the 40pt chart.1.
A triple bottom sell signal is given at 4320, after which the market falls 640 points in thefirst instance, a fall big enough to realize half or full profits. There is then a scary rally allthe way up to the original sell signal and another slump.
2.
An irregular triangle forms and a buy signal is generated at 3840. Because it’s thetreacherous triangle, one would have had no difficulty raising a stop to minimize losses oncethe market had advanced 4 further boxes to 4000. The stop is triggered as the market fails.
3.
A bullish signal reversed sell signal/further irregular triangle sell signal occurs at 3560. Becauseof the triangular shape, it’s probably not worth trading (it did in fact yield a small profit).
4.
A classic triple top buy signal with rising lows occurs at 3400, and it is followed by abullish shakeout buy signal and another triple top taking the market all the way to 4280,a 26% rise in 2 months.
5.
A quadruple bottom sell signals occurs at 3800 which worked for a while but wouldprobably have resulted in a small loss in the end.
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6.
The secondary high in September 2000 is not well signalled at first, but later a very clearbearish signal develops with a sell signal at 3680 followed by a triple bottom sell signalat 3600 (the easier trade) which takes the market all the way down to 3040, ample roomto take half or full profits.
7.
The NASDAQ makes another attempt at a rally with a bearish signal reversed buy signalat 3360 but after a move up to 3520 this breaks down. Probably a small loss here.
8.
A bullish signal reversed sell signal at 3120. As the market falls through 3000, switchcharts to the 25pt chart. A steep rally probably stops one out at entry point and as a resultyou probably miss the next 800 points down. I know I did.
9
9
10
1211
fig 8.3138
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9.
An ascending triple top buy signal at 2675 evolves slowly and successfully taking themarket up to 2875 before breaking down at 2700 with one of my favourite signals, thistime the bearish version, the descending triple bottom with falling highs. Sell short.
10.
A repeat sell signal is given with a bearish shakeout at 2500. The market falls away, in anorderly fashion, to 1650, a fall of 39% from the original sell signal at 2700.
11.
Because the market has fallen through 2000, I am looking at both the 20pt and 25ptcharts. After another bearish shakeout, the 25pt chart generates an ascending triple topbuy signal at 1975 which takes the NASDAQ up to 2325 (gain 17.7%).
12.
A bullish signal reversed with the shape of a triangle describes itself on the 25pt chart.Confirmed on the 20pt chart which has a very clear triangle. Don’t touch. Sure enoughthe market plunges and instantly recovers.
1315
14
fig 8.4139
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13.
The 20pt chart gives a triple bottom sell signal at 1920, after which there is an immediate3 box reversal. Is this the catapult or a bear trap? The 25pt chart says no bear trap. Stayshort. The NASDAQ plunges to lows at 1400, a move of 27%.
14.
That triple top buy signal, again! The move starts at 1540 and goes all the way up to 2080,a move of 35% with several repeat buy signals on the way.
15.
A bullish signal reversed sell signal at 1920 suggests that the uptrend is over. It isfollowed by a descending triple bottom sell signal, and then a high pole in a downtrendsell signal.
I have not attempted to describe here a full trading strategy, but is this not a wonderfulillustration of the effectiveness of point & figure charts?
