X__O______________77 ......|.....|........|...5.OAC1OXO9O.|X.........|........|......|....|.......O.|X.XO..XOBO|.....5O....X..O.|.......|....75 ......|.....|........|.....9.O|OXO.O.|X.........|........|......|....|.......OX|X2XO..XOXOX.....XO....X..O.|.......|....73 ......|.....|........|........|OX..BX|X.........|........|......|....|.......OX1XO36..XOXOXO....XO....X..OX|.......|....70 ......|.....|........|........|45..OX1X.........|........|......|....|.......OXOXO.OX.XOXOXO....XO..X.X..OXOX......|....68 _______________________________O___OXO2______________________________________CXOX__OXOXO_CXOX___XO__X9X__OXOXO__________66 ......|.....|........|........|....OCO..........|........|......|....|.......OXOX..OXOX..OXOXOX.XOX.8OX..B.OXO.....|..X.64 ......|.....|........|........|....O.|..........|........|......|....|.......O.OX..7XO...OXO2OXOXOX7XO.....CXO.....|..XO63 ......|.....|........|........|......|..........|........|......|....|.........O...OX....O1O.O3OXOXOX......12OX.X..|..XO61 ......|.....|........|........|......|..........|........|......|....|.........|...8X....O|..O.OXOXOX......O.OXOXO.|..XO59 ___________________________________________________________________________________OX__________O46_O_________3XO6O____XO57 ......|.....|........|........|......|..........|........|......|....|.........|...OX.....|....O...........|.O5O.O.|X.5O56 ......|.....|........|........|......|..........|........|......|....|.........|...OX.....|................|.4...7.|3OX654 ......|.....|........|........|......|..........|........|......|....|.........|...OX.....|................|.....O.|XOXO52 ......|.....|........|........|......|..........|........|......|....|.........|...OX.....|................|.....OX|XOX751 ___________________________________________________________________________________O9____________________________OX1XOX_49 ......|.....|........|........|......|..........|........|......|....|.........|...O......|................|.....9XOXOX.48 ......|.....|........|........|......|..........|........|......|....|.........|..........|................|.....ACOXO4.47 ......|.....|........|........|......|..........|........|......|....|.........|..........|................|.....OX2.O..45 ......|.....|........|........|......|..........|........|......|....|.........|..........|................|.....OX|....44 _________________________________________________________________________________________________________________OB_____43 ------8-----9--------9--------9------9----------9--------9------9----9---------9----------9----------------0-----O-0---41 ------9-----0--------1--------2------3----------4--------5------6----7---------8----------9----------------0-------1----
157152148143139135131127124120116113110107103100989592898784827977757370686664636159575654525149484745444341
The gold index – consisting of a portfolio of gold mining companies – is charted over a longtime period, and shows once again the amount of information regarding trading levels which ispacked into a p&f chart. You can clearly observe long-term trends and trend reversals. You canalso see that the chart is bullish, as the last signal was a buy.
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Chart 3.27 – Oil Index [.HUI]HUI / 3 box rev, log3/ 1996.06.04 to 2003.01.31205 6...|.......|..............|..........|............|.............|.................|.......199 O__________________________________________________________________________________________194 O...|.......|..............|..........|............|.............|.................|.......188 OX..|.......|..............|..........|............|.............|.................|.......183 7X9X|.......|..............|..........|............|.............|.................|.......177 O8OXCX......|..............|..........|............|.............|.................|.......172 O_OBOX3____________________________________________________________________________________167 ..A.OXO.....|..............|..........|............|.............|.................|.......162 ....OXO.....|..............|..........|............|.............|.................|.......157 ....124X...A|..............|..........|............|.............|.................|.......153 ....O.OX6..XO..............|..........|............|.............|.....X...........1.X.....148 ______O5OX_XO________________________________________________________X_XO__________XOX_____144 ....|.O.OX9XO..............|..........|............|.............|...XOXO..........XOX.....140 ....|...78OXO..............|..........|............|.............|...XO6OX.X.......XO......136 ....|...O.O.O..............|..........|............|.............|...XO.OXOXO..X...X.......132 ....|.......O..............|..........|............|.............|...X..OXOXO..9O..X.......128 ____________O________________________________________________________X__OXOXO__XO__X_______124 ....|.......O..X...........|..........|............|.............|...X..OX7.O..XOX.X.......121 ....|.......O..X5..........|..........|............|.............|...X..OX..O..XOXOX.......117 ....|.......B..XO..........