/Triple Bottom and their variationsThese are good reliable signals, harmed only by their visibility. Michael Burke says thesesignals have become so popular that they have spawned the bull and bear trap becauseeveryone knows where the chartists will be buying. I’m sure he’s right in somecircumstances, but I still find these formations reliable, particularly the triple bottom andits variations.Bull Trap/Bear TrapYou do see them, but they are very risky to trade on charts with a small box value (lessthan 1.5%). They are a bit better on charts with big box values. Effectively you are relyingon the possibility that the breach of important resistance, and a failure to follow through,means that a trap has been sprung. It can and does happen that way, but bear in mind noimportant support has been breached. This formation can easily convert itself into thecatapult. I never trade this formation.CatapultEffectively this is a triple top or bottom which hints at a bull trap but then moves in thedirection of the initial break. I don’t regard it as a separate formation. I think of it asvariation of the triple top/bottom.Long Tail DownA highly risky form of bottom-fishing, but since you are only ever risking 4 boxes, therisk/reward ratio is not bad.High Pole/Low PoleA high pole in an uptrend is only a warning signal, and it is one that I don’t pay that muchattention to. A high pole in a downtrend was Earl Blumenthal’s favourite signal to goshort. I do trade it, but there is no really good place to put a stop loss, so the risk/rewardratio is poor. If I see a high pole in a downtrend, I revert to my swing charts to see if theywill give me a reasonably close place to put a stop loss. A low pole in a downtrend is awarning signal. A low pole in an uptrend doesn’t seem to have the same sort ofsignificance as the high pole in a downtrend. I keep an eye on it, but I seldom trade it.
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My favourite point & figure signalsThe Triple Top with Rising LowsThere are multiple examples of the triple top with rising lows yielding fine moves. The postSeptember 11th low in the NASDAQ (see page 93) was a classic. Another fine example is ARMin August 2000. The rising lows are a clear sign of increasing eagerness on the part of buyers.
Buy
Rising Low
fig 7.21Obviously this signal, like any other, provides no guarantees. By October 2002 Vodafone wasin a bear market. This time the buy signal (fig 7.22) led nowhere, although the price action didgive you enough time to raise a stop to a level where losses were minimal.
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Buy
Jump in early
Rising low
fig 7.22
What about leaping into the market before the breach of the triple top has been completed? Isthere mileage in jumping the gun by buying on the first 3 box reversal to the upside, as soon asyou can see that a higher low has been made, instead of waiting for the breakout from the triple top?Logically one shouldn’t because the market is still in a broad state of equilibrium. But I dooccasionally jump in early in certain limited circumstances:1. There must be a reasonable advantage to be gained. There was no point in jumping inearly in the ARM chart above. You’d be buying right up against the resistance. All youneeded to do was wait for the market to advance one more box. It follows that I onlyconsider jumping in early when the base is deep i.e. the columns are long. The Vodafonechart just satisfies the minimum criterion. There are 3 boxes to be gained by jumping in early.125
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2. I want the shape of the formation, if it fails, and if it proves to have been a mistake tojump in early, to resemble the bullish signal reversed. In the Vodafone chart, this wouldhave been the case. In other words, had Vodafone executed another 3 box reversal to thedown side, there would have been a sell signal upon which I could have acted to recoverthe loss from jumping in early. The chart below shows what I mean.
275
250
225
fig 7.23In February 2002 Reuters executed exactly this formation.
3. Other considerations apply. It didn’t matter what the shape was in late September 2001,I was not going to sell the NASDAQ. It had already had a calamitous sell-off. Oversoldreadings were extreme. I was simply waiting for the market to settle and give a proper buysignal. So no jumping in early, and no selling if the triple top buy signal failed.
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The Triple Bottom with Lower HighsThe chart below shows the Royal and Sun Alliance coming off its all time highs in April 1998,the breach of the triple bottom beautifully preceded by the lower high. The lower high is a clearsign of increasing eagerness on the part of sellers. It may be that existing holders of the stockhave grown more gloomy or short sellers have become more aggressive. In the case of triplebottoms I never jump in early - markets seem to pause often when going up, without the pauseshaving any wider significance.