When to take profitsPrice objectives
A.W. Cohen put forward a system of vertical counts and horizontal counts to set a price target.The horizontal count measures the length of the base from which the market has broken out, i.e.the number of columns of Xs and Os, multiplies that by 3 and adds the product to the lowestpoint of the base to arrive at a price target.Certainly as a matter of practice, one does often see a loose correlation between length of thebase formation and extent of the ultimate move. But in my view, it is all a little tenuous. It isplain from Cohen’s book that even he regards these as rather rudimentary tools. If you usemodern software, it has the facility to measure the counts for you, and you can decide foryourself whether they are sufficiently reliable.I don’t use horizontal or vertical counts or indeed any mechanical method for setting priceobjectives.Freewheeling approach
It is widely recognised that a buy signal in a chart will often last a few weeks or less. The factthat disequilibrium has occurred gives one no real insight into when and where the nextequilibrium will be formed. Of course, the trader is hoping that it takes a big move for supplyand demand to come back into balance, but it needn’t be so. It can and does happen that the newequilibrium is found just fractionally above or below the old equilibrium.The truth is that I don’t have a rule book when it comes to taking profits. That may be
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disappointing, but I don’t pretend to know all the answers. My approach to taking profits is amore freewheeling, open knit approach.Sometimes I wait for the point & figure chart to give me a sell signal. Other times, I set anarbitrary price target. One of the tools I use is the RSI - discussed in Chapter 10.I am particularly keen on taking half profits quite promptly, which means the remaininghalf position can be run for free, as it were.I am not alone in this. Tom Dorsey, avowedly not a short-term trader, thinks it wise even forinvestors to book part of their profits at an arbitrary level after a good advance.Since swing trading usually involves holding a leveraged position (although it need not), anytime that I have a profit of over 10% in an individual equity in just a few weeks, I am ready tohear the sound of the till at the first sign that a market move is running out of steam. My profittargets tend to be modest. I will usually bag as little as 9-10% half profits and then run theremaining half position. Once that reaches the stage of yielding a profit of 11-18%, I am readyto take full profits unless a (previously unperceived) linear phase is unfolding, or some otherconvincing reason presents itself for holding on, which usually doesn’t happen.With equity indices, I’m guided more by the swing chart. I’ve dealt with profit targets in Chapter 5.Wall Street legend Bernard Baruch said you should always sell a stock so the person who buysit makes a profit. He also said “I made my money by selling too soon”. I’m in Baruch’s camp.
Don’t trade every chart formation you seeTrading with the trend
Look at any point & figure chart and you will see a host of good signals. You will also see anumber of buy or sell signals which start off well, but then reverse. This is typical. All thatdisequilibrium suggests is that the market will move in an unstable way until a new consensusis formed.One of the most difficult aspects of point and figure charting is as follows: The chart gives agood buy signal and the share price moves up say 10 boxes (or units of value) from the basefrom which it has broken out. It then forms a new base. Then it breaks down. Should one sell,and if not, why not? Should one conclude that this is the end of an uptrend? What happens witha point & figure chart is that one seldom gets a long and sustained run without some worryinglynegative chart pattern developing. Because the swing trader is usually leveraged, he cannotignore adverse chart signals.
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Are trend lines the solution?The answer to this problem, according to A.W. Cohen, was not to trade against the trend. Verysound advice. Michael Burke makes the matter crystal clear by declining to call the sell signala sell signal if it occurs in an uptrend. He re-christens it a "down" signal.But what is the trend? A.W. Cohen's answer was to draw a trend line. Not the trend line that youfrequently see some people draw connecting a series of bottoms or tops but simply a mechanical45° trend line from the lowest point made by a stock which had just given a buy signal (viceversa for sell signals). As long as a stock remained above the 45° line it was considered to be inan uptrend and any sell signal which occurred was to be ignored.You may think that a 45° line is a rather clunky, unsophisticated approach to defining a trend.Look at www.stockcharts.com and you will see just how often a share breaks its uptrend line(called the bullish support line) or its downtrend line (called the bearish resistance line) withoutthat break actually signalling any change in trend.The situation is not improved by drawing trend lines connecting highs or lows made in the past.Personally I am doubtful about this technique. Suppose a high were made 2 years ago, and thenanother intermediate lower high 1 year ago and then a further lower intermediate high 4 monthsago. Many people will take a ruler and connect the 3 highs and declare that the market is in adowntrend until that trend line is broken. Let us say the trend line declines from left to right ata gradient of 31°. Why is the market not in a bear trend if it stops going down at the rate of 31°?The only conclusion one should draw is that the momentum has changed, that the rate of declinehas altered, not the propensity to decline. A breach of the trend line would not, logically, signala new uptrend, or even the end of the old downtrend. In the fullness of time, the change inmomentum may have relevant implications for the future trend, but that is a separate point.Nothing lasts forever.I don’t seek to criticise the use of trend lines. Traders should use whatever means of identifyingthe trend they feel most comfortable with. You will see later in this chapter that a study of theprofitability of trading with point & figure charts achieved a significant increase in profitabilitywhen trading with the trend, and in that study the 45° lines were indeed used. I’ve even seenmoving averages used to determine the trend, which may seem a little odd since point & figurecharts disregard time.It is vital to have some method of determining the trend so that one is not trapped into acting onevery single point & figure signal, and trend lines are certainly a solution which many peoplefavour.But trend lines are not for me. Take a look at the chart of Logica which I recommended buyingat 730p in The Trader column of Investors Chronicle of 12th October 2001. You can see thataccording to the trend line, Logica was in a long-term downtrend at the time.My reasoning was pretty straightforward. Working from the top down:142
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1.
