Understanding Point and Figure Charts

By Jeremy du Plessis CMT FSTA

Point and Figure Charts: Calculating Price Targets

Another objective feature of Point and Figure charts is in calculating price targets.  Targets may be established using two methods, vertical and horizontal.  The vertical method uses the first column from any top or bottom to establish the target. 

The length of the thrust determines the extent of the move, so the greater the initial thrust, the greater the target. 

The horizontal method requires a top or a bottom where there has been some sideways movement and is based on the width of the top or bottom pattern to determine the extent of the move.  Both methods can be used on the chart, but there are more opportunities to use the vertical method.



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Understanding Point and Figure Charts: Defining Price Targets

Figure 6 is a 15 x 3 Point and Figure chart of the S&P 500 showing some vertical and horizontal price targets.  Notice how accurate they have been in both the uptrend and the down trend, remembering that targets are established well in advance of being achieved.


Figure 6 S&P 500 Index 10 x 3 Point and Figure chart showing price targets
Figure 6  S&P 500 Index 10 x 3 P&P chart showing price targets

Price targets are a guide, it should never be assumed that they will be achieved exactly.  They give an indication of the strength of the chart and provide a potential target area.

Because Point and Figure signals are so clear cut and unambiguous, it is easy to see where a buy signal has occurred and what is required to cancel the signal and consequently where a stop should be placed.  This means you can calculate the risk reward ratio based on the price to target divided by the price to the stop.  This tells the trader the potential number of points of reward for every point of risk taken on.  Because the targets and stops are objective, these risk reward ratios can easily be calculated by a computer.
 




Figure 7 shows the same S&P 500 chart but as at 27th December 2011.  The 1440 target has been established with two possible stops at 1200 and 1155 identified, because a break below these levels would generate double bottom sell signals.  This allows two risk reward ratios of 2.2 and 1.4 to be calculated depending which stop level is used.  These ratios help you to decide, firstly whether the take the trade and secondly where to place your stop.  In this example the price rose and hit the 1440 target in September 2012.


Figure 7 S&P 500 Index 10 x 3 P&F chart as at 27th December showing risk reward ratios
Figure 7  S&P 500 Index 10 x 3 P&F chart as at 27th December showing risk reward ratios

It is important to understand that objectivity implies there is no ambiguity, but it does not mean infallibility.  It means there is no argument as to whether a signal, trend or target exists or where it is positioned.  So objectivity does not guarantee accuracy, but it does remove any doubt about the analysis.


Next: Point and Figure Charts part 4: Technical Indicators or Return to Part 2







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