Point And Figure Charting, Part One

Point and Figure Charting

Part I: The Basics

What exactly makes a stock move? You'll get a variety of answers, depending on who you ask. Investors who use fundamental analysis will point to changing business conditions or major news stories, while those with a more technical approach might focus on breaches of key trendlines or areas of support/resistance.

But when you take it down to the most fundamental level, stock movement is driven by only one thing: differences in supply and demand. When buying outstrips selling (or vice versa), an equity's price changes.

Point-and-figure charting is a tool that can help traders monitor significant changes in the supply/demand relationships, while filtering out the "noise" brought about by day-to-day price gyrations.

For those used to conventional bar charts, a point-and-figure chart looks more like a big game of tic-tac-toe than a typical graph of an equity's movement. And in addition to all those X's and O's, the "time" axis (or X-axis, on a bar chart) is missing completely.

Let's take a look at some of the main features of a "p-n-f" chart:

Intel (INTC) - Point and Figure chart:

This chart depicts INTC's movement from early-2002 through the first quarter of 2006. Even though there's no axis that measures time intervals, reference points show us what timeframe we're looking at. The lines extending from the "03" and "04" at the bottom denote the beginning of 2003 and 2004, while the red numbers in the various columns signify the month. Months are represented by the red numbers 1-9 (for January through September) and the capital letters A-C (for October through December).

The left-most red letter is "2", which shows up in the chart's second column. Looking below we see no year marker to the left of "03," meaning THAT column was formed in 2002. So this particular chart extends back to February 2002. There is no standard time interval for p-n-f charts - some might show activity dating back only 5-6 months, while others (like INTC) have a longer timeframe. In general, stocks that trade in wider price ranges tend to create more columns.

P-n-f charts are formed by alternating columns of "X" (rising price) and "O" (falling price), with the price axis showing the extent of the movement. For example, a stock that rose from 30.00 to 33.00 would form a column that looked like this:

35
34
33 X
32 X
31 X
30 X

This column would continue until the stock (we'll call it ZZZ) produced what's referred to as a "three-box reversal." Each "box" is a price unit. For stocks trading at 20-100, the box size is one dollar. Box size decreases to 0.50 intervals in the 5-15 range, and is bumped up to 2.00 for equities trading above 100. This difference is visible on the Intel chart, with the price axis shrinking to 50-cent divisions below 20.00.

These varying box sizes take into account the relative impact of a stock's movement, depending on its price; a 2-dollar move is a lot more significant for a stock trading at 12.00, compared to one that's trading at 43.00.

Let's return to our example. ZZZ is trading between 20 and 100, so it'll take a reversal of 3 boxes (3 dollars) to create a column of O's. Subtracting 3 from the column's high (33), we see that ZZZ will have to hit 30 in order to form a three-box reversal. But momentum is on the bulls' side. Shares only pull back to 31.75, then rise to a new high of 34.15. This adds another "X" to the column:

35
34 X
33 X
32 X
31 X
30 X

Finally, a more meaningful sell-off takes place as the stock falls from its relative high of 34.15. At this point it would take a trade at or below 31.00 to mint a three-box reversal (34 - 3 = 31). ZZZ falls to 31.02, then pauses. At this point there is still no reversal - the actual price level (31.00) has to be traded first. Finally, there's another round of selling and shares hit an intraday low of 30.93. The p-n-f chart now shows ZZZ trading in a column of O's:

35
34 X
33 X O
32 X O
31 X O
30 X

The stock would remain in a column O's until it gave a three-box reversal to the upside. For example, a decline to 25.70 would extend the column all the way down to 26. (But not 25 - it would take a tick at or below 25.00 to accomplish that). ZZZ would then have to turn around and move back to 29.00 (26 + 3 = 29) in order to create another column of "X."

Another point to keep in mind is that opening and closing price data is not used in p-n-f charting. What matters is the intraday high or low. If either of these extremes adds to a column or creates a three-box reversal, appropriate changes are made to the p-n-f chart. Any other movement is ignored. This goes a long way towards filtering out the price movements that don't have a major impact on the supply/demand relationship.

We can identify key turning points in that relationship by using trendlines, which are familiar to most bar chartists. These trends always form a 45-degree angle, and are denoted by "+" signs.

Adobe Systems (ADBE) - Point and Figure chart:

P-n-f trends are formed differently, but don't let that confuse you; approach them just like would with a conventional bar chart trend. As shown on the ADBE chart, strong reversals can take place when a downtrending stock encounters bullish support.

The same is true of an uptrending stock when it meets bearish resistance. Violations of those levels are also significant. The red arrow points out the recent breakdown below support, which is a negative sign for ADBE.

These are just one way to profit from point-and-figure analysis. In "Point and Figure Charting Part II: Profiting From Patterns" we'll delve deeper and discuss buy/sell signals (which indicate key turning points in the all-important battle between supply and demand), charting of indexes, and a useful technique to help manage risk.