Analyzing Supply and Demand Using Point and Figure Charts
by Wayne A. Thorp, CFA
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.
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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.
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 it represents the value given to each box (X or O) on the chart. It is the minimum price change needed to continue the trend—i.e., to add an X to the top of the column of X’s (or the minimum price decrease needed to add an O to the bottom of a column of O’s). The reason that this is even an issue is because a reversal of $3 for a $10 stock is more dramatic, on a different scale, than a $3 reversal on a $100 stock. 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 to eliminate momentary price reversals, yet at the same time allow enough through so you can identify when a significant reversal is taking place.
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Discussion
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.
posted about 1 year ago by Douglas from Virginia
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.
posted about 1 year ago by Bradley from Colorado
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.
posted about 1 year ago by John from
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).
posted about 1 year ago by John from
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.
posted about 1 year ago by John from
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.
posted about 1 month ago by Vaidy Bala from