|..........|............|.............|...5..O...O..XABOC..+....114 ....|.......O..4O..........|..........|............|.............|...X......O..8OXO|.+.....110 ____________O__XO____________________________________________________X______OX_XOX__+______107 ....|.......O..XO..........|..........|............|.............|...X......OXOXOX.+.......104 ....|.......O..XO..........|..........|............|.............|.X.X......OXOXO.+|.......101 ....|.......O2.XO......X...|.........X|............|.............|.4OX......O.OX.+.|.......98 ....|.......CXOX6......XO..|.......X.XO............|.............|.XOX........OX+..|.......95 ____________OXO3O______XO__________XOXO____________________________XO_________O+___________92 ....|.......OXO.O....X.XOX.|.......XOXO............|.............|.X..........+....|.......90 ....|.......1X..O....XOXOXO|.......XOAO............|.............X.X...............|.......87 ....|.......OX..7..X.XOAOXO|.......XO.O............|.............XOX...............|.......85 ....|.......O...O..XOXO.OXO|...X...X..O............|.............XO3...............|.......82 ________________OX_XOX__OBO____5O__X__OX_________________________XO________________________80 ....|.......|...8XOXOX..O.OX...XO..X..OXO..........|.............X.................|.......77 ....|.......|...OXOXO.....CXO..XO..X..BXOX.........|...X.........2.................|.......75 ....|.......|...OXO.......OXO..XOX.X..OXOXO........|...XO........X.................|.......73 ....|.......|...OX........OXOX.XOXOX..CXOXO........|...XO....X...X.................|.......71 ________________OX________OXOXOXO8OX__OXO_O____________XOX___XA__X_________________________69 ....|.......|...OX........OXO2OXOXOX..1X..OX.......|...XOXOX.XOX.X.................|.......67 ....|.......|...OX........O1O.OXOX9X..O2..OXO......|...XOXOX9XOXOX.................|.......65 ....|.......|...OX........O|..3X6XO...O...3XO......|...XO6OXOXOBOX.................|.......63 ....|.......|...O9.........|..O47.....|...OXOX.....|...XO.78O.O.O1.................|.......61 ________________O_____________O___________O5OXO________X__O_____O__________________________59 ....|.......|..............|..........|...4.O6O....|.X.X.........|.................|.......58 ....|.......|..............|..........|.....O.O....|.3O5.........|.................|.......56 ....|.......|..............|..........|.......7....|.XOX.........|.................|.......54 ....|.......|..............|..........|.......O....|.XOX.........|.................|.......53 ______________________________________________OX_____XOX___________________________________51 ....|.......|..............|..........|.......OXO..|.XOX.........|.................|.......50 ....|.......|..............|..........|.......O9O..X.XOX.........|.................|.......48 ....|.......|..............|..........|.......8.O..XOX4..........|.................|.......47 ....|.......|..............|..........|.........O..XO2...........|.................|.......45 ________________________________________________AX_XO______________________________________44 ....|.......|..............|..........|.........OCOX.............|.................|.......43 ....|.......|..............|..........|.........OXOX.............|.................|.......42 ....|.......|..............|..........|.........OXO1.............|.................|.......40 ....|.......|..............|..........|.........OXO|.............|.................|.......39 ________________________________________________OX_________________________________________38 ....|.......|..............|..........|.........OX.|.............|.................|.......37 ....|.......|..............|..........|.........BX.|.............|.................|.......36 ----9-------9--------------9----------0---------O--0-------------0-----------------0------35 ----7-------8--------------9----------0------------1-------------2-----------------3-------
205199194188183177172167162157153148144140136132128124121117114110107104101989592908785828077757371696765636159585654535150484745444342403938373635
The oil index is a portfolio of oil companies. In its p&f chart you will observe a nice trendinesswhich tells us that it is attractive to trade. Moreover, we see that the chart is bullish (by the end ofJanuary 2003) as its last signal was a buy and as the prices are moving above a bullish support line.Scaling for different marketsAn important issue when using point-and-figure for all investments is the scaling (i.e. putting a159
The Complete Guide to Point-and-Figure Charting
value on the box size). It is easy to understand that a government bond has a much lowervolatility than a stock and should therefore use a smaller box size. Otherwise price movementsthat would be relevant for a bond, would not show up in a chart scaled for stocks.Below we list some recommended scales for: bonds, commodities and market indices. We haveto insist that one has to try with different scales. We give our recommendations in the following,but again those values are indications only. In an exceptional case, like the famous attempt bythe Hunt brothers to buy up all silver contracts (the ‘Silver Corner’) which lead to an explosionof the price, you would most probably have to adjust the scale by using a multiple of the originalbox size.Table 3.2 – Scaling bonds
