- 2002: Volume 11, No. 1 The Xs and Os of Point & Figure Charting

Some things, like the bicycle, have remained basically unaltered since their invention. Other things, like the personal computer, remain steeped in change. And so it is with trading methods: some remain basic and simple while others are constantly evolving. For the small-scale trader, time, energy and technology seem to dictate taking the simpler path. This article will describe and discuss a method that is as basic as the bicycle. The signpost up ahead: Point & figure charting.

The origin of point & figure charting (P&F) is traced back to the 1880s. Its original appeal was the ability of a chartist to update a large book of charts in a small amount of time; that appeal remains more attractive now than ever. The modern-day chartist can keep and update 25 charts every day in about 20 minutes. There is also a Web site (www.stockcharts.com) that will construct P&F charts for the user. The site also has an excellent tutorial on P&F.

P&F is a way to measure supply and demand. When demand exceeds supply, price goes up and is measured by a column of Xs. When supply exceeds demand, price goes down and is measured by a column of Os. There are three major things that differentiate P&F from the more conventional method of bar charts: (1) a filter is applied to price movement so in order for price to be plotted, it has to move a certain amount. It is not uncommon for a day or even a few days to pass by where nothing is charted, (2) time is not charted, and (3) volume is not charted.

There have been numerous books about P&F published, the most notable being How to Use the Three-Point Reversal Method of Point & Figure Stock Market Charting by A.C. Cohen. I believe Cohen's book is now out of print but it is certainly worth the effort to attempt to locate a copy.

P&F charting must be done on some type of graph. I use regular graph paper purchased at the local drugstore. When constructing a P&F chart by hand, there are three main criteria: (1) a "box size" must be assigned. This means that each box on the graph is assigned a point value. An example of this would be that each box is equal to two points. As an example, the first box above the box at 40 would be 42 and the next box would be 44. Conversely, the first box below 40 would be 38 and the next box down would be 36. The size of the box is subjective, but Cohen suggests various box sizes for stocks and for futures. It has been my practice to "twiddle the knobs" when attempting to find an optimal size box. (2) A reversal size must be determined. A reversal size is the number of boxes needed for the column to reverse. Cohen represents that a three-box reversal is the best and in my experience, that is true. (3) The price highs and lows are used; closing prices are not used. We will now look at an example of these criteria in action with a box size of one and a reversal size of three, also known as a 1x3 chart.

We will be using the following price data for our example:

• Day One = high of 48, low of 42 (Close at 42. Close is used to determine the first column and is factored in to the charting on the first day only.)
• Day Two = high of 43, low of 38
• Day Three = high of 44, low of 37.25

On day one price was down six points so we chart a column of O's from the high at 48 down to the low at 42. On day two, since price continued lower, we chart more O's down to 38. The trend continues down as long as prices continue lower, i.e. an additional box to the downside is reached. On day three, since price did not reach 37, a new O could not be added. Prices did, however, reverse at least three boxes, resulting in a change in columns from Os to Xs. If prices moved to 45 on day four, we would continue to chart a column of Xs but if they reversed and the low was at least to 41, the column would reverse again to the downside. The first X or O of the new column is always charted one box up from the previous column of Xs or Os.

48 - O
     O
46 - 0
     O
44 - OX
     OX
42 - OX
     OX
40 - OX
     OX <— The first X in the reversal column
38 - O       is charted here and not at 38.

36 -

Now that we have examined how to chart the Xs and Os, the next logical question is "what produces a buy or sell signal?"

The prime mover behind buy and sell signals in P&F is formations that develop among the Xs and Os. These formations are not unlike the formations found on bar charts, such as triple bottoms or ascending triangles. And while there are numerous formations in P&F that provide buy and sell signals, the simplest ones, double-tops and double-bottoms, lie at the heart of the rest of the formations.

