above 82.e. Where there is no obvious close swing high or low, use a stop loss of 80points.
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BuySell
2
3
4Sell
1
Sell
6Buy
Buy
5
7
fig 5.101.
19th April. There is a clear change of trend as market makes a huge gap opening above theprevious swing highs. Although I will activate positions on gap openings, this one is solarge that it would be impossible to do so. There would be no sensible place to put a stoploss. Wait for continuation of trend signal.
2.
26th April. Buy on (gap) opening at 1839 as market exceeds previous swing high of 1825.In this instance there is a sensible, if distant, place to put a stop loss (underneath the putativeswing low at 1743). Potential linear phase. Take half profits of 140 points on 2nd May.Stopped out of remaining position at entry point on 4th May. Although the activation of thisstop loss seems wrong because the market later goes up, no linear phase does in fact eventuate.
3.
15th May. Buy at 1821 as market takes out highs of 14th May. Later take profits of 100 and140 points.
4.
1st June. Buy at 1838. Take half profits of 100 points. Stopped out of remaining position atentry point.
5.
14th June. Sell short at 1766 as market changes trend by breaching lows of 30 May. Takehalf profits of 100 points. Stopped out of remaining position at entry point.
6.
3rd July. Sell short at 1814. Potential linear phase. Take half profits of 140 points and then460* points on 7th September 2001 on the RSI reading.
7.
3rd August. Sell short at 1717. Later take profits of 100 and 140 points.
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Sell
8
10Buy
Sell
9
fig 5.11
8.
29th August. Sell short at 1525. Later take profits of 100 and 140 points.
9.
24th and 25th September are up days. 26th September is a down day. 28th is an up day.A swing chart sell signal is generated on 29th September. Stopped out for 80 point loss.
10.
3rd October. Until just prior to the close, the NASDAQ had spent 3 days under theputative swing low. Although this looks like a buy signal, it is admittedly not crystal clearfrom the swing chart alone. In fact the point & figure chart of the NASDAQ Comp gavemy favourite buy signal on this very day (see page 93), so I never was in much doubt.Buy at 1257. Later take profits of 100 and 140 points. Hereafter one is looking keenly fora 3 day swing low to trade a linear phase. But it never quite happens. There are several 2day setbacks in the course of October and November, but no 3 day setbacks. It is clear bythe end of November that the occasion for a linear phase has gone. No trading after 10thDecember. In any event, the weekly RSI is over 79. The chart is quite murky thereafter.
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1211Sell
Sell
17
161513
Buy
14
19
18
Buy
Sell
Sell
2021
fig 5.12
11.
Come early January, it is a bit of a puzzle. It is not clear what is the trend. The plunge on20th December could be interpreted as a swing low in an uptrend, or more reasonably20th December turned the trend down. There were enough days (3) above the swing lowsto satisfy my rule of thumb about change of trend signals, but there was no followthrough. A clue is provided on 11th January when the 10pt point & figure chart generatesa sell signal, but since this is a swing chart model I won’t count that. Matters are madeclear on 18th January as the market breaks its December lows. This must be a downtrend.But it is too late to act on a change of trend signal. The market is merely revealing thatthe previous equivocal position was in fact a downtrend. Wait for a continuation of trendsignal which should be a linear phase.
12.
24th January is an up day. 25th January is a down day. 26th January is an up day. 29thJanuary does have a higher high, giving one the signal to put a stop sell order below thelows of 26th January. But its high remains below the high of 24th January. I mentionedthis problem in the section on complex swings on page 42 and on page 44. In this sort ofposition I would take a half position because:a. 29th turns out to be an outside day, and the highs of the 29th and 24th are fairly close.b. If the market had set up perfectly, this would have been a linear phase.c. The Dow gave a classic continuation of trend sell signal on 29th January.Later take profits of 140 points.
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13.
15th February. Sell short at 1470. Later take profits of 100 and 140 points.
14.
On 25th, 26th and 27th February the market does rally, and ordinarily one would havegone short on 27th February but the weekly RSI is at 16.8, so this sell signal is not actedupon.
15.
