Wayne Thorp recently spoke at the 2015 AAII Investor Conference. For information on how to subscribe to recordings of the presentations, go to www.aaii.com/conferenceaudio for more details.
Without a doubt, software and Web sites have made the lives of numerous investors easier by speeding the analysis process. One area that has seen notable improvement is chart creation. Instead of having to spend time each day manually updating charts—which limits the number of securities one can realistically track—investors can now create an endless array of charts in a matter of seconds with today?s technical analysis and charting services. Reviews of the top software and Web-based technical analysis and charting services can be found in the Computerized Investing archives.
The advent of computerized charting resources has also led to the emergence of some relatively obscure chart types, such as candlestick, equivolume, and point and figure. This article serves as an introduction to point and figure charting and also covers resources for creating and learning more about these charts.
One of the basic principles of economics is the law of supply and demand. It states that in a free market when there are more buyers than sellers—demand outstrips supply—prices will rise, all else being equal. Point and figure charts attempt to capture the battle between supply and demand.
Point and figure charts have been in existence for more than 100 years, but it took the advent of computer software and Web sites to bring them into the mainstream. Their usefulness lies in their ability to filter out market ?noise?—short-term price fluctuations that occur during longer, more established trends. They differ from more conventional charts such as open-high-low-close charts in that they ignore the passage of time—they are only affected by ?significant? price movements. Figure 1 is an example of a point and figure chart for Moody?s Corporation (MCO) that covers the period of January 4, 2002, through June 6, 2003. At first glance, you may notice that this chart is quite different from the oft-used line or bar charts. First, the chart is made up of columns of X?s and O?s—X?s represent rising prices and O?s represent falling prices. Put another way, X?s represent demand and O?s supply. The movement from columns of X?s to O?s and back again creates patterns that may be used to make buy and sell decisions. Also, note that there are numbers and letters dispersed among the X?s and O?s. Since point and figure charts are not impacted by the passage of time, per se, numbers and letters are used to represent months. The first box entered in a month is represented by the numbers one through nine for January through September and A, B, and C for the ?double-digit? months of October, November, and December. So a ?1? would be used to indicate the first point of January and ?B? would represent November.
There are two key items you need to address before you can begin creating your own point and figure charts—the box size and reversal amount.
The box size is based on the scale you wish to use for a particular security or index and represents the value given to each box—X or O—on the chart. It is the minimum price change needed to continue the current trend—i.e., to add another X to the top of a column of X?s or to add another O to the bottom of a column of O?s. This is an important decision because a move of $3 for a $10 stock is more dramatic than a $3 move on a $100 stock. Each box corresponds to a $1 stock price move in our example in Figure 1. Furthermore, since point and figure charts are used to filter out ?noise? in the market, you will want to be sure that you are filtering out just enough momentary price reversals, yet at the same time allowing some to pass through so that you can identify when a significant reversal is taking place.
As you use point and figure charts, you may find that different box sizes work better for your trading style or for a particular security. Traditionally, however, box sizes have been broken down into the following levels:
|Share Price||Box Size|
|Between $5 and $20||$0.50|
|Between $20 and $100||$1.00|
The other key to the analysis of point and figure charts is how you move from one column to another, called the ?reversal method.? The reversal amount determines how many boxes the price must reverse course by in order to move to a new column and switch from X?s to O?s, or vice versa. While this can be left to the individual creating the chart, the typical reversal is the ?three-box? or ?three-point? reversal. This methodology is thought to eliminate spurious price fluctuations and focus only on ?significant? price movements.
Based on the traditional parameters shown here, if a stock is trading below $5 with a box size of $0.25, it would take a price move—up or down—of $0.75 to generate a three-box (three-point) reversal. The box size for stocks trading below $5 is $0.25, so a three-box reversal would take at least three $0.25 price moves to necessitate a shift to a new column of X?s or O?s. The same principle applies no matter the box size. Depending on the software package or Web site you are using to create point and figure charts, you may have the ability to specify the box size as well as the reversal amount.
