<s> TheComplete Guide to
Point-and-FigureChartingThe new science of an old art
Heinrich Weber & Kermit ZiegHh H a r r i m a n H o u s e P u b l i s h i n g
The Complete Guide toPoint-and-Figure Charting
The Complete Guide toPoint-and-Figure ChartingbyKermit Zieg and Heinrich Weber
HARRIMAN HOUSE LTD3A Penns RoadPetersfieldHampshireGU32 2EWGREAT BRITAINTel: +44 (0)1730 233870Fax: +44 (0)1730 233880Email: enquiries@harriman-house.comWebsite: www.harriman-house.com
First published in Great Britain in 2003. Reprinted in 2008Copyright © Harriman House LtdThe right of Kermit Zieg and Heinrich Weber to be identified as Authors has beenasserted in accordance with the Copyright, Design and Patents Act 1988.ISBN 1-897-5972-82British Library Cataloguing in Publication DataA CIP catalogue record for this book can be obtained from the British Library.All rights reserved; no part of this publication may be reproduced, stored in aretrieval system, or transmitted in any form or by any means, electronic,mechanical, photocopying, recording, or otherwise without the prior writtenpermission of the Publisher. This book may not be lent, resold, hired out orotherwise disposed of by way of trade in any form of binding or cover other thanthat in which it is published without the prior written consent of the Publisher.Printed and bound by Biddles Ltd, Kings Lynn, Norfolk
No responsibility for loss occasioned to any person or corporate body acting orrefraining to act as a result of reading material in this book can be accepted bythe Publisher, by the Authors, or by the employers of the Authors.
ContentsAbout the authors
1
Preface
3
Introduction
9
1. Drawing point-and-figure charts
21
BackgroundHow to draw the chartsComputerised charting2. Interpreting the charts
55
Buy and sell formationsTrend lines3. Trading applications
107
Judging the distance of a moveThe use of stop ordersRisk and position sizePyramiding made simple and profitableSwing tradingDay-trading, speed trading, scalping and market makingExtending point-and-figure to other marketsAbout shorting, brokers and commissionsTips from experienced traders4. New optimisation methods
Optimisation techniques – making the good betterOptimisations and simulationsPoint-and-figure parameter sets for different volatilitiesOptimisation with a standard software packageHow to benefit from optimisations
177
The Complete Guide to Point-and-Figure Charting
5. Profitability analysis – does p&f charting really work?
197
Why point-and-figure is a good trading systemIntroduction to the historical studiesThe profitability of p&f stock trading – the original researchThe profitability of p&f commodity futures trading – the original researchLater commodity profitability researchProfitability of p&f commodity trading 1996-1997Profitability of p&f stock trading 1994-1996Weber-Zieg study on European stocks 1988-20026. Technical notes
219
The conflict between technical analysis and academic researchMore about scalingDescription of the program environment used
Appendices
239
1. Quick reference guide to buy and sell signals2. Glossary3. Recommended websites4. BibliographyIndex
263
About the authorsKermit C. Zieg, Jr., Ph.D.Being an avid investor since age 12, Dr. Zieg has a BS with a Finance Major from IndianaUniversity, an MA in Investments from Ohio State University, and a Ph.D. in Finance andInvestments also from Ohio State. Based upon over 40 years of personal investing experienceand academic research, he has written nine books and numerous articles on many of the mostsuccessful investment strategies. He is a Full Professor of Finance and Investments at FloridaInstitute of Technology’s National Capital Region campus in Alexandria, Virginia, where hekeeps his finger on the pulse of the markets through active trading. He travels extensively,training, lecturing, consulting and serving as an expert witness.Dr Zieg’s research and writing is unbiased. He is not a broker, and does not manage money,other than his own. He doesn’t publish a newsletter, and is not an investment advisor. His twomajor areas of trading and research interest are point-and-figure charting and options. In hisstudy of point-and-figure charting conducted continuously since 1961, he has run thousands oftests (back tested and live), and numerous what-if simulations.Dr. Zieg is active in trading options and fully utilizes point-and-figure in all of his decisionmaking. He lives in Vienna, Virginia.