Lower High
Sell
fig 7.24
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The Bearish or Bullish ShakeoutThe shakeout formation was first identified by Earl Blumenthal. In his book published in 1993Michael Burke thought it to be the best point & figure formation of recent years.The heart of the bullish shakeout signal is a decline by a share or index which breaches a doublebottom. Traditionally that has been regarded as a negative development, and as the bullsperceive that support in the market has not held, liquidation takes place. Other traders may entershort positions. But if the market makes a 3 box reversal within a box or two of breaching thedouble bottom, it is often a trap. In fact, Earl Blumenthal’s hypothesis was that the first sellsignal in a bull market is actually a buy signal!In this formation, like the bull trap, the buy signal occurs on the first 3 box reversal. In mostother point & figure formations the buy signal comes only after a consolidation phase has endedin a breakout. The chart of Six Continents in October 1992 shows this formation clearly.
Buy
Bulls shaken out
fig 7.25128
Point & Figure Signals
Michael Burke has a number of other criteria for the establishment of this signal which I do notfollow, so I suppose my shakeout is a really a variation on the original.My criteria for the bullish shakeout are:1. The previous signal given by the share must have been a bullish one.2. As the market declines, a double bottom is breached by 1 box or 2 boxes (if the boxvalue is high) but no more than 3 boxes (if the box value is not high).3. The market then executes an upward 3 box reversal. BUY and place a stop and reversebelow the lows i.e 4 boxes away.What I like about this formation is that it gives one a double option. Do you see what wouldhappen if no trap results - if the breach of the double bottom really was an early signal of comingweakness? The chart pattern would convert itself into a descending triple bottom.
600
550Buy
500
Sell
fig 7.26It follows that one has the market surrounded. Either the shakeout will prove to be a profitablebuy signal, or a descending triple bottom sell signal will be given which itself should beprofitable. Of course it is possible that the shakeout signal will cause a loss, and the descendingtriple bottom will cause a loss as well, but that is very, very rare.The very best feature of this formation is that the initial risk is only ever 4 boxes becauseone is buying on the first 3 box reversal, and placing a stop and reverse order to capturethe descending triple bottom.
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The converse formation is the bearish shakeout. Look at Vodafone in 2002.
Bears shaken out
Sell
Bears shaken out
Sell
fig 7.27The first sell signal at 177p was not countermanded at any point before the lows at 93p. Thesame is true of the second sell signal at 141p.But the shakeout does often fizzle out after a relatively short period so you would need a rulesuch as the raising of a stop loss to your entry point to prevent losses from offsetting these 2sparkling profits.The bullish and bearish shakeouts have a high level of accuracy, particularly if measured over ashort period. It is the closest I come to day trading. My usual objective on the shakeout is a mere5 to 7 boxes which usually takes no time at all to happen. Likewise my objective on thedescending triple bottom is modest.
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Take the Dow Jones index 50pt chart from the start of 1997 as an example:
7
6
8
9543
2
1
fig 7.28I am looking at this chart mechanically which is not the real position as I would always beconsidering the swing chart as well. Imagine one sets a profit objective of 6 boxes for thesepurposes. That may sound very little, but on the Dow it is 300 points which is not bad.1.
A bullish shakeout in January 1997. There is easily 300 points profit available, especiallyafter the formation converts itself into a spread triple top.
2.
Another bullish shakeout in March 1997. It resolves to the downside by converting itselfinto a descending triple bottom. The initial loss of 200 points is offset by a profit of 300 points.
3.
Another bullish shakeout in June 1997 yields 300 points.
4.
Another bullish shakeout in October 1997 converts into a descending triple bottom sellsignal. The initial loss of 200 points is offset by a profit of 300 points.
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5.