Having established the parameters for the essential elements of a point and figure chart, you must then look at which price(s) you will use to plot your chart. Purists generally use the high and low prices for the period (day, week, month, etc.), while others may focus strictly on a single price such as the close. This decision may be driven by the data source you are using—whether or not it offers high and low prices or merely the closing price. Depending on the price(s) you use, you may get different results. For this reason, it is also important to find out the method used by a software package or Web site to create point and figure charts.
When creating point and figure charts, you remain in the same column of X?s or O?s as long as prices continue to rise or fall, respectively. For example, if a chart is in a column of X?s and prices are rising, you would need to identify whether the price raised one full box or more. If you are basing your decisions on high and low prices and not the closing price, this is done by looking at the high price for the day. If the price did rise by at least one box, you would add an X to the top of the column. At that point, you are done for the day. As long as prices continue to rise (or do not fall); the low price is disregarded. If the high price rose by one box but the low price was several box sizes below it, you still only plot the one box increase. As long as prices continue in their current path, you are only interested in one direction per period.
If, however, the next day the price does not rise by at least one box (staying with our example of being in a column of X?s), you must look to see whether the price reversed by three or more boxes. If it did not, nothing is added to the chart for that day. This is an example of point and figure charts filtering out ?insignificant? price movements; it also differs from bar charts, where we would still plot a bar even if prices do not move. If and when the price reverses downward by three or more boxes, you would shift one column to the right and begin plotting a new column of O?s.
Although computerized tools can create point and figure charts for you, it is always necessary to understand the underlying process. For this reason, we will show you how to manually construct a point and figure chart.
Figure 2 shows the high and low prices for Moody?s Corporation for the period of January 2, 2003, to February 4, 2003, as well as the point and figure chart constructed using this data. Dates that are bolded and italicized identify where a shift takes place from a column of X?s to a column of O?s, or vice versa.
When manually creating a point and figure chart, it is helpful to determine the ?action points? for each period (also shown in Figure 2). For a chart in a column of O?s, the first action point is the price that is one box lower than the last. If the low price falls to this point or below, we add to the column of O?s down to the low price for that period. The second action point would be the price at which a three-box (three-point) reversal occurs. This point is three boxes above the lowest O. If the high price for the day reaches this point, assuming another O was not added to the column, we would then switch to a new column of X?s.
When you are in a column of X?s, the first action point is the price that is one box above the last X. The other action point—where the three-point reversal takes place—is the price that is three boxes below the highest X. If this level is reached, we switch to a new column of O?s.
Now, let?s walk through the plotting of data from select days in Figure 2.
January 2: When you begin plotting a point and figure chart, you first must decide whether you are in a column of X?s or a column of O?s. There are a couple of different methods to use—use the prior day?s close as your reference point or use the first day?s opening price. Once you select the reference point, the closing price on the first day you are plotting will dictate whether you begin plotting X?s or O?s. Note that this is the only time opening and closing prices are considered.
For this example, we use the opening price on January 2, 2003—$41.50—as as the reference point. Comparing the closing price on that day—$43.70—to the reference point, we see that the price increased, meaning we begin our point and figure chart by plotting X?s.
When plotting a point and figure chart, it is easier to deal in whole numbers, so the high and low prices for each day are rounded upward or downward—low prices are rounded up to the next whole number and high prices are rounded down. Therefore, $43.70, the high price, is rounded down to 43, and this is the point where we plot the first X of our point and figure chart. However, since this is the first plot in January we use a 1 instead of an X. We are now done for the day.
January 3: Since we are in a column of X?s, the first action point is where we would add another X to the current column, in this case 44—one box above 43. The other action point is 40, which is three boxes below the current X at 43. The high for the day is $43.95, rounded down to 43. Since this is below the first action point, we do not plot another X. Instead, we look at the low price for the day to see if a three-box reversal has taken place. The low price—$43.12, rounded up to 44—is higher than the second action point at 40, so we do nothing for the day.
January 6: The first action point is that level that is one box above the highest X in the current column—44 (43 + 1). The high price for the day, rounded down, is 44. Since this equals the first action point, we stay in the same column and add an X at the 44 level.