Heinrich A. WeberHeinrich A. Weber is a recognised expert in finance. He was co-founder and managing directorof the emblematic market-making firm, Servisen Trading/QT Optec. He learned technicalanalysis while working with one of the early gurus, Ed Hargitt. In a joint venture operation withHSBC-James Capel, he directed the development of one of the first trading systems using theHurst coefficient.He is a partner and risk manager of the active Eurex member firm, DeTraCo. As a partner, hedevelops risk models and financial forecasting applications with AleaSoft1, the European leaderin the use of neural networks for the prediction of energy prices. Occasionally he does specificconsulting in the securities area, some of which is conducted jointly with Dr. Zieg.Heinrich studied at the Swiss Federal Institute of Technology (EPFL) at Lausanne, Switzerland,and is pursuing a PhD after receiving an MBA at Rushmore University.He lives with his wife and two young daughters in Geneva, Switzerland.
1 www.aleasoft.com
1
PrefaceWho this book is forPoint-and-figure is the best of all technical analysis methods. That’s our firm conviction. Theaim of this book is to explain point-and-figure to European investors and traders, and we havetherefore used European securities in all the examples given. But because p&f is universal,exactly the same concepts and techniques apply equally well to US securities. Prior to thisEuropean-focused work, the authors have written books applying p&f trading techniques tocommodities and US equities2.This book covers every aspect of point-and-figure from the basic concepts to advanced technicalinformation, because the book is meant for the novice as well as the experienced trader. We haveincluded all the relevant information, from drawing your own charts manually to thecomputerisation of p&f, so the book can also serve the committed independent trader whocontrols his own computer environment.What the book coversWe have put every effort into writing a book which is based on facts, research, and genuinemarket situations, in contrast to many technical analysis books which list all sorts ofhypothetical buy or sell situations. This was done because we are professional traders, marketmakers and academics, so we understand the need for an approach that is academically sound,based upon rigorous testing and analysis, but which is also of practical use to active traders. Ourbook is a manual, not a compilation of anecdotal evidence. We are convinced that when youhave studied it, you will understand:••••
point-and-figure chartingpoint-and-figure trading tacticsthe essence of optimisationthe application of all this to real trading
The purpose of the book is thus to cover all material aspects of point-and-figure charting.Whether you are a novice or an experienced trader, you should find answers to all p&f-relatedquestions. We explain the concepts thoroughly, though in a way that is easy to understand.
2 Kermit C. Zieg,
Point & Figure Commodity and Stock Trading Techniques, Traders Press, 19973
The Complete Guide to Point-and-Figure Charting
In this book, we use simple charts for illustrative purposes, but also real charts of the kind werely on in our daily analysis and trading. We have mainly chosen charts of stocks from the FTSE100, EuroSTOXX 50 and Techmark index. We also use some other interesting examples, suchas the impact of the 1987 crash on the S&P 500 index or the decline of the Nikkei 225.The book is structured in such a way that it can be used by readers of all levels of trading andinvesting knowledge from the novice to the experienced trader.Structure of the bookThe book makes use of many real and recent charts to illustrate the points made in the text. Butin some instances, especially in the first part of the book, we use small excerpts of charts in orderto illustrate a specific idea with the utmost clarity.The book is divided into six sections, which are summarized below.Section summaryIntroduction
The uniqueness of point-and-figure is explained, and as a contrast some other types of pricecharts are presented. The advantages of p&f are listed explicitly, and the method by whichinvestment decisions are reached is briefly touched upon.Drawing point-and-figure charts
In this chapter we explain how to draw a point-and-figure chart, with pencil and paper andalso with computers.Interpreting the charts
We explain the basic buy and sell signals, then more complex signals, and finally show howtrend lines are incorporated into a chart.Trading applications
Horizontal and vertical count methods are used to estimate the size of upcoming pricemoves. Stop-orders are used to protect positions and to enter into the market. Pyramiding isused to concentrate capital in the trending positions. The subject of risks relating to pointand-figure trading is dealt with. Swing trading is a trading style that profits from mid-termswings in the market and can be implemented well by adapting the point-and-figureparameters. Trading styles that generate a high number of transactions are analysed withpoint-and-figure. Other investments than stocks are briefly mentioned. And finally we listtips and strategies of experienced traders.