1st March. Market moves through highs of 27th February. Equivocal presentation. Couldbe a change in trend buy signal or just a swing high in the making, especially since theweekly RSI is oversold (until the close that day). Do nothing.
16.
By 5th March, as the market breaches the swing high of 14th February, it becomes clearthat the move on 1st March was in fact a change in trend, but its too late to act on that.Instead look for the first continuation of trend signal for a linear phase position.
17.
18th March. Buy at 1499. This potential linear phase does not work out.
18.
20th March. Is this a change of trend or a complex swing low in the making? Not clear.Stop loss on linear phase position activated below the putative swing lows at 1469, butdon’t go short (pity) because picture unclear.
19.
21st March. Clarity is achieved. This looks like a swing low after the market bounces offits lows, and closes up firmly after an outside day. Buy at 1489. But do not confuse claritywith accuracy. It is not a swing low. The market continues to decline. Stopped out underthe putative swing low (1442) on 25th March.
20.
25th March. This cannot any longer be the same swing low forming in an uptrend. It mustbe a change of trend signal. That impression is confirmed by the Dow which has alreadygiven a very clear change of trend signal. Sell short at 1442. Later take profits of 100 and140 points.
21.
18th April. Potential linear phase. Sell short at 1392. Later take profits of 140 points and231 points on 6th May when an RSI reading of 12.2 is obtained.
*In fact the RSI reached only 15.5 on 7th September, so according to the above the rules thislinear phase position would have been held through 11th September and a much bigger profitwould have resulted, but I decline to count that windfall.
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Analysisa. Linear phases: There were 2 attempts to trade the same linear phase in mid-March. I countthat as one failure costing a total of 107 points. There were 3 winners totalling 1111 points. Netgain 1004 points.b. The non-linear swings had 1 loser costing 160 points and 8 winners totalling 1780 points fora net gain of 1620 points.The net result is 2624 points, or the equivalent of 1312 points per contract, a return of close to80% unleveraged over the period of one year and a bit. The accuracy rate of 11 winners to 2losers is rather better than you should expect over the long term, but it does demonstrate howsimple and profitable swing charting can be.Of course, now that the NASDAQ 100 is trading below 900, my sights are lowered. One needsto take account of the fact that a 140 point move in the NASDAQ 100 now would be rather morethan you could fairly expect from an ordinary swing. So my profit targets are now 60 and 90points on regular swings.
Individual equitiesIf swing charts are so brilliant, why do I use point & figure charts as my main guide when swingtrading individual equities?You can successfully trade many high volatility, high volume stocks using swing charts only.But merely because swing charts are excellent seems little reason to ignore every other indicator.Swing charts are occasionally ambivalent.Swing charting is profitable when applied to active stocks. There are many stocks which are tooinactive for swing charting to be of any value. Even stocks in the FTSE 100 index which attractgood daily levels of volume can be unsuited to swing charting. Many of the old economy stocksplod dolefully on, like Eeyore. Excellent long-term investments they may be (I even have a fewof them in my self-select pension fund), but instead of taking 3-5 days to make swing lows theycan often take weeks. They are much more inert.Look at the chart of Reckitt Benckiser, one of the top 40 companies listed on the London StockExchange.
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36
1
852
4
7
fig 5.131.
The stock made a high on 3.7.01.
2.
It took 8 days to make a new swing low on 13.7.01.
3.
A new high was made on 1.8.01.
4.
It took a further 8 days to make a a swing low at 990p on 13.8.01.
5.
The swing low is breached on 10.9.01 leading to a sharp fall from which the sharerecovers.
6.
It takes 17 days to make a new swing high on 4.10.01, generating a false buy signal whilstdoing so.
7.
16 days pass before a new low is made on 29.10.01.
8.
It took a further 12 days to make a swing high on 14.11.01.
