Understanding Point and Figure Charts

By Jeremy du Plessis CMT FSTA

Understanding Point and Figure Charts: Part 2

Modern computer-drawn Point and Figure charts are constructed in a variety of ways using a variety of time-series data.  For medium to long-term analysis, either the high/low method or the close method is used with end-of-day data.  The availability intraday time-series data means that shorter-term charts may be constructed using the close or high/low at the end of every minute or every hour or in fact any intraday time frame.  The result is that the Point and Figure method can be used for all time frames and time horizons.

What is important to understand is that the time horizon of a Point and Figure chart depends not only on the underlying data being used, but also on the box size.  The time horizon of the chart can be altered without changing the underlying data by varying the box size.  The smaller the box size, the more sensitive the chart to price movements and consequently the shorter the time horizon.

Typically, a Point and Figure analyst will look at two, perhaps three Point and Figure charts of the same instrument but with different box sizes to obtain a clearer picture of what is happening.

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Point and Figure Charts Explained

Point and Figure construction on a squared grid, with data placed into boxes, allows objective application of tools and therefore objective analysis.

3-Box reversal charts, more so than 1-box, are best used for this objective application and analysis making them a favourite amongst Point and Figure chart users. 

The interpretation of 3-box charts is more objective because the patterns are more defined with fewer variations than those in 1-box charts, consequently chart patterns can be uniquely identified.  Essentially all signals from 3-box Point and Figure charts are based on breakouts.

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Understanding Point and Figure Charts

A basic Point and Figure buy signal occurs when a column of Xs rises above the previous column of Xs, called a double-top buy; a sell occurs when a column of Os falls below the previous column of Os, called a double-bottom sell.  Figure 3 shows these two basic Point and Figure patterns.

Figure 3: P&F Chart Double-top and Double-bottom Patterns
Figure 3  P&F Chart Double-top and Double-bottom Patterns

The strength of any Point and Figure pattern depends on the pattern’s width.  The more columns it takes before the breakout, the stronger the subsequent signal.  So a triple-top or triple-bottom leads to a stronger signal than the double equivalent.

In all Point and Figure pattern analysis, reassertion of control is important for determining pattern strength.  This occurs when a pattern switches from being bullish to bearish and back to bullish again.  The most common example is the catapult pattern, where there is firstly a triple-top breakout, followed by a pullback into the pattern which is then reversed resulting in a double-top breakout.   The converse is true for sell patterns.  The fact that, in spite of being rebuffed, a group can regain control is important for the pattern’s strength.  See Figure 4 for the bullish and bearish versions of the catapult.

Figure 4: Point and Figure Chart Bullish and bearish Catapults
Figure 4  Point and Figure Chart Bullish and bearish Catapults

Many other Point and Figure patterns have been indentified and named.  Not every breakout is taken as a buy or sell.  Point and Figure analysts look to see if it is part of a bigger pattern, but also they take note of trend lines.

Understanding Point and Figure Charts: Trend Lines

The way trend lines are drawn and used is another advantage of 3-box reversal charts.  Unlike trend lines on bar, line and candle charts which must be positioned subjectively, the Point and Figure squared grid allows trend lines to be drawn at a true 45° from major lows and highs.  Once a 45° uptrend from a low is broken, a 45° down trend is drawn from the high so they alternate between a bullish uptrend and bearish downtrend and show the last level of support or resistance. 

They have proved to be very effective indicators of the trend and allow anyone to glance at the Point and Figure chart and be in no doubt as to what the trend is.  Because they emanate from a top or bottom at 45°, they are independent of subsequent price action.  If however, the price does react back to an already established 45° trend line, the line’s strength is reinforced.  This is shown in Figure 5, which is a 10 x 3 Point and Figure graph of Associated British Foods. Notice how the 45° trendlines have described the trend.  Notice too how these lines drawn at 45° from highs and lows have provided support to the price.

Figure 5 Associated British Foods 10 x 3 Point and Figure with 45° trend lines
Figure 5  Associated British Foods 10 x 3 Point and Figure with 45° trend lines

Once the main 45° up or down trend has been established, additional (thinner) 45° lines from reaction points within the trend may also be drawn.  These are called internal trend lines and show minor support and resistance levels within the main trend.  When internals cluster together, the area becomes a stronger support or resistance area.  Clustering is shown in Figure 5.

Next: Point and Figure Charts Part 3: Price Targets or Return to Part 1

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