4
Preface
Advanced analysis and new optimisation techniques
Optimisation and simulation are explained in detail. We show you how to do it and how toavoid the most common trap – ‘over-fitting’. Then we list our most conclusive results andshow you how to profit best from those techniques.Profitability analysis
Here we summarize the original Davis, Davis-Thiel and Zieg studies, and also summarisethe results of our most recent research regarding the profitability of point-and-figure trading.Technical notes
Research in quantitative finance is explained. Technical details regarding scaling andoptimising are clarified, and we show in detail how we have programmed our p&f computerprogram. Computer-related issues such as databases and data feeds are covered.At the end of the book, you will find a bibliography, a glossary, an index of websites and ageneral index.The structure of the book reflects a top-down approach, whereby we start with the twofundamental concepts of point-and-figure, namely the law of supply and demand and thediscretization of price. Onto those concepts we build layer upon layer of more detailedinformation. The technical chapter – which constitutes the last part of the book – should help toresolve any remaining questions.
How to make the most out of the bookNovices
If you are new to point-and-figure and would like to apply the technique to guide yourinvestment strategy, then the introductory chapters are a must. You have to become proficient indrawing a p&f chart yourself, and therefore it is imperative that you do the exercises. Once youhave gone through the basics, we suggest that you do p&f charts of your favourite stocks.When you feel you are familiar with the concept, you should continue to increase yourknowledge base so that you will be able to apply point-and-figure to real trading. You willprobably have to buy one of the software programs we recommend or subscribe to a chartservice (some products allow for free trial periods). On page 24 we have listed the serviceswhich we use personally, with contact information for each.
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The Complete Guide to Point-and-Figure Charting
Experienced traders
If you are knowledgeable about investing or trading, but want to know more about point-andfigure charting, we still recommend that you go through the introduction and the basics, and trythe charting exercises. Once you are able to draw the charts set out in the exercises, study thetrend lines and pyramiding, because both are different – although more precise – than in barchart analysis. Then go to the chapter which is related to your investment or trading style. Youwill probably not need to go through the technical chapter.Professional traders
If you are a professional trader and already have an understanding of point-and-figure, butwould like to increase your arsenal of trading concepts, then you should read quickly throughthe basics and trading applications, where you may well learn something new, and then studyin-depth the subject you are most interested in, be it day-trading, swing trading or optimisations.Point-and-figure experts
If you are already an expert in point-and-figure, but are looking for some additional gems, wesuggest you read through the Chapter 4 on optimisation, and Chapter 6 on technical matters.Youwill probably also want to study Chapter 5 on profitability analysis, because it includes newresearch. Note, too, the section entitled ‘Tips from experienced traders’ which is part of Chapter 3.TerminologyA quick note on the format of company codes used in the text.All company codes use the format:[Company symbol].[Exchange]For example:VOD.LAEGN.ASCARR.PASAPG.DE
-
Vodafone shares trading in LondonAegon shares trading in AmsterdamCarrefour shares trading in ParisSAP shares trading on Xetra
This is a standard code system used by information services such as Reuters.
6
Preface
Supporting websiteThe website supporting this book can be found at:http://www.harriman-house.com/pnf.ConclusionThe objective of this book is to provide the reader with all of the basics and the most significanttechnical topics to point-and-figure charting. It represents a training manual explainingeverything you need to know to become a successful chartist in an easy-to-understand mannerthrough a few words, accompanied by lots of examples and figures.When you have worked through the book, you will know how to do it! It is a p&f ‘cookbook’.The recipe works, and the product is great.We hope that you enjoy the book and that it will help you to become an even more successfulmarket participant. Point-and-figure is easy to do, the best of all technical analysis systems, andtherefore we encourage you to start implementing it for your benefit as soon as possible.So let’s get started!