January 9: After adding a new X to the current column on January 6, no action was taken on January 7 or 8. The first action point is now 45 (44 + 1). The high price for the day, rounded down, is 41—no additional X?s are added to the column. The second action point is 41 (44 ? 3). The low price for the day is $40.61, which we round up to 41. Since the low for the day equals the second action point, a three-box reversal has taken place. Therefore, we shift one column to the right and start a column of O?s that begins at 43, one box below the highest X of the previous column, and goes down to 41.
January 10: Now that we are in a column of O?s, we want to know if the price fell. The first action point is the level where we would add another O to the current column; in this case, the box below the lowest O at 41 is 40. The second action point is where a three-box reversal would take place and is three boxes above the lowest O: 44 (41 + 3). The low price of the day, $39.50 rounded up to 40, equals our first action point. Therefore, we stay in the column of O?s and add another O to the bottom of the current column at 40.
February 3: Since point and figure charts are only concerned with ?significant? price movements, do not be surprised if days or even weeks go by with no activity on the chart, as was the case between January 10 and January 31. We are still in a column of O?s with the lowest at 40. Looking at the action points for the day, the first is 39 (one box lower than the lowest O at 40) and the second is 43 (three boxes above the lowest at 40). The low price for the day, $41.88 rounded up to 42, is above the first action point, so we move on to the high price for the day: $43.11, rounded down to 43. This equals the second action point, so we shift to a new column of X?s that begins at 41 and goes up to 43, with a 2 at 43 to represent February.
Although we have shown how you would manually create point and figure charts, realistically you would use a software package or Web site to create them for you, allowing yourself more time to perform actual analysis. There are several tools available to aid you in this pursuit.
While a relative newcomer to the arena of Web-based charting, the StockCharts Web site has transformed itself into a leader in the field. Not only does it offer a wide array of charting options—including point and figure—it also offers chart scanning capabilities and an extensive educational area dealing with charting and technical analysis. The site offers both free access as well as expanded features with a variety of subscription options ranging in price from $9.95 to $30.95 a month.
Two types of point and figure charts are offered: text-based ?classic? charts and Java-based ?dynamic? charts. While the classic charts can be viewed with any Web browser, you must have a Java-enabled Web browser to view dynamic charts.
Free access at the Web site allows you to plot up to three years of data on a chart; subscribers can plot data going back to 1990. Subscribers also have the benefit of being able to save the charts they create for future viewing. One drawback with the classic chart is that you are limited to predefined time periods over which the data can be plotted. While slightly cumbersome, the dynamic charts provide a sliding bar where you can specify the exact time period you want charted. With both types of point and figure charts, you can specify the reversal amount for a chart as well as the box size. By default, the dynamic charts use the high/low range in creating the charts, which is the method we used to create the Moody?s chart. With the classic point and figure charts, you have the option of using the high/low range or the closing price.
Once you have created your point and figure chart, you have a number of additional analysis tools and features at your disposal. With the classic charts, users can apply price overlays such as trading bands, automatic trendlines, and moving averages. While these features are not available with the dynamic charts, users can plot their own trendlines within the Java applet. The site also automatically generates point and figure alerts for any chart you create. These alerts are available on the classic charts and are meant to alert you to changes in the supply/demand relationship of the stock point. Figure 3 is an example of a point and figure alert for Moody?s—in this case, a bullish ascending triple-top breakout alert.
Another unique feature is the relative strength chart, which is also available only with the classic charts. This point and figure chart compares one ticker to another. The price of the first symbol is divided by the price of the second and then scaled to create the chart.
Beyond charting, the StockCharts Web site offers stock scans, which are formulae applied to the site?s universe of stocks, mutual funds, and indexes that return a list of tickers that match the filter criteria of the scan. These scans are broken down into groups—technical indicator scans, candlestick pattern scans, and point and figure pattern scans. There are currently 17 predefined point and figure pattern scans; see Figure 4 for a listing of these scans. As this figure also shows, the site offers a link to the list of tickers matching each scan—as of the end of the last trading day—broken down by exchange. From this list, you can access charts for each of the passing tickers.
Subscribers to the site can also create their own scans and save them (Extra! subscribers only). Basic subscribers can create single-expression scans, while Extra! subscribers can create multiple-expression scans (Figure 5). Once you have created a scan, you can view anywhere from 10 to 999 of the passing tickers, depending on your subscription level.
