CLASSIC TECHNIQUES
It's Been Around Forever, And It Still Works
Classic Point And Figure
by David Vomund
It was around before computers; it was around before
calculators. It's been around forever, and despite that, it still works.
It's point and figure charting, and it still offers unique advantages.
Here are some examples.
Most people use bar charts or candlestick
charts in their analysis. Another charting form, point and figure, is less
known but offers unique advantages over the more traditional charting methods.
The point and figure charting technique became popular in 1948, when A.W.
Cohen published his book on point and figure. Surprisingly, the methodology
has hardly changed since then.
Unlike bar charts, where the vertical coordinate is based on price and
the horizontal coordinate is based on time, point and figure charts are
only concerned with price. Although the year and months are reported on
the horizontal axis, they are shown merely to establish a frame of reference.
Since time is not a factor, small fluctuations in price are often not
charted. Without these disturbances, it is easier to spot critical support
and resistance levels. It is also easier to visually locate chart patterns.
Point and figure charts are plotted with Xs and Os. Vertical columns
of Xs represent increasing prices, while the Os represent decreasing prices.
Each X or O represents a specific increment of change in price, which is
referred to as the box size.
For example, each X may represent a $2 increase in the price of the
stock. Every time the stock price increases by $2, an X is plotted. Time
is irrelevant, so it doesn't matter how long it takes for the security
to make the $2 advance. If I am plotting Xs, I know the stock is advancing.
Most analysts use a three-box reversal, which means a stock must fall
by three times the box size before a new column of Os will appear to indicate
a trend reversal. In our example of a $2 box size, a stock must fall by
$6 (three times $2) before a new column of Os is plotted. The three-box
reversal eliminates all minor and sometimes confusing fluctuations.
As with log-scale charting, there are different box sizes depending
on the stock price. Normally, each box for a stock between $20 and $100
represents a $1 move. If the stock is between $5 and $20, then each box
represents a $0.50 move.
These box sizes work fine, but I find that larger box sizes are more
appropriate in today's volatile market. This is especially true with Nasdaq
growth stocks. I've doubled the recommended box sizes so that a stock between
$20 and $100 has a $2 box size and a stock between $100 and $500 has an
$8 box size. With the larger box sizes, the reversal areas represent more
significant support and resistance levels.
It is helpful to understand the mechanics of point and figure charting,
but it is not critical. I use AIQ's TradingExpert to take care of the construction
of the charts, which allows me to concentrate on their interpretation.
Luckily, it is much easier to interpret the charts than it is to understand
their construction.
SUPPORT AND RESISTANCE
As I noted earlier, it is easier to identify support and resistance
levels for stocks using point and figure charting techniques. For resistance
levels, look for a level where several columns of Xs end.
In examining Emerson Electric (Figure 1), I quickly identified a resistance
level around $65. Emerson [EMR] rose to this level three times over the
last three months, but sellers emerged each time the level was tested.
The same level acted as resistance in August 1999 as well.
FIGURE 1: EMERSON ELECTRIC. Prices break a resistance
level in EMR. Prices at which the Xs and Os stop are your resistance and
support levels.
To find support levels, look for a level where several columns of
Os end. Three columns of Os ended at about $61, which represents a support
level for the stock. I drew lines on the EMR chart to help you identify
the support and resistance levels.
A buy signal is registered on a point and figure chart when one column
of Xs moves higher than the previous column of Xs. The theory behind a
buy signal is that the stock is able to rise above an important resistance
level (that is, a price level at which sellers have appeared when the stock
previously reached this same level). A buy signal is never registered when
a stock is at or near its lows. Instead, the buy signal comes when a stock
breaks out above resistance. The stock then remains on a buy signal until
a column of Os falls below a previous column of Os.
PATTERNS FOR SIGNIFICANT SIGNALS
I can now spot buy and sell signals, but how do I know which ones will
be the best? There are patterns that point toward the more significant
signals. First, I'll explore the triple-top pattern. The name sounds bearish,
but it is actually a bullish pattern. For a triple-top pattern to occur,
the stock must rally to a specific level at least two times before sellers
emerge. That means two columns of Xs will end at the same level. To complete
the pattern, the stock must rally above the high point of the previous
column. This formation must have a minimum of five vertical columns.
An example of a triple-top buy signal can be seen in Figure 2. Concord
EFS Inc. [CEFT] entered a trading range from May to August. On two occasions,
CEFT rallied to $29, but sellers emerged. It wasn't until the third attempt
that CEFT rallied above the $29 resistance level, thereby registering a
buy signal. An all-stock screen, which lists all the stocks that have given
a triple-top buy signal, can be a valuable trading guide.