7
IntroductionWhy point-and-figure?There are a number of charting methodologies including line, bar, candlestick, Kagi and pointand-figure, to name but a few. Each of these is illustrated below.Chart 0.1 – Line chart of NASDAQ rise and decline
Source: MetaStock
The line chart is the simplest way to display the price history of a security, namely byconnecting subsequent closing prices. It is the standard method used to display any kind ofsequential data, e.g. temperature.
9
The Complete Guide to Point-and-Figure Charting
Chart 0.2 – Bar chart of NASDAQ rise and decline
Source: MetaStock
In contrast to a line chart, the above bar chart – the most widely used chart type – also showsthe trading range (open, high, low) in addition to the closing price. The high and low of the daydefine the length of the bar. The open is marked with a tick on the left and the close with a tickon the right side of the bar.Like the line chart, the bar chart shows how the price moves over time using equal-spaced timeintervals. In the chart above, you can see that calm periods like April 1999 are given the sameimportance as highly volatile periods like April 2000.
10
Introduction
Chart 0.3 – Candlestick chart of NASDAQ rise and decline
Source: MetaStock
The candlestick chart tries to highlight patterns by coloring the rectangle formed by the highand the low either black (if close below open) or white (if close above open). This feature is usedfor visual analysis by identifying specific patterns, like a “big black candle” or a “morning star”.Interestingly, candlesticks are a very old concept, being used to analyse rice contracts in Japanaround 1600.
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The Complete Guide to Point-and-Figure Charting
Chart 0.4 – Kagi chart of NASDAQ rise and decline
Source: MetaStock
The Kagi chart is a sort of Japanese point-and-figure chart. It dates back to the opening of theJapanese stock market and was introduced in the West much later. Its strengths are similar to thep&f charting technique – for example, in its use of a variable time axis.
12
Introduction
Chart 0.5 – Point-and-figure chart of NASDAQ rise and decline
Source: MetaStock
Finally, the point-and-figure chart.
Much has been written on all the charting types mentioned above, and there are strongsupporters of each technique. But there are significant advantages of point-and-figure over allother charting systems. And so major are these benefits that if you know point-and-figurecharting, there is no need to use any other system.
13
The Complete Guide to Point-and-Figure Charting
The powerful advantages of point-and-figurePoint-and-figure is truly superior to all other charting approaches for the following reasons:•
It is easy to understand.It takes only a few minutes to become an expert p&f chartist! The techniques are simple.No maths skills, prior market knowledge or special tools are required. Just learn a fewbasics and you are up and running.
•
It focuses on what really matters: price movements.All other technical analysis is based on a fixed time axis, whereas p&f only considers pricemovements and therefore prevents erroneous trading signals originating from timelineinduced distortions.
•
The methodology is a chart and trading system in one.Not only does the p&f chart depict price moves, but most importantly the charts translatedirectly into a trading methodology, producing buy and sell signals!
•
It has been rigorously tested and it works.Numerous academic studies have been conducted over a span of decades and the resultsare always the same: p&f charting is profitable.
•
There are exact decision rules.You know exactly where to enter and exit trades. There is absolutely no guessing required.
•
It is universal.Once you know the basic rules you can chart every investment media including stocks,commodities, mutual funds, stock and commodity options, indexes, and even coins, stampsand art. The same techniques apply for all investment products.
•
It always gets you in on a major move.You will never miss a major move since there will always be an entry signal. You mightchoose not to trade the signal, but the signal is always there.
•
It works for long and short positions, and always displays stop-loss points.Whether you trade only long, only short, or both, the charts display all exact entry pointsas well as exact stop points. No guessing is required.
•
It concentrates money in the trending positions and keeps little in the whippy ones.The inherent pyramiding technique shifts money automatically into the profitable trades,exactly where you want your money to be.
14
Introduction
•
It generates crystal-clear trend lines.In contrast to the typical bar chart and other charting methods, point-and-figure is nonambiguous about where to trace the all-important trend lines. Again, no guessing isrequired.
•
The charts are simple to maintain.In 10 minutes a day you can manually maintain 100 charts. No computer or expensivesubscription or data service is needed. All that is required is the daily newspaper, a penciland graph paper.
