Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

# Making A Point: Point & Figure Is Important Technique, Which When Used, Is Likely To Help Make Right Stock Decisions

Technical charts such as bar chart, line chart, candlestick chart and the likes may be the norm today, but a century-old charting technique called point and figure(P&F) is relevant and in use in present times too. The point and figure chart makes use of the simple x and o in its plotting, which can be done manually using a graph paper and pencil. The central tenet of P&F charting is that it focuses solely on the price factor and completely ignores the time factor.

This is to say that if a stock or the underlying moves by a certain price amount, only then is that price action plotted on the chart. However, it does not plot how much time period it has taken for the price move. This is unlike most charting techniques where every time period such as a minute, hour, day, or week is plotted even if the price move is small or there is no price move.

Let us understand this technique in greater detail. Say you have specified that only if the price moves up or down by Rs. 2, should it be plotted. In such a scenario, if on Day 1, the price moves only 1.90 paise, nothing is plotted. On day 2, if the price moves down by 1.60 paise, nothing is plotted. On day 3 if the price moves up by 2.20 paise, only then is the price move plotted.

The main objective of the P&F chart is to eliminate smaller or minor price fluctuations, thereby eliminating insignificant market noise. It focuses on the larger or major underlying trend, points out the major support and resistance and breakouts and shows the main price direction.

HOW TO DRAW

As discussed earlier, in a P&F chart you plot the price only if it is higher than the previous high by a certain amount or lower than the previous low by a certain amount. Take a graph paper or draw a table on your computer having intersecting rows and columns, forming equal sized square boxes.

A series of rising prices is represented by "X" plotted down to up in a column of vertical boxes. A series of falling prices is represented by "O" plotted up to down in a column of vertical boxes.

Important: A column of X cannot have an O and a column of O's cannot have an X.

The main components of a P&F chart are Box Size and Reversal Size.

BOX SIZE

It is the size or amount that a price has to move to add another X or an O. It is the minimum price change needed to continue a trend. Say, you have specified that a Box Size is Rs. 1. A stock ABC is rising and is currently at Rs. 70. If the price moves from Rs. 70 to Rs. 71.05, then an X is added to the chart since X signifies an upmove. If, however, instead of Rs. 71.05 the price has moved from Rs. 70 to Rs. 70.99, then the Box size criteria of Rs. 1 is not fulfilled and, hence, nothing is plotted on the chart.

Similarly, consider that stock ABC has been falling and is currently at Rs. 70. If the price moves to Rs. 68.10, then an O is added to the chart. But if the price falls to Rs. 69.05, nothing is added since the criteria of Box size of Rs. 1 has not been met. Remember, a column of X will continue until the uptrend halts and the price reverses by a certain amount called the Reversal amount post which a new column of O is plotted.

REVERSAL AMOUNT

It is the size or amount that a price has to move before a new column is added to the P&F chart. If the reversal amount is Rs. 3, in other words a 3-box reversal, the price has to fall by Rs. 3, if the previous column is X (rising prices) before adding a "O" to a new column. If the previous column has been an O (falling prices), then prices have to rise by Rs. 3 before a new column of X is added to the chart.

Generally in most charting software, the reversal amount is 3-box sizes. But it can be changed according to user preference. Sounds confusing? Let's simplify it with an example:

Box Size = Rs. 1
Reversal Size = 3-box sizes or Rs. 3

Imagine that the current price is rising. The close today is Rs. 70, and the Box size is 1.

1. Put an X in the box next to Rs. 70.

2. Next day the price closes at Rs. 71. Now, you enter a new X in the same column above the first X in the box next to Rs. 71.

3. If the next day prices close at Rs. 73, you put two Xs in the boxes next to Rs. 72 and Rs. 73.

4. You keep adding X's in the same column until the price rise ends. Say in the above case price closes at a maximum of Rs. 74.

5. After Rs. 74, the upmove is over. The prices move lower and next day the price falls to Rs. 73. But you do not plot anything since the reversal amount is Rs. 3 or 3-box size.

6. The next day the price falls to Rs. 71, it is a 3-box reversal from the top of Rs. 74 and, hence, you start a new column of O next to the column of X. Since each price move needs to be plotted, put an O in each box corresponding to the level 73, 72, and 71 (i.e., in the opposite direction of the X column, in other words plot the O from up to down).

7. The next box of O is plotted only if the price falls further by Rs. 1.

8. For a new column of X to form, price has to rise again by Rs. 3. Say next day the prices rise to Rs. 73, you again don't plot anything since it is not a 3-box reversal

9. And the next day when the price rises back to Rs. 74, you plot a new column of X.

Here's How The P&F Chart Will Look:

 Day Price 1 70 2 71 3 73 4 74 5 73 6 71 7 73 8 74

The selection of the Box size is a subjective thing. A Rs. 1 move on a 10-rupee stock amounts to a 10% change while the same Rs. 1 move on a Rs. 100 stock in the market amounts to a mere 1% change. A smaller box size means a lot of detail and noise and a very large box size means overlooking many minor but important moves.

