That Figures – Using Point and Figure Charts to Stay in the Trend In a recent Online Trading Academy Mastermind Community Clubhouse Clubhouse session I was teaching some advanced stock charting techniques. A few of the students asked if I could revisit an old topic I had written about called Point and Figure charting. I had learned this trading chart technique as I was studying for f or my Chartered Market Technician’s exams and have used it on occasion to identify dominant trends and to keep myself f rom exiting positions too early. Long before we had computers to chart price, traders were making a living and doing it by watching price movement. One of the earliest types of stock trading charts was called point and figure charting (P&F). It started from traders who would tick off prices as they watched the trading. Eventually the ticks changed to X’s and O’s to note movement in price and even see trends. Today, many chartists have switched to candlestick charting to make their decisions to buy or sell. A drawback to this style of charting is that many people are prone to exiting early from profitable trades when they see small pullbacks or corrections. An advantage of point and figure charting is that it allows the trader to see the trend and stay in the trend even through minor minor corrections. For this advantage we may sacrifice some profits with a larger stop, but with the larger profit potential it may be worth it. Another interesting interesting feature of point and figure figure charting is that it does not take take time into account account when charting. On a candlestick chart, you will have a candle for every period. For instance, on a five minute chart you would have a candle every five minutes whether the price moved or not. In a P&F chart, a new notation is made only when price moves by a certain amount. If there is no trading or if price does not move enough, no notation is made. To create the trading chart, you will use an “X” to note when prices rise by a certain amount and an “O” when they decline by an amount. You only put either X’s or O’s in a column. If you need O’s due to a reversal in price, you would start a new column. You do not put X’s and O’s in the same column. You must first decide the minimum amount of movement to note. This is referred to as the box size. You can set the box size for anything you would like but remember, the smaller the size the more sensitive the chart will be. This may be good for short term traders but it can cause you to overreact to slight corrections. As a rule of thumb, you should set the box size at about 1% of price. You could use 2% when charting indexes like the S&P 500 and the NASDAQ. You also need to decide the reversal setting. This will be the multiple of the box size that would create a reversal signal. For instance, if you set the box size at $1, a 1×1 chart would change from a column of X’s to a column of O’s when when price price reversed by $1. On a 1×3 chart, you would continue to mark X’s for the upward movements until you have price reverse by at least $3 ($1×3). Once that happens, you would start a column of O’s to the right of the previous column.
The larger reversal size will filter out many small corrections that might have otherwise scared traders out of positions. Buy and sell signals can be as simple or as complex as you would like. You can take a simple buy signal when a column of X’s rises above the previous column of X’s. You could stay long until a sell signal has been generated. The simple sell signal comes when a column of O’s breaks below a previous column of O’s.
When we trade, we should know at least three things about the position before we take it. We need to know our entry, the stop, and the target we hope to achieve. A point and figure chart can offer all of that to us. We can place our stops for longs just under the last column of O’s. As long as there is no reversal that breaks that low, we stay in the trade.
The system would be similar for shorts. We would enter a short on a sell signal and place our stop above the previous column of X’s. We would stay in our short position until we have breached that previous high.
If we happen to be long or short in a large move we may not want to wait for a large reversal to exit. If we were to wait, we may give back too much profit. So, instead of waiting for the typical sell signal, stop yourself out when you have the first three box reversal.
For the target price, we can use a horizontal box count. When prices move, they usually originate from a basing area. We can project the width of this basing to offer probable targets for the trend when we are in. The target does not have a timeframe and can take time to reach. Remember, only price movement matters, not the passage of time.
If we are using a larger reversal size, 1×3, 20×3 or so, we can still use a horizontal projection. In this case, we would multiply the horizontal box count by the box size and the reversal size to determine the projection length.
So, these are the basics of point and figure charting. Next week I will explore more advanced techniques and patterns that you can trade using this style of charting. Until then, trade safe and trade well. Brandon Wendell
That Figures Part 2 – Using Point and Figure Charts to Stay in the Trend In my first article on Point and Figure (P&F) charting, I discussed the basics of creating that style of chart. In this article, I will build upon that knowledge and show more advanced methods for identifying patterns and projecting price movement. I want to mention that I tend to use this method of charting for longer term swing or position trades rather than intraday. Remember that time is not a factor while attempting to achieve targets in P&F and you will likely hold positions for some time. Patterns in P&F charts are a bit different than what you may be used to in candlestick charting. A triple top formation is not necessarily a reversal formation, it could be a continuation. It will still offer a trading opportunity however. Look at the following examples of both the bullish and bearish triple formation.