=====
Why is point-and-figure so appealing visually?Because it is totally symmetric as defined by the two forces of supply and demand,described by the symbols O for supply and X for demand. This symmetry can befurther appreciated in the instructions for drawing the charts which consist of twosymmetric sets of instructions. Also, buy signals are the exact reverse of sell signals,and trend lines only exist with three angles: horizontal, diagonal up and diagonal down.Beauty through simplicity.=====
The investment decisionInvesting involves a very limited number of decisions:1.
What stock (futures contract, equity option, index option, commodity option or otheritem) should I buy?
2.
At which price level should I buy it?
3.
Having purchased it, at which price level should I sell it?
To be a successful investor, one needs not only to select the best stocks to own, but buy them atthe right time, and then employ appropriate exit strategies to stop-losses and let profits run.The limitations of fundamental analysis
Most investment services, newsletters, advisors, and brokerage firms select stocks to purchasethrough the use of fundamental analysis, the reason being that wrong advice is easy to justify bypointing at a change in some exogenous variable, market environment or geopolitical situation.Fundamental analysis involves the study of the quality of the company, its sales, earnings,management, and other factors relating to how the company has performed over recent history,15
The Complete Guide to Point-and-Figure Charting
how it should fare in the future and how it compares with other firms within its industry sector.There are hundreds of factors, ratios and indicators that can and are employed to track pastperformance, anticipate future results and measure one company against its peer group.But as important as knowing what stock to buy, is knowing when to buy it. How often have thefundamentals pointed to a very positive scenario, only to have the securities price collapse?Technical analysis is employed to determine when to buy the fundamentally strong stock.The ideal investment approach marries fundamentals to technical analysis in order i) to identifythe best stocks and ii) to select the most efficient entry and exit points. To use only one,fundamental or technical analysis, is to admit that the quality of the company does not matter,or that it is not important when to buy and sell. Both are needed.If we had to decide whether fundamental or technical analysis is most important, andcould employ only one, we would select technical methods. It is always preferable to owna beautifully market-performing stock, with well orchestrated buy and sell points, than anextremely strong fundamental stock that is going nowhere in the market.There are dozens upon dozens of methodologies for evaluating security price movements (i.e.technical analysis). There are technical methods that utilize bar charts, moving averages,Bollinger Bands, Gann Arcs, Fibonacci Fans, Renko, Candlesticks, Standard Deviations andPrice Rate-of-Change, to name but a few. Some are old, some new, some time-tested, and manytotally untested. A few are simple to employ, but most are confusing. Others require a highdegree of mathematical expertise, a fast PC with lots of hard drive space, and a person whodesires to delve into the mysteries of the incomprehensible.Then there is point-and-figure, one of the oldest, easiest to understand, simplest to employ,academically tested, and most profitable of the lot.
Since when has point-and-figure been used?Point-and-figure charts have been around since the late 19th century. There is someanecdotal evidence that early forms of the technique were used by European traderseven before Wall Street was founded in 1792. They were considered as an ideal way tokeep track of stocks since they show the past history in a very concise, readable formand are easy to keep up and study. An experienced chartist can manually update 100charts in 10 to 15 minutes per day. But it was not until 1958 when A. W. Cohen firstpublished his book, The Three Box Reversal Method of Point and Figure Stock MarketTrading that the techniques became widely recognized as a valuable market strategy.The original publisher of the Cohen book was Chartcraft, Inc., which is today the majorsupplier of subscription charts in the US.
