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Analyzing Supply and Demand Using Point and Figure Charts

by Wayne A. Thorp, CFA

Analyzing Supply And Demand Using Point And Figure Charts Splash image

One of the basic principles of economics is the law of supply and demand. It states that when there are more buyers than there are sellers of a given good, the price should rise. Likewise, when there are more sellers than buyers, the price should fall. In this technical analysis article, we focus on a type of chart that attempts to capture the battle between supply and demand: the point and figure chart.

Point and figure charts have been in use for over 100 years, yet they exist in relative obscurity compared to bar charts and candlesticks. 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 the more conventional charts in that they ignore the passage of time and do not take trading volume into account—they are only affected by price movements.

Figure 1 is an example of a point and figure chart for Cisco Systems, which covers daily price movements for the period from January 4, 1999, through April 31, 1999. Immediately, you should see some significant differences from other charts. First, the chart is made up of columns of X’s and O’s. X’s represent rising prices while 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 you may use to make buy and sell decisions.

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Wayne A. Thorp, CFA is a vice president and senior financial analyst at AAII and editor of Computerized Investing. Follow him on Twitter at @AAII_CI.


Discussion

Douglas from Virginia posted over 2 years ago:

I check P&F charts occasionally but I never actually use them for decisions because I lack one piece of information -- their validity.
I have never seen any kind of statistical study of their predictive ability.

Perhaps someone at AAII can find or perform such an analysis, since I'm too lazy to do it myself. My programming skills have all but vanished.


Bradley from Colorado posted over 2 years ago:

P&F charts are not predictive, they show what is going on in a specific manner. Particularly in this highly volatile market, they smooth things out from the more usual candlestick or ohlc chart. If you are looking to predict the market, history tells us it will continue to go in the direction it is going until it goes the other way. P&F does the job best of showing trend. When trends start to break down, they may be predicting, or maybe not.


John from posted over 2 years ago:

Douglas,

In the book New Trading Systems and Methods, 4th edition, by Kaufman there is a comparison of 6 trend trading systems. Using data from page 320, for the Eurodollar from 1985 to 1994 with parameters resulting in fewer than 100 trades in total, the following is my ranking of performances, all with profits before trading costs, from best to worst:

1. NDay Breakout (Turtle trading rule)
2. Swing Breakout (Kagi, Livermore)
3. P&F
4. Simple single moving average, exponential single moving average
6. Linear regression slope

With parameters resulting in more than 300 trades in 10 years they all lost money.


John from posted over 2 years ago:

In the same book, on page 919, there is also a comparison of 12 trading systems for 12 futures markets from 1978 to 1984. Following is my ranking, from best to worst: 1. Directional parabolic (directional movement combined with parabolic), 2. Channel breakout (NDay breakout or Turtle), 3. Dual moving average crossover, 4. Directional movement, 5. Wilder's parabolic. Inferior, without ranking are: Range quotient, MII price channel, LSO price channel, Reference (volatility) deviation, Directional indicator, Moving average with % price band, Alexander's (simple swing) filter rule. Source: Lukac, Brorsen and Irwin, "How to test profitibility of technical trading systems," Futures (Oct 1987).


John from posted over 2 years ago:

Well-known technical trading systems may not be profitable anymore. See: The Profitability of Technical Trading Rules in US Futures Markets:
A Data Snooping Free Test.
Cheol-Ho Park
University of Illinois at Urbana-Champaign
Scott H. Irwin*
University of Illinois at Urbana-Champaign
May 2005
*
Abstract.
Numerous empirical studies investigate the profitability of technical trading rules in a
wide variety of markets and many find positive profits. Despite positive evidence about
profitability and improvements in testing procedures, skepticism about technical trading
profits remains widespread among academics mainly due to data snooping problems. This
study mitigates data snooping problems by confirming the results of a previous study and
then replicating the original testing procedure on a new body of data. Results indicate that
technical trading profits have gradually declined over time in 12 futures markets.
Substantial technical trading profits during the 1978-1984 period are no longer available
in the 1985-2003 period.


Vaidy Bala from posted about 1 year ago:

I read the book ETF Trend Following PLAYBOOK (2010) by Tom Lydon. While the scientific evidence is not clear, the author encourages EMA to find clear buy or sell signals. He also claims the trend line can figure out most of the time ( I presume 75 %) in all sectors and in all markets. The book has numerous references at the back, something to consider reading and may be even worth trying.


Lee Dunn from North Carolina posted 8 months ago:

In A.W. Cohen's book, "How to Use the Three-Point Reversal Method of Point & Figure Stock Market Trading," on page 74, he outlines the various P&F formations [both long and short] and the % of time profitable, average % gain, and the average time to achieve these results. The book was published in 1978 and might be difficult to obtain -- but it certainly a classic and endorsed in Thomas Dorsey's books on P&F charting.

In and article entitled "Testing Point & Figure Patterns" by Michael J. Carr, CMT, 10,000 P&F trades are tested between 1990 and 2006. The author's conclusion was: "In testing, only the triple-top buy signal outperforms the stock market across all time frames. Traders can use this strategy and obtain a very high number of winning trades." Over a 60-day hold period, the % of wins was 91.71%. See, Stocks & Commodities v. 26:9 (54-56) Working Money.


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