The swings are plain to see, but my style of trading a 3 bar countertrend move/1 bar tradingsignal would not work with this stock. In Reckitt’s case, a 6 bar countertrend move/2 bar tradingsignal might work. I don’t know. I would guess that it is possible to devise a viable swing chartwhich varies with the volatility of a stock. Paritech (www.paritech.co.uk) market software87
Marc Rivalland on Swing Trading
known as Hot Trader which may be the best software on the market for swing charts. It is veryversatile. You can stipulate various lengths of swing chart i.e. 1 bar, 2 bar, 3, 4 or 5 bar etc. Whatyou cannot do, however, is stipulate a 6 bar swing to define the desired correction, and a 1 barswing to activate the buy or sell signal, although I should imagine it would not be too difficultfor the programmers to make that change.I steer clear of stocks and securities that are not susceptible to my style of trading.When trading individual equities, I have regard to both the swing chart and the point & figurechart and it is the point & figure chart which has primacy. But I want to make crystal clear thatswing trading purely with swing charts can be successfully undertaken in individual equities.In Appendix 2, I show how all the swings in Rio Tinto could have been successfully traded withswing charts for the 26 month period ending April 2002.
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6
POINT & FIGURE CHARTS• Introduction• Ethos
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IntroductionThe origin of the term point & figure is shrouded in mystery. It is said to refer to the way grainmerchants recorded prices in the late 19th Century.The man who originally made point & figure famous was A.W. Cohen in his book How to Usethe 3-point Reversal Method of Point & Figure Stock Market Trading, published by ChartcraftInc. in 1947. It has been re-printed several times, but is now out of print. Michael L. Burke ofInvestors Intelligence is the spiritual successor to A.W. Cohen. Mr Burke remains one of theworld’s best known point & figure practitioners.I do not want to bog down the text at this point with a detailed explanation of how to constructa point & figure chart, (see Appendix 1 if you want guidance on this) but I do need to deal withsome aspects of construction because they are germane to interpretation. I also need to set out abrief glossary at this point so that the uninitiated can follow:• X represents rising prices• O represents falling prices• Box The name originates from the squared paper on which point & figure charts areusually drawn. Each box is the unit of price movement chosen for that chart. Choosinga lower unit value makes the chart more sensitive and increases the number of signals,both good and bad. A higher value reduces the number of signals.• 3 box reversal It is usual (but not compulsory) to plot a new column representing achange in direction only when the price moves 3 boxes in the opposite direction. Thepoint of this requirement is to eliminate minor moves which would otherwise clutterthe chart without a corresponding benefit in interpretation. Effectively, all pricemovement which runs counter to the existing plotted direction but falls short of 3boxes is deemed to constitute mere background noise.• No time scale Point & figure charts are constructed ‘under eternity’ as A.W. Cohen'sbook rather grandly puts it. This means that there is no time axis. If a share pricemakes tiny oscillations for days on end without ever achieving a 3 box reversal therewill be no addition to the chart. Effectively the X axis simply records, by columns ofXs and Os, the number of occasions upon which there has been a relevant reversal inprice.The only record of time in a point & figure chart is when an X or O is replaced withthe number of the month. This occurs on the first addition to the chart made in themonth. It is simply a reference point. Modern software will allow you to rest the cursoron any column of Xs or Os to see exactly when the price action took place.90
Point & Figure Charts
EthosThe point & figure chart is much loved by day traders and floor traders (they still exist in theUS). It has stood the test of time. It is still very often the chart of choice for many technicalanalysts and traders despite the fact that much more sophisticated analysis can be done withPCs. Why?• Point & figure charts have a huge advantage which distinguishes them frommost other charts. Every other chart measures time on the X axis thereby implicitlyaccording equal weight to each day’s price action. This is counterintuitive. Everytrader knows that not all days are equally informative; not all days have price actionwhich is equally representative of the balance between the forces of supply anddemand. The point & figure chart uniquely and automatically attempts to differentiatebetween the useful and the unimportant.• Point & figure charting is not rocket science. The charts are easy to read and they areeffective. The picture of supply and demand is very clear, which gives one confidencein the message conveyed. By contrast, many of the indicators available on chartingsoftware are purely arithmetical calculations. They are used because they have workedin the past when the market is trending, but they convey comparatively little in termsof supply and demand.• Because the X axis does not measure time but only movement, the chart displaysmore clearly the change in volatility and interest in a particular stock. Write in the dateon a point & figure chart and you will see that 20 columns can sometimes cover justa few weeks trading, other times it will cover a year’s trading.• Almost all other charts use the closing price of the day or the high low close of theday as a reference point. Since one cannot tell during the day what will be the high lowand close, most charts are dynamically retarded by one day. But point & figure chartsare often used in real time.Strictly speaking it is not even necessary to have a computer with the requisite software on it.For years, I speculated only in the futures markets of bonds, gilts, the FTSE and the Dow Jones.All I needed was 4 hand-drawn charts and a helpful broker. I still keep half a dozen charts whichI update manually every day (for the times when I am sent to some faraway court on circuit andwill not be returning to my computer that night). It takes a total of about 5 minutes to completethe manual updating.As I’ve mentioned, I do need to cover two important aspects of construction: ‘Data to be used’,and ‘Box value’.