The bounce in the market indices after the September 20th low had become pronounced,quite untypical of a bear market rally.
Down trend line
Ascending triple topbuy signal
fig 8.52.
The NASDAQ gave one of my favourite point & figure buy signals on 2nd October.However the swing chart was not terribly clear.
3.
The FTSE gave an equivocal change of trend buy signal on 3rd October on its swingchart, but any doubt was resolved by a clear ascending triple top buy signal on the point& figure chart.
4.
The software sector chart gave a buy signal on its swing chart on 8th October (sinceLogica is one of the main components of the sector index, it made the sector chart carry143
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less weight in my mind). In addition, also on 8th October, Logica’s swing chart gave abuy signal and the point & figure chart gave the ascending triple top buy signal at 740pseen above.5.
Logica’s relative strength chart against the FTSE was fairly inconclusive but it had beengaining in strength for over a week.
Not the most difficult decision I’ve ever had. The column sold out of Logica at 870p and 940p(two purely arbitrary levels which I had selected based on the irresistible profits which theoption trade had accumulated).You can see the trend line on the chart. This trade would have been prohibited if onemechanically applied a rule that no buy signal was to be respected if it occurred below the 45 °trend line. Note also the irony that within a few days of Logica breaking through the trend line,apparently proclaiming itself to be in a bull market, the uptrend came to an abrupt end.So I agree one should only trade point & figure signals with the trend. It is simply that myapproach to defining what is the trend does not involve being ruled by a 45° line or any otherkind of trend line. It will not surprise you to read that I determine the trend of the market byreference to my index swing charts.There are two different aspects to this approach - the initiation of positions, and the holding ofpositions:Initiation of positionsAs a general but not inviolable rule I wait for my FTSE swing chart to turn up.Then I scour the sector indices and then the big cap stocks, looking for a recentor imminent buy signal. It is rare for me to act on a buy signal in an individualstock when the swing chart is still negative, but on occasions there may seemlike a good reason for so doing. Vice versa for downtrends.Holding of positionsOnce the position has been initiated, as long as the FTSE swing chart remainsin an uptrend, I will treat any sell signal given on the point & figure chart of anindividual stock with utmost suspicion. Vice versa for downtrends.You have the example above of Logica. A more extended example follows with BSkyB. Whatyou will see is that my approach is very conservative. My approach would have resulted in 4profitable trades in the first 10 months of 2001. If instead you had acted on every point & figuresignal on the BSY chart, you would have had 7 profits and 2 losses, and you would have mademore money than following my approach (but I doubt whether acting on every point & figuresignal, regardless of trend, would be sensible over a longer period of time). Every trader has adifferent attitude to risk. You must choose the course which suits you the best.144
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1
2
Sell
3
SellSell
45
76Buy8
fig 8.61.
BSY gives a spread triple bottom sell signal on 02.02.01. I would not sell short becausethe FTSE swing chart is still pointing up and there is no developed downtrend in BSY asyet. So that opportunity was missed. The FTSE swing chart was equivocal in earlyFebruary 2001, but it turned down by the latest on 20.02.01.
2.
BSY manages a small rally on 28.02.01. It looks as though a bearish signal reversed buysignal has been given. If you were acting on every signal you would have to buy at thispoint. But for me the FTSE swing chart is pointing down and the BSY medium term trendis firmly established. Was BSY really going to start a new uptrend in the teeth of the FTSEdowntrend? Wasn’t it just pausing after a steep fall? The next day it executed a 3 boxreversal. Now it looked more like a bearish shakeout, which would be consistent with theFTSE swing chart. I do nothing on both occasions.
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3.
