The modern point and figure (P&F) chart was created in the late nineteenth century and is roughly 15 years older than the standard OHLC bar chart. This technique, also called the three-box reversal method, is probably the oldest Western method of charting prices still around today.
Its roots date back into trading lore, as it has been intimated that this method was successfully used by the legendary trader James R. Keene during the merger of U.S. Steel in 1901. Mr. Keene was employed by Andrew Carnegie to distribute the company shares, as Carnegie refused to take stock as payment for his equity interest in the company. Keene, using point and figure charting and tape readings, managed to promote the stock and get rid of Carnegie’s sizeable stake without causing the price to crash. This simple method of charting has stood the test of time and requires less time to construct and maintain than the traditional bar chart. See Figure 10.22.
The point and figure method derives its name from the fact that price is recorded using figures (Xs and Os) to represent a point, hence the name “Point
FIGURE 10.22 Point and figure chart.
Te c h n i c a l A n a l y s i s
and Figure.” Charles Dow, the original founder of the Wall Street Journaland the inventor of stock indexes, was rumored to be a point and figure user. Indeed, the practice of point and figure charting is alive and well today on the floor of all futures exchanges. The method’s simplicity in identifying price trends and sup- port and resistance levels, as well as its ease of upkeep, has allowed it to endure the test of time, even in the age of Web pages, personal computers, and the information explosion.
The elements of the point and figure anatomy are shown on Figure 10.23.
Two user-defined variables are required to plot a point and figure chart, the first of which is called the box size. This is the minimum grid increment that the price must move in order to satisfy the plotting of a new Xand O. The selec- tion of the box size variable is usually based upon a multiple of the minimum tick size determined by the commodity exchange. If the box size is too small, then the point and figure chart will not filter out white noise, while too large a filter will not present enough detail in the chart to make it useful. We recom- mend initializing the box size for a FOREX P&F chart with the value of one or two pips in the underlying currency pair.
The second user-defined parameter necessary to plot a point and figure chart is called the reversal amount. If the price moves in the same direction as the existing trend, then only one box size is required to plot the continuation of the trend. However, in order to filter out small fluctuations in price movements (or lateral congestion), a reversal in trend cannot be plotted until it satisfies the reversal amount constraint. Typically, this value is set at three box sizes, though any value between one and seven is a plausible candidate. The daily limit imposed by most commodity exchanges can also influence the trader’s selection of the reversal amount variable.
The algorithm to construct a point and figure chart follows:
99
X X X X X X X X X
O O O
O O O
One Box Size
Downward Trends Upward Trends
Starting Point
FIGURE 10.23 Anatomy of point and figure columns.
Point and Figure Algorithm
• Upward trends are represented as a vertical column of Xs, while down- ward trends are displayed as an adjacent column of Os.
• New figures (Xs or Os) cannot be added to the current column unless the increase (or decrease) in price satisfies the minimum box size requirement.
• A reversal cannot be plotted in the subsequent column until the price has changed by the reversal amount times the box size.
Advantages of P&F Charts
• Eliminate the insignificant price movements that often make bar charts appear “noisy.”
• Remove the often misleading effects of time from the analysis process (whipsawing).
• Make trend line recognition a “no-brainer.”
• Make recognizing support/resistance levels much easier.
Nearly all of the pattern formations discussed above have analogous patterns that appear when using a standard OHLC bar chart.
Adjusting the two variables, box size and reversal amount, may cause these patterns to become more recognizable. P&F charts also:
• Are a viable online analytical tool in real time. They require only a sheet of paper and pencil.
• Help you stay focused on the important long-term price developments.
Point and figure charts display the underlying supply and demand of prices. A column of Xs shows that demand is exceeding supply (a rally); a col- umn of Os shows that supply is exceeding demand (a decline); and a series of short columns shows that supply and demand are relatively equal. There are sev- eral advantages to using P&F charts instead of the more traditional bar or can- dlestick charts.
P&F charts automatically:
For a more detailed examination of this charting technique, we recommend Point & Figure Chartingby Thomas J. Dorsey (2001: John Wiley & Sons, Inc.).
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