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Data to be used
There are several different ways of constructing point & figure charts. A.W. Cohen was clearthat point & figure charts were not to be based on closing prices. Yet when you use chartingsoftware, you will be offered the option of constructing the point & figure chart on the basis ofthe closing price. This is not as absurd as it sounds. In many illiquid stocks a single largepurchase order can cause movement during the day which is not truly representative of thetotality of the forces of supply and demand. As the market approaches the close and the buyingorder has been filled, the market edges back downwards. In those circumstances, the close maybe more truly representative of the forces of supply and demand than the intraday trading.The same does not apply to the most liquid 100 to 200 stocks where the intraday tradingprovides a valuable guide to the exact level where demand and supply are strongest. In the caseof the most liquid stocks, those to which the swing trader would naturally gravitate, a real timechart is not only more accurate than a chart based on closing prices but also avoids some of theconsiderable perils that can exist in swing trading with a point & figure chart based on closingprices. See Appendix 1 for a description of these perils.There is another method of construction which is intellectually unsatisfactory but is pragmatic.Much of the charting software on the market, if it has a point & figure function at all, will offerthe choice of point & figure charts based on closing prices or on the daily high/low prices. Bycharting the high and low, the computer is attempting to mimic real time.This slightly curious method of construction has led to the belief in some quarters that a point& figure chart cannot be constructed by adding more than one column per day. That is exactlywhat a computer does when it plots the chart based on the high and low price. It only ever addsto an existing column (if prices move in the same direction) or it adds one new column (if pricesmove in the opposite direction by a sufficient amount). But a computer plotting from the highand low price never adds to an existing column, as well as plotting a reversal on the same dayeven though that is exactly what may have happened to the share price. A share which opensway up on the day and declines all day will be recorded by the computer only as havingadvanced. The decline is not plotted. It is fanciful to suppose that that is the right way toconstruct a point & figure chart. There is no conceivable reason why an intraday reversal shouldbe ignored - on the contrary, it will add to the picture of supply and demand, and any chart thatdoes not show that intraday reversal is not telling the full story.But in fact, the damage is minor. A real time chart and a chart based on high/low prices are morethan 90% similar provided a big box size is used.Best of all is the real time chart which shows you every point of supply and demand. I use a realtime price feed, but I do make it clear that although a real time system is best, it is by no meanscompulsory. For the purposes of employing the principles in this book, an end-of-day system,which will plot only one column a day from the high/low price will work perfectly well.
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Box value
This is a more important issue than most people realize. A.W. Cohen gave a detailed account ofhow the box value should change from $1 per box to 50c per box when the share fell through$20. It follows that when a share was trading at about $30 he was using a box value of about3%, when it was trading at $90 he was using a box value of 1.1% and when it was trading atabout $19, he was using a box value of about 2.5%. Be chary of using box values of much lessthan 1%.I agree that the box value should be altered according to the level at which a share or index istrading. For example a 10pt or 20pt box is now appropriate for the NASDAQ Comp, but itwould not have been appropriate when the Comp was trading over 4000.A good illustration of the difference made by box size is provided by the NASDAQ Comp afterit bounced off its lows in September 2001. The 20pt chart is perfect. Not a single false signal.The only failed signal comes as the market makes its peak in January 2002 and even it wouldhave cost very little. In any event, losing money when the market turns is not unusual. As theNASDAQ falls once again the chart is as good as gold. This is point & figure charting at its verybest. The individual buy and sell signals on this chart will be considered in Chapter 8.