16
Introduction
Examples of point-and-figure in actionThe success of point-and-figure charting is revealed by examining a handful of trading signalsyielded by the system in recent years.Chart 0.6 – BAE Systems [BA.L]4003903803703603503403303203103002902802702602502402302202102001951901851801751701651601551501451401351301251201151101051009590
____________________________________________________......................|...X.X.......................X...........X.X.......|...XOX6.+....................1OX.........XOXO......|.X.XOXO+......................OXO......X.XO8OX.B...|.XOXO5O......................_OXO__X_X_X7XO_OXOXO__2_XOXO+O______________________.OXO..45XOXOX..OXOAOX.XOXO4+.O.......................OXO..XOXOXO...OXOXOXOXOXO+..OX......................OXOX.XO.O.....9XOXOXOXO3+...7XO8....................OXO2OX........OXOXO.O1O+....OXOXO.................._OXOXO3________O_OX__C_+_____O_OXO__________________.OXOXO...........OX............OXO...................OXOX............O....|........OX9...................OXOX.................|........O.O...................O.O..................|..........O.................._________________________________O__________________......................|..........O........................................|..........O........................................|..........O........................................|..........O..X.X............._________________________________O__AOXO_+__________......................|..........O..XOXO+.................................|..........OX.XOXOX.................................|..........OXOXO+OXB................................|..........OXOX+.OXOX.X......._________________________________OXO+__O_OXOXO______......................|..........OX+.....OXOXO............................|..........O+......OXOCO............................|..........+.......O.O.O............................|......................O......_____________________________________________O______......................|......................O............................|......................O............................|......................O............................|......................O......_____________________________________________OX_____......................|......................OX...........................|......................OX...........................|......................OX...........................|......................OX....._____________________________________________OX_____----------------------0----------------------O---------------------------2-----------------------------
4003903803703603503403303203103002902802702602502402302202102001951901851801751701651601551501451401351301251201151101051009590
This BAE Systems [BA.L] chart covers the time span January 2001 until end of 2002. A tradingrange during the first 18 months between 260 and 390 is observed. Then a breakout which isdefined by a simple signal and the breaking of a bullish support line. This strong sell signal, at340 in autumn 2002, heralds the decline of the stock toward 100. Although a certain resistanceto that move is experienced in the 175 to 200 region, which generates a small whipsaw: a buysignal is given at 195, and shortly afterwards another sell signal at 180. Thereafter, thedowntrend continues, again introduced by the break of a support and a simple sell.17
The Complete Guide to Point-and-Figure Charting
What do the different colours mean?
We use throughout the book green for a buy signal, red for a sell signal and yellowfor other interesting characteristics, such as trend lines.====Chart 0.7 – BSKYB [BSY.L]BSY.L / 3 box rev, c ext, / 1999.02.17 to 2000.06.052300 ..........................................|........................... 23002250 _____________________________________________________X________________ 22502200 ..........................................|..........XOX.............. 22002150 ..........................................|..........XOXO............. 21502100 ..........................................|..........XOXO............. 21002050 ..........................................|..........XOXOX............ 20502000 ___________________________________________________X_XOXOXO___________ 20001950 ..........................................|........XOXOXOXO........... 19501900 ..........................................|........XOXO.OXO........... 19001850 ..........................................|........XOX..OXO........... 18501800 ..........................................|........XOX..O.OX.......... 18001750 ___________________________________________________XOX____OXO__X______ 17501700 ..........................................|........XO3....OXO..XO..... 17001650 ..........................................|........XOX....OXOX.XOX.... 16501600 ..........................................|........XOX....OXOXOXOXO... 16001550 ..........................................|......X.XOX....4XOXO5OXO... 15501500 _________________________________________________2OXO_____OXOXO_OXO__X 15001450 ..........................................|......XOX......OXOX..OXO..X 14501400 ..........................................|......XOX......OXOX..O.O..X 14001380 ..........................................|......XO.......OXOX....O..X 13801360 ..........................................|......X........OXO.....O..X 13601340 _______________________________________________X_X________O_______O__X 13401320 ..........................................|....XOX................OX.6 13201300 ..........................................|....XOX................OXOX 13001280 ..........................................|..X.XOX................OXOX 12801260 ..........................................|..XOXOX................OXOX 12601240 _____________________________________________XOXOX________________OXOX 12401220 ..........................................|..XOXOX................O.OX 12201200 ..........................................|X.XOXOX..................OX 12001180 ..........................................|XOXOXOX..................OX 11801160 ..........................................|XOXOXOX..................OX 11601140 ___________________________________________XOXOXO___________________OX 11401120 ..........................................|XOXOX....................OX 11201100 ..........................................|XOXOX....................OX 11001080 ..........................................|XO.OX....................OX 10801060 ..........................................|X..