It’s interesting that the point and figure chart shares one thing in common with those three other methods that came so much later – it doesn’t pay so much attention to the time-frame, and concentrates instead on the price movements. In fact, it goes even further than that, and also ignores the volume of trading, which can sometimes be so revealing. But for all that, a system that has lasted for well over a century has proven that it has merit, even if later developments have relegated it to the shadows.
There is a nod to volume, even though it is not shown in the usual way, and we’ll come back to that. But like the other three, the chart is only drawn when the rules demand it, so there is no uniformity to the time-scale. The point and figure chart is focussed around showing the price action.
This chart follows the same convention as used in the previous charts, with black (and crosses) for an up-trend and red (and noughts) for a down-trend.
This type of charting was originally created simply to track the stock price movement, and record each whole point of movement. The charts were drawn on graph (squared) paper as shown above, and Xs or Os drawn each time there was a whole number change in price. It had to be simple, as the system was devised long before computers or even electronic calculators.
If, for example you are in an up-trend and plotting Xs, then you would just plot another X when the price went a whole number higher; vice-versa (with Os) for a down-trend. That is the basic idea, and you can see it is a familiar one, similar to the previous charting methods. You can have a variation, say if the number was large such as an index, when you might wait for the price to change by a certain number of whole points rather than just one point before drawing the next symbol.
So when do you reverse and start drawing the other symbol? Typically, when plotting point and figure you can have three variations, 1 box reversal, 3 box reversal and 5 box reversal. I bet you can guess what they mean. Yes, it’s how far the price has to reverse before you choose to start plotting in the other direction.
For example, if you use a 3 box reversal, which is what is used above, and you are plotting an up-trend, then you would keep plotting Xs while the price was going up. If the price dropped one day, then you wouldn’t immediately change the chart – the high price would still be good. But if the price dropped by 3 boxes, whether they are whole numbers or multiples, then you would move to the next column, drop down a box from the last X, and start plotting the down-trend with Os. You can see from the chart above that you always move down (or up, if going from a down-trend to an up-trend) by one box before drawing the new column.
It’s obvious, but if not much is happening in the market, you can get stuck on one column and even not draw anything for days. That’s fine, because what you have is a chart that clearly shows you when the price is trending, allowing you to place a bet. When you are stuck on one column without anything to draw, then there is also no movement that could be played for a profit.
Volume can come into it in two ways – as shown above with the bar chart under the main chart, you can plot the volume of the above column’s trading. It’s not the same as looking at the trading volume day by day, but it does show the total volume for each column or trend. You can see that the colour is black when the volume is more than that of the previous column, and red when it is less.
Even without this plot, you can get a general idea of active volume from the amount of charting. Usually if there is much price movement and more plotting, that would imply more volume of trading. Not very accurate, but an indication.
Depending on the size of reversal you select, the price will be more or less committed to the trend indicated. A 5 box reversal will not give you so many columns, but when it does change it shows a significant move in the opposite direction. Of course, it is slower to indicate the change in trend, just as explained in the previous types of charts, and therefore may give you a relatively late signal for placing your bet.
Apart from this obvious interpretation, there are a couple of common ways that the point and figure chart is looked at when trading. First, it can be used to indicate a breakout, or a surge in the price in one direction. The way this is usually described is that you look for the column to go at least one box further than the previous column of that type. So looking at the Xs column, the up-trends, you would look for an X column that goes at least one box higher than the previous X column. You can see some upward breakouts on the right half of the chart, but note that on the far right each successive X column is actually lower, which does not show a breakout. In fact, on the far right each successive O column is going further down, so the chart is showing a downward breakout pattern.
If you are looking to trade on breakouts, you would simply wait until the column was drawn the one box beyond the previous one, and then place your bet, hoping that the trend would continue further. As we’ll see in the next chapter, you must always know where you are going to exit the bet, even if it goes against you, as no-one is right all the time. In this case, you would probably want to close the bet if the next O column went further down than the previous one for an up-trend breakout, or if the X column went up higher than the previous X column, if you are betting on a down-trend. In either case, you are seeing that the trend has failed or finished, so there’s no point in hanging on to your bet hoping for good luck.
So going back to the chart again, on the right there is a downward breakout, shown by the O columns going at least one box further down each time. If you bet on this down-trend, taking a short or selling position, you would still be holding the bet where the chart finishes, as none of the intervening X columns gets as high as the previous one.
So that’s the way you can find a breakout and place a bet on it continuing. The second common way that the point and figure chart can be used is to find price targets, that is the number that you expect the security to go to when you place your bet. Again the importance of this is covered in the next chapter on money management, which really is key to safely using the information that you have been learning so far.
Using point and figure charts, the amount of activity in a price when it is moving sideways can be taken as an indication of how far a breakout will go – at least, it often works out that way. So when a breakout is indicated all you have to do is look how far back the trendless or sideways part of the chart goes, and swing that distance vertically to see where the price may finish up.
The charting software that you use may give you another way of looking at the progress of a price trend, and that is by drawing a trend-line for you. On a point and figure chart, these are usually shown at 45 degrees. You shouldn’t expect the trend-line to be repeatedly touched by the price columns, but they give you an indication of support and resistance levels, so in other words if the price breaks through them you should watch out.
The up-trend trend-line would be drawn upwards from the bottom of the lowest O column, and you would expect all price activity to take place above it. It’s a similar idea for a down-trend, where the line would be drawn downwards from the top of an X column and everything would happen beneath it. Often the chart moves well away from the line, and it’s quite in order to draw another line from a later different column which takes it closer.
There are many other ways to interpret point and figure charts, as you would expect from such a long-standing and well researched method. Most of them use the breakout idea, as breakouts are made clear from the way that the chart is drawn, and this is the power of the technique.