fig 6.193
Marc Rivalland on Swing Trading
A series of falsebuy signals andsell signals
fig 6.2Now consider the 10pt chart above which has a box size of closer to half of one percent.Just like the 20pt chart, it signals the bottom very well. But as soon as the market gets to 1700the 10pt chart disintegrates into a mess. It gives a repeat buy signal at 1710. It then reverses,giving a sell signal at 1660 which fails as it re-reverses and gives a fresh buy signal at 1750which again works for a while (up to 1790), long enough to put a stop into place, but thenreverses again to generate another sell signal, which again fails as the market re-reverses.Compare that fevered trading pattern to the serenity of the 20pt chart which has no sell signalsof any kind at that point.I find point & figure charts much more reliable the bigger the box size that is used. I use a boxsize of about 0.5% for the Dow (50 points), 0.8% to 1.2% for the FTSE (50 points), and boxsizes of 1.2% to 2.5% for individual equities. That doesn’t mean I don’t look at the smaller sizecharts. I do, but the bigger box charts have primacy.Test it yourself. Choose what’s best for you. You’ll see very quickly when looking at the sameshare with 2 different box sizes which chart portrays an orderly advance/decline and which chartis too inert/too demented. But as you’ll see in Chapter 8, it has been proven that bigger box sizesproduce more accurate charts.
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Point & Figure Charts
Why do the funny X’s and O’s work?
When my first article on point & figure charts was published in the Evening Standard, theproduction team, who had been editing a business daily for years, were amazed. I guess they hadnever seen anything like it. Poking a little fun must have been irresistible. The article had acartoon of a man looking at a noughts-and-crosses puzzle with a thought bubble saying "Ah, abuying opportunity!" and a sub-headline contained the piratical "X marks the spot". When I amsitting on a train updating my charts manually, I can see fellow travellers’ necks craning as theylook in stupefaction at the strangeness of the chart.I have already explained the theory about why charts "work". I shall not repeat that to any greatextent here. In essence, by employing a method of columnar reversals, the funny Xs and Osclearly demonstrate consolidation or broad equilibrium when the market is moving sideways. Itis disequilibrium between the forces of supply and demand which produces sustained pricemovement and that too is portrayed very well by the point & figure chart.Logically, it must be relevant to know why the price has broken out of a state of equilibrium.But very often one doesn’t know, so the chartist trusts the price action. There are manyoccasions when the reason for a rise or fall in the market is not obvious at the time. It onlybecomes clearer much later. Eugene Ionesco, the French dramatist, observed rather drily thatyou can only predict things after they have happened.Even when you do know why the breakout occurred, you often do not know how much weightto accord a certain factor, whether the market will agree with the weight you place on it, or howdurable the factor will be. The chart takes that value judgment out of your hands, which is veryuseful, at least for me, because I do not have the time or the inclination to do detailed analysisof the world economy, corporate balance sheets or any other such sleep-inducing matters.I still prefer my swing charts when it comes to calling the market as a whole, but I never fail tolook at my point & figure charts, and when it comes to individual equities, point & figure is usedwith, and prevails over, the swing charts.