Another rally ensues in the first full week of March, but this is at the same time that theFTSE is working up to a potential linear phase sell signal. Significantly, BSY goessideways at the very point that the FTSE is making its swing high, demonstrating veryclear relative weakness. The FTSE sell signal occurs on Friday 9th March, and onTuesday 13th, BSY gives a quadruple bottom sell signal. Now sell short at 900p. On03.04.01, BSY is oversold with an RSI reading of 13.6. Take profits at 733p (18.5% in 3weeks).
4.
After a strong rally stalls, BSY gives one of my favourite sell signals on 09.05.01. Butpersonally I wouldn’t act on this. The FTSE swing chart has been pointing up since10.04.01. Pity.
5.
By 23.05.01 the position is a little different. My suspicions about BSY have beenmisplaced. A clear downtrend has developed and a repeat sell signal, again one of myfavourites, the bearish shakeout, has been given. Although the FTSE chart has not givena sell signal, it has stalled for the third time in its attempt to take out the 6000 level.Primarily because I will be risking only 4 boxes and the shakeout is such a reliableformation, a short position can be established at 760p. By 25th June, BSY is oversold withan RSI reading of 14.6. Take profits at 642p (15.5% return in a month).
6.
BSY gives an ascending triple top buy signal on 26.07.01 but by this stage the FTSEswing chart says the overall market is in a downtrend, so I would have missed thisopportunity.
7.
But on 04.09.01 the BSY uptrend falls apart and since the FTSE swing chart is stillpointing down, sell short on the descending triple bottom with long tail at 750p. By10.09.01, the RSI reading is 9.7. In Chapter 10 I explain that RSI readings which occursoon after buy or sell signals can be ignored, but because of the events of 11.09, I shallassume a profit would have been realized here at 688p.
8.
I have already described this buy signal on page 108, which was given shortly after theFTSE swing chart turned up in October 2001.
No doubt there is a variety of ways to determine the trend. I am happy with my method, eventhough I miss opportunities by taking a narrow view of when I should be buying or selling.Effectively, with my narrow approach to initiating positions, and my modest profit targets, mymethod of trading individual equities amounts to a series of short-term raids.
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Reliability of point & figure chartsPoint & figure charts are effective. Having read this far, you ought to need no convincing of that.I have already mentioned the work of Professor Robert Earl Davis of Purdue University, Indianaon page 122. He found reliability rates for various point & figure formations of 80%+ in almostall cases. I have already made the point that such high rates are not achievable in today’smarkets. In 1970 Professor Davis and Charles Thiel did research on commodity futures in whichthey found an overall profitability rate of 53%. This is more in line with my experience.Perhaps the most valuable work done on this subject is by Dr Kermit Zieg. He started off in1974 with commodity futures and found an overall reliability/profitability rate of 40% (numberof profitable trades divided by total trades). He tried again and found a reliability rate of 41%.A third study in 1997 revealed a reliability rate of 45%. Then a study covering stocks during theperiod 1994-1996 found a reliability rate of 41%.Calamity! Why have you been reading these chapters on point & figure? It’s not even as reliableas tossing a coin.Not so. The results were presented by Dr Zieg as a success. Each of his three surveys oncommodity futures resulted in good profits and very handsome returns on margin employed.The survey on stocks also produced a profit although the return was a meagre 3% per annum. Itstill established that one didn’t need a reliability rate of more than 50% to make money.Then Dr Zieg examined the same stocks, but used trend lines to exclude short sales in an uptrendand purchases in a downtrend. The result was a jump in overall reliability to 47% and anincrease in the return to 20% per annum, which is certainly not to be sniffed at.But even these enhanced figures understate the true position in my opinion for a number ofreasons.a. Dr Zieg’s method was to buy on a double top and sell on a double bottom. No otherformations were considered. That is not a criticism. On the contrary, Dr Zieg’s work is veryvaluable. Almost all technical analysis requires some interpretative skills. But if Dr Zieg usedsubjective interpretation, no doubt the validity of his research would have been questioned.He had to use a simple signal about which there could be no dispute. I’ve already made thepoint in Chapter 7 that I consider the double top and double bottom to be poor signals to tradewith, and I believe Dr Zieg’s research bears me out. Moreover you will remember EarlBlumenthal’s point (see page 128) about a breach of the first double bottom in an uptrend.He regarded it as a buy signal, not a sell signal. It is the foundation of the bullish shakeoutbuy signal. So, part of the time that Dr Zieg’s survey was recording a sell signal on the breachof a double bottom, Earl Blumenthal (and you and I) would be getting ready to buy. Indeed,for me, nearly every time there is the breach of a double bottom, I am looking for a quickreversal to buy. I am not looking to sell.147
