A Time-Honored Approach to Charting: Point & Figure Analysis
One of the most interesting and instructive methods of charting is point and figure. In fact, point and figure is one of the oldest methods of keeping track of price changes, developing long before conventional charting methodology, certainly long before the many gimmicks marketed today. Yet, as readers will see for themselves, the strength in point and figure is in its simplicity, in its ability to get down to the “bottom line.”
The main characteristic of point and figure is that only prices are tracked; time does not play a part, unlike most charting techniques.
In point and figure, an advancing price is shown by an “X,” and a declining price is shown by an “O.” As long as the stock price continues in the same direction, Xs and Os are entered in the same column; new columns are started only when price changes direction. The result is a series of X and O columns.
As a comparison, Figure 1 presents the typical bar chart for Kmart, where price is plotted along the y-axis and time along the x-axis. Figure 2 shows the point-and-figure chart for Kmart over the same time period, where only price is plotted.
In order to establish what price changes constitute an “X” or an “O,” certain assumptions must be made. For instance, on a $100 stock, a move up of ¼ point does not seem significant, while a 2-point move may be. On the other hand, as we’ll see, a ¼-point move may be highly significant on a lower-priced stock.
The conventional parameters are:
Size of Significance
|$5 - $20||½|
As an example, take Cola-Cola, trading at around $50 a share. Using the above parameters, if the stock moves up by less than $1, there would not be any entry—it takes at least a $1 move to score a mark. On the other hand, if the stock moved up $4, there would be four entries.
Some of the technical analysis software charting programs calculate marking sizes automatically. MetaStock 5.1, for instance, calculates marking sizes automatically based on the high/low price range multiplied by 0.04. The size that it calculated for Coca-Cola was 0.74, using the last 12 months’ data range of 537/8–35¼—in other words, each mark represents a change of $0.74.
You can see that, on one level, using the point-and-figure approach not only eliminates time, but also price changes that may be considered minor. Some investors may find time significant—for instance, the amount of time spent at some level. On the other hand, in the final analysis, it is only price that counts, and that is the strength of point and figure.
On the next level, the objective of point and figure is to highlight reversals. Most investors know that by the time Wall Street warms up to a stock, the best part of a move is over. However, if an investor can zero in on important reversals in a stock, the probability of finding winners early is enhanced.
In order to effect reversals, of course, the price must first move in the opposite direction. The question remains as to how far, or how many marks, must a stock move in the opposite direction to be considered a reversal. Under conventional point and figure, the norm is three.
Thus, in the case of Kmart in Figure 2, where each mark equals $0.50, it takes a move of $1.50 in the opposite direction to be considered a reversal.
The next level in point and figure is the buy and sell signals. Simply, a buy signal is when a series of new Xs break above a prior column of Xs, separated by a column of Os:
X O X
X O X
X O X
A sell signal is when a series of new Os break below a prior column of Os, separated by a column of Xs.
O X O
O X O
O X O
With Kmart, a sell signal was given at A, and a buy signal was given at B; buy signals were also given at C and D. These are just simple buy and sell signals; the nuances of point and figure are intricate and refined. Interested readers should investigate Michael Burke’s Investors Intelligence for a deeper understanding of point-and-figure analysis [Investors Intelligence is published by Chartcraft, P.O. Box 2046, 30 Church Street, New Rochelle, NY 10801; 914/632-0422].
This leads me to state what I think is the most important aspect of point and figure, and the heart of practical technical analysis for that matter: the identification of support and resistance levels, as bull trends are classified by the breaking above resistance, bear trends are classified by the breaking below support. And the nature of the trend—either minor, intermediate, or major—is determined by the nature of the support or resistance levels. The breaking of support and resistance levels is what determines trend, continuation patterns, and ultimately reversals.
In terms of the Xs and Os of point and figure, the top of any X column obviously reflects resistance, otherwise the column would not have topped out but would have continued upward. Consider with Kmart how the advance E stopped right at the middle of the resistance level identified as EE.
Likewise, look at the trading level identified by FF. When Kmart breaks above those levels, the trend will be decidedly bullish. Of course, should Kmart break below the support, it would be bearish.
I’ve only touched on a few point-and-figure points with Kmart, but investors can see the interworkings of support and resistance as highlighted by the point-and-figure method in determining trend. The parameters, of course, need to be customized for each stock.
A more dramatic example of point and figure can be seen by looking at the chart of Chryon, one of the best-performing stocks in the recent past on the New York Stock Exchange, up over 1,000% since early 1995. Chryon had been a low-priced and depressed stock, declining to a low of 3/8 in 1995. Investor psychology is such that if a stock is “low priced,” it is undesirable.
Figure 3 is the point-and-figure chart for Chryon. Each mark represents a 1/4 move in price. Notice how the stock first developed a well-defined trading range, where support consistently kept supporting the stock at around 3/8 for over two years, from March 1993 through April 1995. Then Chryon started to move higher in a point-and-figure pattern in about as “orderly” a fashion as could be expected, which also describes the pattern of the stock’s decline after mid-year 1996.
The pattern of Chryon at the lows is reflective of a broader principle regarding risk. In terms of investment merit, low-priced issues are very high-risk. However, in terms of volatility, these issues are low-risk.
But, whether we are discussing an issue like Chryon, or a stock like Kmart or Coca-Cola, in the final analysis, it is price that counts.
And, since point and figure is solely based on price, it is a branch of technical analysis that merits a higher degree of attention than many of the more “exotic,” but less informative, facets of technical analysis popular today.