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96
7
POINT & FIGURE SIGNALS• Introduction• The signalsThe Double Top and Double BottomThe Bullish SignalThe Bearish SignalThe Bearish Signal ReversedThe Bullish Signal ReversedTrianglesThe Triple TopThe Ascending Triple TopThe Spread Triple TopThe Triple Top with Long TailThe Bull TrapThe CatapultThe Triple BottomThe Descending Triple BottomThe Spread Triple BottomThe Triple Bottom with Long TailThe Long Tail DownThe High Pole• My evaluation• My favourite point & figure signalsThe Triple Top with Rising LowsThe Triple Bottom with Lower HighsThe Bearish or Bullish Shakeout• The Whipsaw97
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IntroductionPoint & figure signals are so simple to understand that they require little explanation.Accordingly, in this chapter, I run briefly through the main signals, and I provide my personalevaluation thereafter. Then I deal in more depth with my two favourite point & figure signals.If, after reading the first half of this chapter you still struggling to understand how point & figuresignals work, please go to the free point & figure library at www.marcrivalland.com or buy oneof the standard works on point & figure:• The Three-Point Reversal Method of Point & Figure Construction andFormations by Michael L Burke (Chartcraft-1993)• Point & Figure Charting by Thomas Dorsey (John Wiley & Sons 1995)• Point & Figure (Commodity and Stock Trading Techniques) by Dr KermitC Zieg (Traders Press 1997)• How to Use the 3-point Reversal Method of Point & Figure Stock MarketTrading by A.W. Cohen (Chartcraft Inc.1947) - currently out of print.In many cases, I have illustrated the various chart patterns with examples from my columns inthe Evening Standard and Investors Chronicle. I hope this is not too jarring. It is not meant tosuggest that I am a whizzkid. I have done it because I thought it would be interesting and itwould dispel any notion of 20/20 hindsight. It should also make clear that using point & figurecharts is a relatively easy and disciplined way to trade the markets. Some of the calls I made inmy columns did not work out. I would have included them here if I thought there was somethingsignificant to be learned from them.
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Point & Figure Signals
The Double Top and Double BottomThe most basic point & figure formations are the double top and double bottom.
Double TopBreach ofdouble topbuy signal
750
700
fig 7.1aThe first column of Xs depicts the stock advancing to 750p. At that point sellers temporarilyovercame buyers and forced the stock back down to 700p, depicted by the column of Os. Itcould fairly be said that 750p was a point of resistance, a point where the force of the buyingpower was overcome. Thereafter the stock advances back up to 750p, forming a double top atthat level. Until it breaches the established level of resistance, no safe conclusion could bedrawn about the future destination of the stock. Once 760p prints, the dominance of the buyers isre-affirmed. The breach of the double top is said to constitute a buy signal. Note that in forming thedouble top at 750p, the stock may pause at that level for several days, or perhaps only a fewminutes. It matters not.The converse formation is the double bottom.
750
700
Breach ofdouble bottomsell signalDouble Bottom
fig 7.1b99
Marc Rivalland on Swing Trading
Although A.W. Cohen starts off with these two formations, in my opinion they are simply notreliable enough to count as buy/sell signals.Naturally you will see a lot of double tops and bottoms being breached in the course of anytrend. The breach of a double top in an uptrend is valuable in that the making of new highsconfirms the continuation of the uptrend. By contrast when there is a breach of a double bottomduring an uptrend, it is a negative sign. It casts doubt on the continuation of the uptrend becausethe presumed support (made by the first column of Os) has not held.Of course, on a small box chart the support which has failed to hold may have been so minorthat its breach is almost irrelevant. If you take the price action on a bar chart, and you examineit to see exactly what it takes to form a breach of double bottom you will notice that in no realsense can the market be described as having been in an equilibrium before the breach. I prefersignals that clearly portray a meaningful disequilibrium.There are two good reasons, however, not to ignore double tops and bottoms:1. Occasionally there is no clearer signal from any of my charts, including my swing charts,other than the breach of a double bottom in an uptrend, or the breach of a double top in adowntrend. Very occasionally I use that signal to close an unsatisfactory position.2. It is worth looking out for the breach of a double bottom in an uptrend or the breach of adouble top in a downtrend (i.e what looks like negative price action). These formations canconvert themselves into one of my favourite signals, the bullish and bearish shakeout, byreversing shortly after the double top or bottom is breached.
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Point & Figure Signals
The Bullish SignalThis point & figure formation is known as the bullish signal because it has the classic pattern ofeach rally making a higher high and each setback making a higher low. Although I like the seriesof rising lows, the bullish signal always makes me a little nervous because the buyers neverseem to be winning comprehensively. Each rally only barely exceeds the high of the previousrally. What is really needed is some acceleration. Marks and Spencer had just started thatacceleration phase when I reviewed it in the Evening Standard in early February 2001. Itbecame the best performing FTSE 100 stock of 2001.
Rising Highs
Rising Lows
fig 7.2
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The Bearish SignalThe bearish signal is the opposite of the bullish signal. The chart of Vodafone in the period JuneAugust 2000 demonstrates this pattern.
Lower highs
fig 7.3
102