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Point & Figure Charting
The Smart Profits Report: Issue #412
Friday, April 13, 2007
Point & Figure Charting: An Accurate Way To Spot Key Stock Trends
By Mark Whistler
Small-Caps Specialist, Mt. Vernon Research
I’m about to share with you one of the oldest and most trusted ways to chart a stock’s current performance and accurately pinpoint its future movement.
You won’t hear about this technique very often (certainly not on those “one-size-fits-all” financial TV shows anyway). But if you add it to your toolbox, you’ll be able to buy low and sell high in a new and dynamic way.
I’m talking about Point & Figure charting. Let’s see how it works…
Plot The “X’s” And “O’s” And Become The Vince Lombardi Of The Stock World
Long before computers became commonplace in industrialized America, Point & Figure charting was a key element of investment analysis. Even legendary investor Charles Dow, the pioneer of Dow Theory, used it to track of his positions.
Simply put, it cuts out the “noise” of the stock market. Unlike candlestick, bar, or line charts, it immediately allows you to see “pure trends” in the stocks you follow.
The beauty of Point & Figure charting is that anyone can do it. All you need is any given day’s stock prices. In the old days, you needed some graph paper and a pencil, too. But today, computers do most of the work for you.
Point & Figure charts are primarily made up of “X’s” and “O’s.” An “X” indicates that the stock price is moving up; an “O” shows a stock moving down.
What makes Point & Figure charts unique is that there is no structured measurement of time, like there is on normal charts. The movement is solely dependent on price action, because the stock must close above or below a pre-defined unit - otherwise known as “box size.”
So what is box size?
How Box Size Determines Price Movement
On the vertical axis of a Point & Figure chart, each box denotes a price. For example, if the box size was $1, the price would increase in $1 increments - $25, $26, $27, etc.
Box sizes vary depending on the price of the stock, though Stockcharts.com publishes a great breakdown of the norm:
For example, let’s take Lifecell (Nasdaq: LIFC), which is currently trading around $25. If the stock closed above $25 yesterday, it must close above $26 today in order for us to add another “X” to the column. If the stock closes at $25.75 today, we would not add an “X,” since it did not close above our pre-defined “box size” of $1. So you might not see an “X” or an “O” marked on the chart each day.
There’s just one more ingredient to Point & Figure charting…
Reversal Reveals Trend
This is where Point & Figure charts become very effective at identifying stock trends.
When a column of “X’s” or “O’s” has started, a new column can not begin unless the price moves beyond the predetermined “reversal amount.” The reversal amount is how many boxes the stock must backtrack over before a new column is started.
Because most Point & Figure charts are based on a “three-box reversal,” small price hiccups or stagnation in the stock’s movement is disregarded, thus removing the day-to-day market fluctuations of normal charts.
For example, in a $10 stock, if the box size is $1, and the stock moves up slightly more than $1, above $11, then we would add an “X” to the chart. So if we use a traditional “three-box reversal,” the stock would have to fall $3 before we would start a new column of “O’s.”
Here’s how it all looks, using Microsoft (Nasdaq: MSFT) as an example. Note that time is measured as 1 through 9 from January to September, while A to C represents October to December.
As you can see, Microsoft moved up through January of 2007, but than began to fall in early February.
However, the column of “O’s” didn’t start until the stock dropped below $28, which didn’t occur until the final days of February.
Then, in the second week of March, Microsoft closed below $27, thus requiring us to add the fourth “O,” denoted as a “3″ to indicate the first “O” in the month of March.
At present, we cannot add another “O” to the column until Microsoft closes below $26. Conversely, we won’t start a new column with three “X’s” unless Microsoft closes above $30. If Microsoft closes above $30 we would add three “X’s” to the chart in the $28, $29 and $30 boxes - indicating the “three box reversal.”
Okay, so now you’ve seen what a Point & Figure chart looks like, let’s see how we’d apply the technique to an actual trade…
Point & Figure Charting In Action
Take a look at the below chart of Google (Nasdaq: GOOG).
The first thing that immediately jumps out from the Point & Figure chart is an easily identifiable short-term downtrend in Google’s stock, denoted by the declining red line on the upper right of the chart.
And the Point & Figure chart is telling us that if we’re thinking about buying shares, there will be upward resistance in the $482 area. But in February, Google also broke support of its 6-month trend at $458. So the chart also indicates that buying Google here may not be prudent, as the stock is trading in the middle of that range and could go either way.
Savvy investors who follow Point & Figure charts know that buying when the stock is near support at $338, or waiting for a confirmed breakout above its resistance at $482 before jumping in, may be a safer way to invest in Google in the near-term.
Really, Point & Figure charts allow us to take a step back from the fluctuations of regular charts and see the bigger picture in an easily understandable format. They’re best used when looked at in conjunction with normal charts, just so you are aware of the smaller price movements. But by revealing larger, “pure” trends, they show you more ideal buy and sell points without the confusing chatter of commonplace daily charts.
Good investing,
Mark Whistler
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Today’s Smart Profits Cribsheet
- Mark Whistler recently released his second book, Trade With Passion And Purpose, which explores an area of markets that most investors never look at: Our emotions in relation to investing. After over a decade of professional trading, Mark spent two years researching psychology and philosophy as they apply to the process of buying and selling stocks. Including interviews with some of the world’s most successful traders and business people, Trade With Passion And Purpose provides the essential information you need to take your investment performance to the next level. For more information, please visit this link.
- Whether you use moving averages, Fibonacci retracements, support and resistance points, relative strength, or the Point & Figure charts that Mark talks about here, technical analysis allows you to work with the market, not against it, by pinpointing trends, breakouts and entry/exit points more clearly, so you can take maximum profits.
- At the Smart Profits Report, technical analysis forms a key part of the investment strategies that our professional traders use every day to make money in the market. In fact, our resident commodities expert Lee Lowell has used the concept to help him rack up an 85% winning average for his readers in 2007 alone. Just a few hours ago, Lee locked in a 34% gain in 14 days on coffee options. To find out more about how you can cash in on one of the financial world’s fastest-growing areas, please follow this link.
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- Leonardo Fibonacci: Predicting The Stock Market’s Next Move With The Fibonacci Sequence
- Technical Indicators: Harness The Power Of Leading Indicators And Bollinger Bands
- Sentiment Analysis: Incorporating Contrarian Investing in Your Trading & Financial Endeavors