Finally, for those who are new to point and figure charting or technical analysis, StockCharts.com offers some of the best educational content available for free on the Internet in this area. The site?s Chart School offers an overview of technical analysis as well as discussions of popular chart types (including point and figure charts) and technical indicators. Tutorials are also available on how to use the various elements of the StockCharts Web site.
The MarketScreen Web site, as its name implies, is focused on providing stock screening and market alerts. In a similar fashion to StockCharts.com, the MarketScreen site offers point and figure charting and market scans both for free and on a subscription basis.
From a charting standpoint, the MarketScreen Web site allows users to specify both the box size and reversal amount. Unfortunately, users do not have the ability to specify a custom time frame for a chart—several choices for predefined durations go back as far as five years. Users can specify whether they want to use daily, weekly, or monthly data. Those with subscriptions to the site, which cost $49.95 a month or $439.95 a year, can save charts for future viewing.
This site also uses high/low prices to create its point and figure charts. However, comparing the Moody?s point and figure chart from MarketScreen in Figure 6 to that of StockCharts.com in Figure 3 and the point and figure chart created manually in Figure 1, you can see that they all differ slightly, irrespective of the differing time frames. While they all use high/low prices, there is obviously room for interpretation when creating such charts. Keep this in mind when viewing different point and figure charts for the same security.
The MarketScreen site also offers literally hundreds of market scans or screens covering such areas as price and volume activity, moving averages, chart patterns, support and resistance levels, technical indicators, and fundamental factors. The site provides free access to scan results based upon end-of-day data from three, four, five, and six trading days prior. A subscription is required to access intraday results as well as end-of-day results for each of the last three trading days. There are over 30 point and figure pattern scans available, with the results of each broken down by exchange—Nasdaq, New York, and American—as well as by market cap—micro, small, mid, and large.
The lists of passing companies provide links to charts, quotes, news items, and SEC filings for each company. Subscribers can also create and save their own scans (Figure 7) and view the results on both an intraday and end-of-day basis.
For many years, the Dorsey Wright & Associates (DWA) Web site was the only site offering point and figure charts, and it continues to be the sole site devoted exclusively to the discipline of point and figure. The company?s founder, Thomas Dorsey, is often credited with bringing point and figure charting back from the brink of obscurity and is the author of ?Point and Figure Charting: The Essential Application for Forecasting and Tracking Market Prices? (second edition, John Wiley & Sons, 2001), a must-read for those interested in point and figure charting.
The site is primarily fee-based, with individual subscriptions ranging from $25 to $45 a month. A free three-week trial is also available.
Upon entering the site, subscribers are presented with a summary of the last completed trading day—including the point and figure chart activity of key market indexes and sectors, as well as a calendar of recent and pending economic releases (Figure 8). If you have created any portfolios, you can access them from this page as well.
The DWA site offers some basic screening capabilities. The on-line query allows users to choose from a number of criteria—including relative strength, percent oversold/overbought, market cap—and view those stocks and mutual funds that match their criteria. These queries can then be saved for future use. With the site?s pattern reports, you can view those securities forming both bullish and bearish point and figure patterns.
For point and figure charting, the site uses the high/low price and allows users to specify the box size and reversal amount (Figure 9). Users can also specify the number of years they want charted, with data going back to 1986 when available.
Beyond the point and figure chart, the site provides information regarding weekly momentum, sector status, and the latest chart pattern. Once you have created a chart, you can export a PDF document to print or save to your computer. Users can also create and save notations for the charts they create as well as set action price alerts. If the action price you specify is between the high and low price for the day, you will receive a notification via E-mail.
Each stock tracked by the DWA database has a daily commentary report as well as an evaluation that rates the technical attributes of the stock.
The site?s Point & Figure University is free to all registered users and currently offers six lessons ranging from the basics of point and figure charting to its use in market and sector timing. At the end of each lesson there is a test that allows you to determine your areas of weakness. The site details plans to launch live on-line classes in the future, although no timetable is given.
Point and figure charts give investors a unique perspective when viewing price activity. By eliminating time from the equation and focusing only on ?significant? price movements, they allow investors to focus on the interaction between the supply and demand of a given security—the driving force behind security prices.