FIGURE 2: CONCORD EFS. Concord breaks above resistance at
29. If at least five columns have defined a resistance level, a breakthrough
is a good buy signal.
After a break above resistance, a stock often retests its breakout
before heading higher. Because of this, many traders wait for the retest
before they buy. Look for a bullish catapult formation to buy after a successful
retest. For this pattern, the stock must first give a triple-top buy signal.
After that signal, sellers temporarily emerge. Sometime before hitting
the lows of the previous column of Os, the stock rallies and the buy signal
is registered when the final column of Xs moves above the previous column
of Xs.
An example of this bullish catapult pattern can be seen in Figure 3,
a chart of ADC Telecommunications [ADCT]. In May, ADCT reached $32 on four
occasions, but sellers emerged each time. On its fifth attempt, ADCT moved
above that level, registering a triple-top buy signal. The stock only rose
to $34 and sellers promptly emerged. Selling was short-lived, however,
and ADCT rose again. The bullish catapult buy signal came at $35 when the
last column of Xs rose above the previous column of Xs.
FIGURE 3: BULLISH CATAPULT. ADC Telecommunications breaks
above resistance but is slowed by selling before taking off again. The
catapult formation is so common many traders wait for it rather than immediately
trade the breakout.
A variation of the triple top is the spread triple-top pattern.
This is a broad formation that forms during consolidation periods. The
buy signal on this pattern is generated when the stock penetrates three
tops; the tops need not be in succession, however. There are intervening
moves between the price tops.
An example of a spread triple-top pattern can be seen in Figure 4. Paine
Webber [PWJ] reached $47 on three different occasions, but sellers emerged
each time. It wasn't until the last column of Xs that PWJ was able to rise
above the $47 resistance level, giving a spread triple-top buy signal.
FIGURE 4: SPREAD TRIPLE TOP. Three rejections at a single
price level are overcome when Paine Webber goes over 48. The spread top
needn't have consecutive columns reaching the same price level.
BOTTOM FISHING
If you use point and figure chart patterns, you won't buy at the lows
because it always takes upward price movement before a buy signal is registered.
One pattern that would qualify as a bottom-fishing pattern because it requires
significant weakness is the bullish signal reversal. This pattern requires
at least five columns of lower highs and lower lows. As the stock moves
lower, the point and figure chart is obviously bearish. The buy signal
is registered when a column of Xs finally moves higher than the previous
column of Xs. This pattern formation requires at least seven columns.
Figure 5 shows a bullish signal reversal. Reebok International [RBK]
was one of the worst-performing stocks in the second half of 1999, and
it formed a pattern of lower highs and lower lows. It wasn't until March
2000 that RBK rallied enough to have a column of Xs move higher than its
previous column of Xs. The downtrend had ended.
FIGURE 5: BOTTOM-FISHING. Breaking above a downward descending
series of columns, Reebok punches up to 9. This is one of the few P&F
formations that qualifies as a reversal pattern.
SUMMARY
The best way to learn point and figure techniques is to scroll through
a list of stocks, identifying the patterns I have discussed. Nearly every
stock will show one or more of these patterns. For example, look at Figure
3. Can you identify a slight variation of the bullish signal reversal early
in 2000? Do you see the triple-top buy signal that occurred before the
bullish catapult pattern I discussed? Identifying past patterns will help
you identify current patterns as they develop.
The point and figure charting technique was not designed to eliminate
traditional bar charting; each charting method has its advantages. Point
and figure charts make it easier to identify important chart patterns and
support and resistance levels as they develop. Keep in mind that point
and figure charts are based on price only. I combine point and figure analysis
with technical indicators that incorporate volume in their calculations,
such as money flow or on-balance volume.
SUGGESTED READING
Burke, Michael [1993]. All New Guide To Three-Point Reversal of Point
& Figure Construction, Chartcraft Inc.
Cohen, A.W. [1987]. How to Use the Three-Point Reversal Method of
Point & Figure Stock Market Timing, ninth edition, Chartcraft Inc.
(First published in 1948.)
Sweeney, John [1999]. "On The Opening Bell: David Vomund Of AIQ," interview,
Technical
Analysis of STOCKS & COMMODITIES,
Volume 17: October.
David Vomund is the chief analyst at AIQ Systems, the
leading developer of artificial intelligence-based charting and analysis
software. Vomund is also president of Vomund Investment Services, which
publishes the weekly VIS Alert.com newsletter. He is a regular guest on
financial news programs in Los Angeles and Chicago. He can be reached via
E-mail at dvomund@visalert.com.
Excerpted from an article originally published in the December
2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2000, Technical Analysis, Inc.