A bearish shakeout in November 1997 works to begin with, travelling 200 points in theright direction before a second reversal leads to a strong rally. The initial loss of 200points is offset by a profit of 300 points.
6.
A bullish shakeout in April 1998 leads nowhere and after building a base, the Dow fallsthrough a bullish signal reversed triggering a clear sell signal, coincidentally at one’sentry point. Scratch trade.
7.
A bearish shakeout in June 1998 leads to a profit of 300 points.
8.
I don’t count this as a bearish shakeout. It is too equivocal. It could also be a bearishsignal reversed. Disappointment at missing the 1300 point move is assuaged by theknowledge that the high of this equivocal signal happened to be the third day on the swingchart in the middle of the 1998 linear phase, so the move would not have been missed.
9.
A bearish shakeout in September 1998 yields 300 points profit.
You may sniff at this sort of performance, but I believe the point is well made that this formationis highly reliable. There are seven profits and one scratch trade. The Vodafone 3p box chartduring the period January 2001 to May 2002 likewise produced one scratch trade and sevenprofits using a profit target of five boxes and raising the stop loss to the entry point once theshare had advanced four boxes in the right direction.Because of its reliability, the shakeout provides me with the one qualification to my strategy thatswing charts rule when timing the market as a whole. Shakeout formations sometimes occurwhen the swing chart gives a change in trend signal, which turns out to be false or leadsnowhere. It is a useful filter to be looking at the point & figure chart, alive to possibility of ashakeout. If the point & figure chart signals a shakeout, I always heed it, even if the same storyis not being told by the swing chart.
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The WhipsawAs I’ve mentioned, although one has the market surrounded, it can happen that the shakeout’sdouble option is simply the occasion for two helpings of losses, which is happily rare. The chartof Rio Tinto in 1999 provides an example:
1.Bullish shakeout
3.Buy
2. False descendingtriple bottom sell signal
fig 7.291.
Rio Tinto shakes out the bulls by making a lower low on 13th May then reverses upwardsand gives a buy signal on 18th May.
2.
After some progress, the share reverses and triggers a descending triple bottom sell signalon 26th May but that signal too turns out to be false.
3.
Happily an ascending triple top with rising lows develops. The inference is that buyerscan scarcely contain their enthusiasm, until somewhat later in the year, they are sedatedby a dose of reality (as Warren Buffett puts it).133
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134
8
POINT & FIGURE TACTICS• Choose the right security• When to take profits• Don’t trade every chart formation you see• Reliability of point & figure charts• Tailpiece 1• Tailpiece 2
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Choose the Right SecurityAllied Domecq is one of the biggest companies in Britain and yet look how one would havestruggled trying to trade this stock with a point & figure chart.
Breaches of resistancelead nowhere
Breaches of supportlead nowhere
fig 8.1And that struggle does not apply only to charts which show a long trading range. There are otherstocks, most of them with low volatility, which lumber on steadily. Every now and then theyexperience a bout of skittishness and they have a mini-sell off. That sell off breaches a supportlevel on the chart, generating a sell signal, which turns out to be a trap, or at least a dead end,when investors nerves settle. These stocks may represent excellent investments for buy and holdarmchair investors, but they are murder for a swing trader.I don’t mean to suggest that every old economy stock is unsuitable for swing trading. Far fromit. But as I’ve noted before, check the chart to see whether your trading tactics would have hadany success in the past.Some might have thought that the volatile NASDAQ Composite would not be the ideal marketto plot on a point and figure chart. But look at fig 8.2 opposite to see how beautifully it works. Istart in March 2000 just after the peak at 5132. Millions of people lost money on this downswing(including my self-select pension fund), but swing traders using charts should have cleaned up.136
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1
2546
34
78
fig 8.2I make plain that I traded bits of this downtrend rather than all of it, so part of the commentarybelow is plainly tainted by hindsight. But I suggest that I am sticking to the principles of the lasttwo chapters. I start off first with