Bond price
Corporate
Government(Box Size)
from
to
(Box Size)
29
60
0.1
0.05
60
140
0.2
0.1
140
290
0.5
0.2
6
14
0.02
0.01
14
29
0.05
0.02
290
600
1
0.5
600
1400
2
1
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Table 3.3 – Scaling commodities
Commodity contract
Points
Corn, wheat, oats
1
Soybeans
2
Sugar
5
Crude oil
10
Cattle, hogs, bellies, cotton
20
Gasoline, NatGas, HeatOil
20
OJ, copper, coffee
50
Lumber, cocoa, soy oil
100
Palladium
50
Silver
100
Gold, platinum
$2
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The Complete Guide to Point-and-Figure Charting
Table 3.4 – Scaling market indexes
Index
LongTerm
MidTerm
ShortTerm
from
to
(Box Size)
(Box Size)
(Box Size)
14
29
0.5
0.2
0.1
29
60
1
0.5
0.25
60
140
2
1
0.5
140
290
5
2
1
290
600
10
5
2.5
600
1400
20
10
5
1400
2900
50
20
10
2900
6000
100
50
25
6000
14000
200
100
50
14000
29000
500
200
100
29000
60000
1000
500
250
For market indexes, the box size you use will depend on the time-span you want to cover withyour chart. If you are interested in long-term charts – more than 5 years – use one scale and ifyou are interested in a chart covering only a few months which needs to depict smaller pricemoves, then you should use the box scales on the right of the table.
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SummaryAll markets are plotted in the same manner, except that box sizes will vary from one market toanother. The scales can change depending upon the trading range of the security and itsvolatility.Except for these minor cosmetic modifications, everything else remains the same. Thetechniques for determining trading formations, trend lines and price objectives are identical forstocks, bonds, commodity and currency futures, stock options and market indicators like theDow Jones index family and commodity indices.It is worth adding that the techniques which have been so successfully employed in the moreconventional kinds of investment are just as applicable to works of art, stamps, coins, real estateor anything else which rises and falls in price over time.As we have explained above, the fundamental property of point-and-figure is the variable timescale, which is a terrific concept, and which can be used for all sorts of prices. Various academicstudies have shown that point-and-pigure is profitable for stocks and commodities. We canconfirm this through our research. If you want to trade something which is not covered by thisresearch, then hopefully you have access to some historical data so that you can figure outyourself (either with computer simulation or by trial-and-error) what sort of box size andreversal number should be applied. And if you can calculate the standard deviation of the pricereturns, then you should try to start with a figure we suggest in the table regarding correlationsof volatilities and parameters. We show you how to do this in a later chapter.
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The Complete Guide to Point-and-Figure Charting
About shorting, brokers and commissions
Shorting
In this section we briefly talk about positions. If you want, you can trade point-and-figure on thelong side only, which means that you enter on a buy and liquidate on the sell. You do not haveto trade short positions – entering on a sell and liquidating on the buy – and you may prefer notto, as shorting can sometimes be difficult for private investors.However, if you want to profit from price moves in both directions you do have to look into thematter of shorting stocks.In practice, due to the history of the markets, short selling of stocks is heavily regulated. This isa sensible precaution because you are selling stocks that you don’t own, which, if conducted byan ignorant or dishonest investor, could damage the market.Shorting can be done in a number of ways. As well as the traditional borrowing of stock andselling it, you can replicate short-stock positions with options, stock futures and otherinstruments. Other alternatives include CFDs and spread betting.Education
If you are thinking of shorting, it is a good idea to discuss this first with your broker. Many ofthe online brokers have articles on their websites that explain how to short, i.e. profit fromfalling prices.Bear in mind that shorting is no mystery, being simply the opposite of buying a stock, with someadditional rules that have to be considered.Choosing a broker
Choose a broker that you hear positive comments about. It is easy to open multiple tradingaccounts with different brokers – so open an account with a new one and try them out.The twomain factors in choosing a broker are:1.2.
Trading costs (including commission, spreads, slippage, and tax)Speed
Transaction costs
It is crucial that you compare the real transaction costs of the different alternatives. Reductionof transaction costs is very important – especially for active traders. Some brokers offer verylow prices for certain contracts, such as CFDs.