Even patterns such as triangles are visible and can be traded on P&F charts. They will work in much the same manner as they would on candlestick charts.
I previously discussed the use of horizontal price projections. Many traders choose a different price projection method. If you are not using a 1 box reversal chart and have instead selected a three box, (this refers to how much price would have to reverse for you to start a new column, $10×3 means price would have reversed a minimum of $30), you can try the vertical price projection method. I have found this style to be more accurate in projecting targets. The vertical price projection can only be made under certain circumstances. They are: 1.
1st move off a bottom (1st row of X’s)
2.
1st move down from top (1st row of O’s)
3.
2nd move from top or bottom
Once you have counted the correct column, you can multiply that count by the per box value and then multiply that number by the size for reversal. Your result should then either be added to the price bottom or subtracted from the price top to give you the price projection.
Now that we know the basics and what to look for, let’s examine a few P&F charts to see this technique in action. I have a chart of the S&P 500 Index 10×3 point and figure format. The 10 means I need a minimum of a 10 point move between closing prices to make a new box of X’s or O’s. I must also have a minimum of 30 points (10×3), to start a new column for a reversal. The numbers and letters refer to the months (1-9 are Jan. to Sept., A-C are Oct. to Dec.)
I can do the same with charts of individual stocks. I would simply adjust the box size on the chart for stocks or the indexes due to their higher or lower prices.
If you are looking for smaller duration trades, you can lessen the box size and also the closing periods. I had been using the daily closes on the previous charts. Depending on the trading software that you use, you can set box size smaller. This makes the chart more sensitive and allows you to see intraday activity. You can set the chart’s period to five minutes. If the close from a five minute period would cause a change in the chart, it is noted instead of waiting for the daily close. By adjusting the box size and even what closing price the box will use, you can create all types of interesting charts to follow trends in the intraday or even multi decade trend following charts. The possibilities are limitless. Next week we will examine more strategies on point and figure charts and how to use them in conjunction with our core strategy of supply and demand. Brandon Wendell
That Figures Part 3 – Using Point and Figure Charts to Stay in the Trend When technicians chart using point & figure charts, they are doing so to identify and stay in longer trends. We do not want to be shaken out too early on a trade that could have yielded much more profit. Therefore, we would want to make our signals less sensitive so we have fewer of them or we need to use some sort of filter so that we do not take every trade we happen to see. We must have a trading plan or system designed around the use of our technical tools. In my previous articles on Point & Figure charting (Part 2), I told you the need for identifying your entry, stop and even projected target for the trade before entering it. Supply and demand levels work the same in point and figure as they do in other styles of charts. Look for an area where trend reversed strongly. Your typical rally-base-drop or drop-base-rally would do just f ine. You should look to buy or sell when you receive entry signals in those areas only.
One of the simplest filters is to make sure the trades we take meet the standard 3:1 reward to risk ratio we always follow in our classes. Since we know our entry, our stop and can use supply and demand or even the horizontal or vertical projections for our targets, there is no reason why you cannot take only the trades that offer the greatest potential for success and the lowest risk in relation to it.
The overall trend of price is something we look at to determine whether we should be a buyer or a seller of a stock. Why should it be any different with P&F charts? The difference in drawing the trend lines is that they are traditionally only drawn at 45 degree angles from a low or from a top. You would not connect multiple lows for an uptrend or multiple tops for a downtrend as you would with candles.
We can also limit our risk in trading by only trading with the trend. If you are above an uptrend from a low, you would only look to enter trades when you receive a buy signal. Use the selling signals to exit those longs only. You would not take a sell signal as an invitation to enter a short as it is counter trend and has a lower probability of working. The short positions should only be entered when you have a sell signal when you are trading below a trend line drawn from a high. You would use a buy signal to exit those shorts but not to enter longs.
Breaking a previous column of X’s is a simple signal. So is breaking a previous column of O’s. I showed you some patterns that can be used as more advanced entry signals. There are many others. Some technicians will only enter trades on a complex signal and then exit upon receiving a simple signal. This will also serve to filter out a lot of unnecessary trades. There are a lot of choices to screen out trades that are marginal. We want to trade smarter, not more. No matter what system you create, be sure that it manages your risk properly and offers you the opportunity to identify and take high probability, low risk trades. There are plenty of them in the markets waiting for you. Brandon Wendell
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