A double top in P&F is when two Xs are formed at the same price level. The following is an example:

20 - O
     O
18 - OX X <— Double-top at 18
     OXOXO
16 - OXOXO
     OXO O
14 - OX
     OX
12 - O

At 18 supply met demand and price was unable to move higher.

A double bottom would be the same thing, but with Os at a bottom instead of Xs at a top. An example is given below:

100 - O
      OX
98 -  OXO
      OXOX
96 -  OXOX
      OXOX
94 -  O O  <— Double-bottom at 94

At 94 demand met supply and price was unable to move lower.

Buy and sell signals occur when double tops and double bottoms are broken. When this occurs, it signifies that either demand has exceeded supply or supply has exceeded demand. Due to the necessity of anticipating price movement and not reacting to it, it is necessary with P&F to enter buy or sell orders on a stop basis. We will now look at an example of buying what is called a double top breakout, when price moves above the two horizontal Xs.

An example of a double-top breakout on a 1x3 chart.

74 -
     X
72 - X
     X   <— Double-top breakout at 71
70 - XX		
     XOX
68 - XOX
     XOX
66 - XOX
     XO
64 - X

On the above chart, a buy order would be placed on a stop basis at 71. Because of the anticipation of breakouts, it is necessary to look at the charts after updating them to determine at what price an order would be entered.

A double-bottom breakdown would be the same thing, but with Os at the bottom and price breaking through the two horizontal Os and continuing lower.

The most important item on a trader's checklist is the stop loss. At what point does the chart tell the trader he is wrong and it is time to get out? The trader might place a sell stop or a buy stop at the point when a new column of Xs or Os would start to form, depending on the trader's risk parameters. An example of this is found below on a 2x3 chart:

108 -

104 - X X
      XOXO
100 - XOXO      Buy stop was placed at 98, the point
      XOXO <— at which price would need to reach to
96 -  XOXO      start a new column of Xs.
       O O
92 -     O <— Sell order placed at 92,
                break down of double bottom.

We will now look at a real trade with December oats.

December Oats 2x3
                 X
                 X
                 X
                 X
170 -            X
                 X
                 X
               X X
               XOX
160 -          XOX
               XOX
               XOX
             X XO
             XOX
150 -        XOX
             XO
         X   X
         XO  X
         XO  X
140 - O  XO  X
      OX XOX X
      OXOXOXOX
      OXOXOXOX
      OXOXOXOX
130 - OXOXOXO
      OXOXOX
      OXO O
      OX
      O
120 -

To the beginner, this chart may look a lot more complicated than it really is. But keeping in mind the principles discussed above, and with practice, things should begin to fit together.

The first buy signal on this chart is in the second column of Xs at 140, after a double top had formed at 138. An initial sell stop could have been placed at this time at 134, a risk of $300. Price then moved up to the 146 level in a straight column of Xs. When a large, uninterrupted column like this forms, the sell stop can be moved up to half the height of the column, in this case at 136. Price reversed in a column of Os down to the 126 level but the stop at 136 should have limited the loss to $200.

The next buy signal came at 140, after a double top was formed at 138. An initial sell stop could have been placed at 134, risking $300. After an initial move up to 154, a new column of Os started and moved down to the 148 level. After the run up to 154, the sell stop could have been moved up to the 50 percent level at 142. The fact that the new column of Os occupied only three boxes before reversing indicates strength in the uptrend. The price eventually moved up to 178. I was stopped out of this trade at 155 because I was going on vacation; I did not want an open position if I was unable to update and follow this chart.

One final interesting pattern on P&F charts, and one that is seen on the oats chart, is that like with bar charts, resistance becomes support and vice versa. An example of this on this chart is at the 154 level where price came down to that level but found support at the two Xs at 154.

Once the basics of how to construct a chart and what constitutes a reversal are learned, P&F charting becomes, like the bicycle, both easy and fun to use.

Jim Niendorff is a part-time futures trader who uses point and figure charting as his trading system. He can be reached by e-mail at tradeit44@hotmail.com.