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Trading Applications
If you trade cheaply, you can use p&f with parameters that generate many transactions. If yourtransactions costs are high, you should trade less frequently, using standard box sizes andprobably 3 box reversals.If you trade derivatives based on the chart of the underlying, we suggest that you trade with theless active parameter sets, in order that you avoid surprises due to sporadic small changes in thecorrelation between the derivative and the underlying in phases of high volatility. This adviceapplies, of course, only if you base your trading decisions on the chart of the underlying. If youchart the derivative, then you do not incur that problem.Further references
Trade execution by brokers is a subject unto itself. For the UK investor the book by StephenEckett on Online Investing3 is an excellent compilation of answers to frequently asked questionsabout the whole process of opening accounts, choosing brokers, etc. The title of the book is abit misleading as it also answers all sorts of questions a non-online investor would have. For theother European markets no such compilation of questions and answers exists, at least to ourknowledge. You could ask your broker, or the exchange themselves. Most continental exchangeshave good information and educational material. We have provided a list of exchange websitesin Appendix 3 on page 250.
3 Stephen Eckett, Stephen Eckett on Online Investing, Harriman House, 2002
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The Complete Guide to Point-and-Figure Charting
Tips from experienced tradersThere are refinements as well as trading tips, drawn from the experiences of successful traders.The tips are not meant to be hard and fast rules, but are simply ways in which some chartistshave made the basic p&f system more applicable to their specific needs. Their use is purelyoptional. Adapt them to your own trading system if youu wish, or totally ignore them in favourof the traditional method.The modifications have the advantage of:1.2.
keeping tighter stopsrealising profits more frequently.
But they have the disadvantage of increasing the number of trades as well as forcing morefrequent changes in the open stop-loss orders held by the broker.Take your charting seriouslyPoint-and-figure charting is a dynamic market technique which must be practised daily. Acasual weekly review of the prior week’s charts is simply not enough – the entire trend of aposition can change in the span of a single day and the casual trader will never be aware ofsuch changes.Because of the speed of trend and signal changes, p&f charts can only serve as a useful tradingtool if they are kept up to date each and every day. This is also vitally important since signalsare anticipated through the placement of stop orders at the signal prices. However, since signalpoints change with every single reversal, the orders must be continually adjusted, and onlythrough daily chart updating can the required adjustments be known.
Speeding up the processDaily updating and analysing takes only a few minutes a day, but there are some tricks whichwill speed up the process, make it more effective, and provide better results:•
Only analyse charts of securities or futures contracts which you are seriouslyconsidering for portfolio inclusion and those in which you already hold a position. Thissounds easy and logical, but many chartists who followed a certain position a few years agowhen it was ‘hot’, religiously continue to maintain the chart long after the move is over, andlong after concluding that they would never again trade the position.
•
Update and study your charts before the opening of the market each day, since allsignals are anticipated. It is no good learning that a buy signal will occur at 300 the day after
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Trading Applications
it occurs. Prior to the market opening, your chart should contain all of the previous day’sdata so that you can correctly anticipate signals before they occur.All the software products that we recommend in this book can be configured so that they collectmarket data after the daily close. Some even scan the charts of an entire portfolio automaticallyfor break-outs or whatever signal you stipulate.Keeping the size of losses to a minimumThe traditional point-and-figure technique calls for you to take a position when you receive asignal, but a variation on this approach can be used if you need to keep your immediate capitalexposure small. The variation involves scanning the charts for favourable entry points where therisks are relatively small should the position be reversed and stopped out.Example 3.7 – Limiting losses, silverChart 3.28 – Silver, small risk
450
440
430
420
410
.........................................................................................................................................................................................................................................................X...................X.X...................XOX...................XOX<-Reversal..........O.............................................................................................................................
Chart 3.29 – Silver, big risk
450
440
430
420
410
440 ..............................................................................................................430 .............................X...................X.X...................XOX...................XOX..............420 ......OX....................OX....................OX....................OX....................OX..............410 ......OX....................OX....................OX....................OX....................OX..............400 ......OX....................O.................................................................................