Hence, selection of an appropriate box size is very important. You can decide on the appropriate box size based on your preference and success rate. Given below is just a guideline on how to choose your box size.

 Stock Price Box Size Rs. 5-20 0.50 Rs. 20-100 1 Rs. 100-200 2 Rs. 200-300 4 Rs. 900-1000 10

Many P&F charting software have the box size default setting. You can either choose to go with it or enter your own. Similarly, the reversal size is also default, but can be changed.

There are 2 methods of selecting the prices for the Box size.

1. Close Method
2. High-Low Method

CLOSE METHOD

This is a relatively simple method as it uses only the closing price for the period.

If prices are moving up:

· Plot an X when closing price of the period is greater than Box size.

· Plot an O when closing price of the period is lower by 3-box reversal.

If prices are moving down:

· Plot an O when closing price of the period is lower than the Box size.

· Plot an X when the closing price of the period is higher by 3-boxes.

HIGH-LOW METHOD

In the High-Low method, either use the high or the low, but never both.

If prices are moving up:

• Use the high when another X can be drawn, ignore the low.
• Use a low, when another X cannot be drawn and the low triggers 3-box reversal.
• Ignore both when high does not warrant another X and low does not trigger a 3-box reversal.

If prices are moving down:

• Use the low when another O can be drawn, ignore the High.
• Use high when another O cannot be drawn and high triggers a 3-box reversal.
• Ignore both when a low does not warrant another O, and high does not trigger a 3-box reversal.

Usually the Close method is chosen because it is much easier and gives good results in the short- to medium-term.

INTERPRETATION OF P&F

A column of X's indicates Bullishness whereas a column of O's denotes Bearishness.

Trends

Just like any other technical chart, a chart where there are higher highs and higher lows signifies an uptrend. Similarly, a chart where there are lower highs and lower lows signifies a downtrend. So an uptrend in a P&F chart is depicted when there are rising levels of Xs and rising levels of Os. Similarly, a downtrend is depicted when there are falling levels of Xs and falling levels of Os.

Uptrend charterized by higher highs and higher lows rising X and rising O

Downtrend characterized by lower lows and lower highs falling O and falling X

Support And Resistance

· Support levels are price levels at which 2 or more columns of "O" end or bottom out. i.e, "O" columns ending at the same or equal level.

· Resistance levels are price levels at which 2 or more columns of "X" end or top out., i.e, X columns ending at the same or equal levels.

More the number of columns ending at the same level, the stronger is the support or resistance.

Breakout

Breakout above a resistance level is a bullish sign and breakout below a support level is a bearish sign.

Double Top And Double Bottom Breakout

When a column of Xs rises above the previous column of Xs, it is called a Double top breakout and it signals bullishness and one can buy. A sell signal occurs usually when a column of O's falls below the previous column of Os and is called a double bottom breakout.

Triple Top And Triple Bottom

When column of X rises above 2 previous X columns at the same level, it is called a Triple Top breakout and is a strong bullish signal. When a column of O falls below 2 previous columns of O's at the same level, it is called a Triple bottom breakout, and it is a strong bearish signal in the market.

Remember: The strength of a P&F chart depends on the width of the pattern. i.e., the more column it takes before a breakout, the stronger the signal. Also an upward breakout of a resistance level is considered strong if it is accompanied by a pattern of rising O's. An upward breakout of a resistance level accompanied by a pattern of falling O's signals a weak breakout and can result in a Bull Trap. The opposite stands true for a downward breakout.

Stops

In an uptrend like a double top or a triple top, place a stop below the bottom of the last column of Os. In a downtrend like a double bottom or a triple bottom, place a stop above the top of the last column of X.

Failed Break

If after a breakout, the trend reverses and goes back below the resistance in case of an upward break or back above the support in case of a downward break, it is known as a failed break. Traders should ideally wait for a few more trades to determine if the breakout is a continuation or a failed break. A failed break is a sign of weakness, suggesting that the breakout is not supported by volumes. If an upward breakout retreats back below the resistance, it is known as a Bull Trap.

Similarly, if a downward breakout reverses and moves above the support level, it is known as a Bear trap.

Catapult

When a pattern switches from being bullish to bearish and back to being bullish again it is known as a Bullish Catapult. Similarly a pattern which switches from being bearish, to bullish, back to being bearish again is known as a Bearish Catapult. For example, a triple top breakout, followed by a pullback below the resistance, which is again reversed resulting in a double top breakout.

Plotting Of Trendlines

Trendlines on a P&F chart are plotted at an 45 degree angle, i.e., one square box across, (up or down).

A Bullish trendline, also known as a Bullish Support Line, will be drawn from an important Low exactly at 45 degree going upwards from left to right. A Bearish Resistance line will be drawn from an important High exactly at 45 degree going downwards from left to right. An uptrend is present when prices are above the Bullish Support Line. A downtrend is present when the prices are below the Bearish Resistance Line.

Remember: An Uptrend that is penetrated by a column of "O" is a bearish signal and a downtrend that is penetrated by a column of X is a bullish signal.