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b. The surveys do not deal at all with the signals I regard as the most reliable (the triple topand its variations, the bearish signal reversed, the bullish shakeout and the obverse bearishsignals).c. The surveys do not deal with profit-enhancing techniques like doubling up in a linearphase or raising one’s stop loss.d. Dr Zieg’s original surveys did not employ any optimising techniques (see below).Optimisation
Dr Zieg’s surveys were based on point & figure charts constructed in the standard way putforward by A.W. Cohen. But what would happen if you used much smaller or much bigger boxsizes, and a 4 box or a 5 box reversal method (for example)? The Davis-Thiel study which hadproduced profitability levels of 53% was based upon the best box sizes and best reversaldistances for each commodity examined. So Dr Zieg decided to explore optimisation. He usedover 306 combinations (and sometime thousands of combinations) of box sizes and reversaldistances in an attempt to optimise profitability by finding the best box sizes and reversaldistances for a range of commodities. The results spoke with one voice. It was plain that thebigger box sizes worked best and that the 3 box reversal was still superior to any other reversaldistance. The reliability rate for all the commodities considered in his second survey jumpedfrom 41% to 66%. For a full treatment of this subject see Chapter 9 of Dr Zieg’s book.Dr Zieg’s point, and I endorse it with respect, is that investors and traders should examine, notjust once but on a continuous basis, which box sizes are working best for their style ofinvesting/trading in the markets in which they are participating. Using the right box size willraise the profitability/reliability rate comfortably over 50%.I have not made any concerted attempt to audit the reliability of the best point & figureformations for swing traders on the UK market. As a matter of impression, I would have thoughtthat the reliability rate for most stocks is in the bracket 55-65%, and for some stocks even higherfigures can be achieved.• Moreover the whole point of being a top down type, using swing charts side by side withpoint & figure charts and looking at other indicators including moving averages, is to try toraise the profitability rate from the mechanically measured 55-65% rate to more like 70%. Ihave my doubts that a reliability rate of better than 70% is achievable over a sustained periodof time.• Even that statistic disguises a good deal. My trading experience is that a good part of one’strading year is spent grinding out miserable profits. I’ve not measured reliability rates but Iwould guess that they would be about 45-60%. Then along comes a linear phase and for 610 weeks, you’re golden. Only by adding this golden phase to the ‘grinding out’ phase, doesone come up with the rather misleading target statistic of 70%.148
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The above analysis looks at accuracy in a global way. Looking at the accuracy of individualsignals, I take no account of whether the signal ultimately produces a profit. This may soundodd, but I regard the decision to take profits as entirely separate and as having no bearing on theaccuracy of the original signal. I make the following, somewhat arbitrary classification.a. If, after a point & figure signal, a security immediately reverses without moving morethan 1 box, that is well documented as a bull or bear trap, effectively a false signal.b. If, after a point & figure signal, a security moves only 2 or 3 boxes from the equilibriumand then reverses, I call that a failed signal.c. But if the share price or index moves at least 4 boxes, I classify that as a good signal.After all, if one is using the FTSE 50 point box chart, it would mean that the FTSE hadmoved 200 points from the equilibrium, certainly enough for a trader to consider it asuccess. There would be plenty of time either to take profits or to place a stop loss at theentry level.