440
430
420
410
400
=====
In the example above left, if silver with 200-point (2 cent) boxes and a three-box reversal chartgives a buy at 428, the minimum potential loss is the sell signal price which can never be lessthan five boxes away (three to create a reversal and two additional to trigger a sell). Thus theminimum loss would be 1,000 points or $500 (see chart above). But it could be considerably167
The Complete Guide to Point-and-Figure Charting
larger if the column of Xs was longer (see chart 3.29 on page 167), where the stop is sixteenboxes away.Traders working with a very limited amount of capital should avoid taking a position on theoriginal signal but instead they should attempt to take the position close to support where therisk exposure is considerably lower. This is basically waiting for a better entry point.As a further proof of the logic of this technique, let us assume a trader has £5,000 to invest andthat he is trading commodities requiring £2,500 in initial margin, or stocks selling at £25 pershare. If he takes the original signals and loses £500 per trade he can sustain only fiveconsecutive losses in a row and still remain in the market trying for the big winner. But if hetakes positions close to the stop-loss point and thereby risks only £100 per trade, he can bewrong twenty-five times in a row. And we all know there are long strings of losses in trendlessmarkets which must be absorbed while you patiently wait for the major money-making moves.Only if capital can be protected during these bad runs can a trader expect to profit in the longrun.But this technique is not without its risks. There is the risk that the position shows a dramaticmove in the direction of the breakout immediately after the signal, thus the position is never taken.Unfortunately some chartists do what should never be done. They take the original signal butsuperimpose a stop within their risk parameters. For example, if the chart stop-loss point basedupon taking the original signal is £1,000 away, yet they are willing to risk only £300, they takethe signal but place a stop at such a level as to produce a loss of no more than the £300. Thereis absolutely no justification for this action, since it involves the selection of an arbitrary stopwhich lacks universal acceptance and thus is not self-validating. The point-and-figure systemworks well in the normal manner, but such modifications are not valid, have not beeninstitutionalised into practice, and have not been optimised and, therefore, have a very limitedchance of success.Evaluating signalsQuite often a trader will find himself in a situation in which two or more different contracts arepoised for signals, in which formation types, past profitability, and reliability figures are similar,and in which he must decide which one to take and which to ignore. With all major factorsidentical, the decision boils down to determining which has the closest stop-loss point asmeasured in pounds. If one has a stop £600 away, one £700 and one £1,000, the contract withthe closest stop would be the one to enter on the signal.Another common situation is that a trader will look at the three trading opportunities and saythat the loss on all three is too large in relation to the size of his capital or in view of hispersonality makeup. If this is the case, the positions could be acquired on the pullback towardsupport following the initial signal or the trades could be passed completely. Hence the rule:168
Trading Applications
If the risk on a trade is too great, either pass the trade, or take a commitment onlyafter a reversal which brings the price close to the stop-loss point and thus reduces therisk to a tolerable level.And, as mentioned earlier, it is preferable to take a position on a positive reversal after the stopholds than closer to the stop during a move in the negative direction.Taking profits earlyModern financial econometric analysis has shown that volatility is clustered, which simplymeans that after big moves you tend to get more big moves.In the context of point-and-figure trading, this translates into the unpleasant experience ofgiving back open profits or, on the chart, of moving up one column and down the other becausea stock or commodity moves a substantial distance after a signal with no reversal occurringduring the move.To prevent this from happening, we recommend that you establish levels at which you take openprofits. Such a strategy – getting out of winners early – can significantly improve the returns onpoint-and-figure trading, especially in whippy markets.As we explained in the chapter covering stop and limit orders, it is often better to take profitsbefore an opposite signal occurs, and we showed there that you have three ways of taking profitsearly, namely:1.
Using the tailing stop at the level of the reversal
2.
Using a fixed profit target (e.g. 12 boxes)
3.
Using a variable profit target. (e.g. half the number of the boxes of the previous column)
We have shown the method for taking profits at the level of the reversal in a previous chapter.This method of protecting profits in a situation where a pole is formed is often called: up 10,down 3 and out, referring to the insertion of a trailing stop after a pole of at least 10 boxes inheight is formed. The target height of 10 boxes for the pole can be altered, but should not besmaller than 2 times the reversal distance, i.e. 6 boxes. The use of such trailing stops is easy.One has just to find the hypothetical reversal level and use it as a level where profits would berealized. That’s as easy as counting up to three!
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The Complete Guide to Point-and-Figure Charting
Example 3.8 – Taking a profit early on a reversal in three occasionsChart 3.30 – Profit targets, HBOS [HBOS.L]HBOS.L / 3 box rev
8808608408208007807607407207006806606406206005905805705605505405305205105004904804704
....|....................|................_____________________....|.................B..|.................XOX|................OXOXO................OXOXO________________OXOXO................OXOXO................OXO.O................O...C