Tailpiece 1I have not dealt separately with sector indices, but they are an important part of tradingindividual equities. Tom Dorsey makes the valid point that 80% of the risk in investing inequities is a market/sector risk. Only 20% of the risk is company specific. In other words timingone’s entry into the market and picking the right sector are four times as important as pickingthe right company. Of these Mr Dorsey, backed up by academic studies, says that picking theright sector is the most important, accounting for nearly half the risk. One doesn’t need to doanything more than study a list of the sector leaders and laggards of the FTSE in 2000 and 2001to know that if you were invested in the right sector each year, you would have made moneydespite the fact that the FTSE fell markedly in each year.I start off looking at the market indices of all the main markets, and before turning to the chartsof any individual shares, I go right through the swing charts and the point & figure charts (andrelative strength charts - see Chapter 10) of every FTSE sector index. Admittedly because Iswing trade only the biggest stocks which have the biggest weighting in the sector indices, thereis an element of duplication, so I don’t want to overstress this point for swing traders. But beingin the right sector is crucial and I urge you not to ignore the sector index charts.
Tailpiece 2There is no need to embrace my conservative style of trading individual equities, but if you arenot harnessing the power of a point & figure chart, I hope I’ve demonstrated that you’re missingsomething.
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For those who already use point & figure, keep an eye out for the shakeout especially, and alsofor Earl Blumenthal’s high poles in a downtrend, two formations which I think are underused.Above all:a. Look at charts with different box sizes. When I trade the Dow I look simultaneously ata 20pt chart, a 25pt chart a 50pt chart and a 100pt chart. With individual equities I havea main chart, but I will frequently alter the box size up or down to see what that tells me.b. If you wait for the point & figure chart to generate a sell signal before you liquidateyour long position (vice versa for short positions), I fear you may become disappointed.It is the right strategy when the market is in a violent short-term downtrend or a raginguptrend, but much of the time you will find that taking at least part of your profits earlywill leave you much better off (quite apart from the happy effect that regular profits willhave on your confidence and resilience).
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9
INTEGRATING POINT &FIGURE AND SWING CHARTS• Integrating p&f charts and swing charts whentrading indices• Integrating p&f charts and swing charts whentrading individual equities• Tailpiece
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So far I have dealt separately with swing charts in 3 chapters, and with point & figure charts in3 chapters. I have dealt separately with the tactics I employ with each type of chart. But in realtime the two are not separated - they are integrated. In Chapter 8, I explained that when I amusing a point & figure chart to trade UK individual equities, it is important to determine what isthe trend. Many people use trend lines or moving averages applied to the individual equity chartto tell them about the trend of that particular share.But I swing trade only in the 50 biggest stocks, and it is rare to see such stocks have a trendwhich is independent of the FTSE 100 index. Indeed by definition the FTSE index trend ismerely a composite of the trends of its constituents and since it is weighted by marketcapitalisation, the 50 biggest stocks account for about 86% of the movement of the FTSE index.It may be that an individual stock in that top 50 has the wherewithal to carve out its own trend,but I am sceptical. Since I analyse matters from the top down, I use a swing chart of the FTSEindex to tell me what the overall market trend is and that is what I use as my filter to guide mewhen to act on, or refrain from acting on, a point & figure signal on the chart of an individualequity (rather than trend lines). As demonstrated in the last chapter, this is a conservativeapproach.But guidance as to the overall market trend is far from the only way to combine the use of point& figure charts and swing charts.
Integrating p&f charts and swing charts whentrading indicesWhen trading index options and futures, the swing chart is my main guide. Of course I look atthe index point & figure charts every day (the 10pt chart, the 20/25pt chart and the (mostimportant) 50pt chart). Generally, I initiate positions only when the swing chart gives a buy orsell signal. The point & figure chart of the index, however, comes in very handy in three mainsituations:1. I have shown how the swing chart presentation can occasionally be equivocal, so that I amleft in doubt whether the short-term trend is changing or whether the market is simplyexecuting a complex countertrend correction. The point & figure chart often helps me resolvethat doubt. A good example was the change in trend in the NASDAQ index after theSeptember 2001 lows (see page 93).2. Occasionally the swing chart will give a false change of trend signal which shows up as ashakeout (or triple top/bottom with a long tail). If I see a bullish shakeout on the point &figure chart shortly after the swing chart has given a sell signal, I am inclined to trust thepoint & figure chart because the shakeout is such a reliable chart formation, and I will at leastclose my short position.152
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3. It is quite often the case that I will use a low box value point & figure chart to liquidatean existing position. I’ve already mentioned that knowing when to close out a position is oneof the great unsolved puzzles for chartists. One can’t