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Point and figure charting is one of the oldest charting techniques in existence, and it was the first method of technical analysis used to track share prices. It was developed for the stock market and with the specific requirements of share trading in mind. Investors who favour this method of analysis maintain that it is the clearest and most unequivocal form of technical analysis. Unlike line charts, bar charts and candlesticks, which are two dimensional, point and figure charts are based on price only – and are therefore largely one-dimensional. They do not take into account time and they do not show volume traded. The one-dimensional point and figure chart therefore requires a different interpretative standpoint.
The great advantage of the point and figure chart over other technical methods of analysis is that it allows us to make a rough prediction as to how far a price is likely to move by using what is known as a “horizontal count”. In addition, it gives reliable long-term signals on trends. If there is a criticism of point and figure charting, it is that it is slow to give signals – so it is not generally of interest to short-term traders, but rather to medium- or long-term investors. The modem oscillators discussed in other modules tend to give buy and sell indications much earlier in the cycle.
The objective of this module is to provide an understanding of the way in which point and figure charts work, how they are constructed and how to interpret them. The module should enable you to evaluate market analysis based on point and figure, and to develop your own point and figure charts. 
<h2>RATIONALE BEHIND POINT AND FIGURE CHARTS</h2>
 
The main objective of most technical analysis is to pinpoint the turning points in the market, to identify the peaks and troughs, and therefore the optimum buying and selling opportunities. In order to achieve this goal, the technical chart is designed (i) to highlight the dominant price trend, and (ii) to eradicate "noise" – interference from daily fluctuations or minor corrections and rallies, which make it difficult to perceive that underlying trend.
As you know, line charts meet these criteria by using, among other things, trend lines and moving averages. The point and figure chart is constructed in such a way that these characteristics are inherent in the graph itself.
Firstly, only price changes greater than a pre-determined magnitude are recorded on the point and figure chart. This avoids the "noise" in the market. The minimum value for a recordable price change is called the box size.
Secondly, a change in trend is only acknowledged on the chart if the price reverses by a certain multiple of the box size, usually three times. This ensures that minor price movements are not interpreted as changes in the basic trend. The number of boxes required to record a change is known as the “reversal”.
 
<h2>CONSTRUCTION OF P&F CHARTS</h2>
 
<h3>Basic Principles</h3>
Let us look in more detail at the procedure used to construct a point and figure chart. As the 3-point reversal is by far the most commonly encountered, we shall use that as the basis for our description. Later on, you will see for yourself how simple point and figure charts (those with no reversal multiple) or charts with other reversal formulae can be constructed.
Originally, point and figure charts were built up over time on a standard piece of arithmetically ruled graph paper. Two basic principles underlay the construction of the chart. Firstly, up moves and down moves are recorded in adjacent columns; secondly, changes are only recorded once box size and/or the reversal has been reached.
Two symbols are used on the charts:
<ol style="text-align: justify;">
<li>X's are used to record upward movements in price.</li>
<li>O's are used to record down moves.</li>
</ol>
Only X's or 0's (never a mixture) may appear in any one column of the graph. As long as a share is going up we continue to work in one column, and we only move into a new column once the price of the share has dropped by 3 times the box size.
Let us look at a practical example to make this clear:
Assume that the price of a share trading at R50 is being plotted with a box size of 100c. It has moved up from R44 since we have been monitoring it, so at this stage our chart looks like this:
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure1.jpg" alt="" />
<figcaption class="figure-caption">Figure 1 - First step in constructing a point & figure chart</figcaption>
</figure>
 
Notice that in recording the price movements so far, we have ignored all changes of less than 100c in magnitude. This is because the box size is 100c. If the price moves up to 5075c now, nothing will be recorded on the chart. Likewise, if the price moves down to 4900c or 4800c, nothing will be recorded on the graph because we need three times the box size (i.e., a reversal of 300c) to record a change in direction. However, if the price now moves down (gradually or suddenly, it does not matter) to 4700c, the change will be recorded as follows:
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure2.jpg" alt="" />
<figcaption class="figure-caption">Figure 2 - Second Step: Price reversal is recorded in the next column</figcaption>
</figure>
 
It should be clear from the above that in a 3-point reversal chart there can never be fewer than three O’s or X’s in any column.
<h3>Determining the Box Size</h3>
By now you will have perceived that the overall appearance of the graph will be largely determined by the box size. In the same way that a short-term moving average results in a more sensitive graph, a smaller box size produces a more sensitive point and figure chart.
Traditionally, in America where this method originated, point and figure charts constructed by hand, use a box size of $1 (a full “point”) for all stocks over $20 in price, and a half or even quarter point box size for cheaper stocks. In the local context this can be translated into a box for lower priced shares of between R1 and R100, and R100 to R1000 for more expensive shares, while penny stocks can have a box size of 50c or 25c or less.
One effect of this system is that graphs on shares that are trading around the R20 level will be semi-logarithmic. In other words, the box size will change on the graph when the price moves below R20 (see figure 3).
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure3.jpg" alt="" />
<figcaption class="figure-caption">Figure 3 - Semi-logarithmic construction of P&F chart on low priced shares</figcaption>
</figure>
 
The effect of this, obviously, is that a price change of only half the magnitude will be required to record the move on the chart when the share is trading below R20.
With the advent of computer-generated point and figure charts which are adjusted automatically, the need for defining box sizes as points or fractions of points has largely fallen away.
In South Africa, the box size is usually defined in cents, thus obviating the need to work in fractions of a “point” on lower priced shares. If you want to develop a P&F chart for a share trading under 100c, for example, your box size might be as small as 5c or less.
<h3 style="text-align: justify;">Reversal Size</h3>
The reversal size, as we have already seen, defines the magnitude of the price change required before the move is interpreted as a definite change in trend. Increasing the reversal multiple reduces the effect of whipsaws – which are often misleading – and also compresses the chart, allowing a longer history to be plotted.
The 3-point reversal is the most commonly used, although it tends to give longer-term signals. Single point reversals can be used if sensitive short-term charts are required, and 5-point reversals are sometimes used to monitor long-term primary trends.
As a general rule, the 3-point reversal is recommended as this produces the most reliable graphs for vertical and horizontal counts. These allow us to arrive at price objectives, which will be explained fully further on.
<h3 style="text-align: justify;">Dates</h3>
It is customary to record the passage of time on the point and figure chart itself in order to provide some frame of reference for interpretation. The most common method is to replace the X or O nearest the month-end with a number representing the month. The time frame will of course not have any chronological regularity with respect to the X-axis, but it will tell us when the share moved. For example, in the illustration below (figure 4), we can infer that XYZ share was volatile in May (5th month) but very quiet in June.
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure4.jpg" alt="" />
<figcaption class="figure-caption">Figure 4 - Illustration showing the manner in which dates are recorded on a P&F chart</figcaption>
</figure>
 
Some computerised packages use the letters A,B and C to represent the Oct, Nov and Dec months, as we have done in the example above.
While on the subject of dates, you will be aware that most point and figure charts are built up over the long term, and may reflect years of trading. They are not commonly used for short-term trading. It is often necessary to add to a chart only once a week or even less frequently.
 
<h2>FORMATIONS AND PATTERNS</h2>
 
The interpretation of the point and figure chart depends on the ability to recognise a number of fairly simple recurring patterns. The theory underlying the interpretation of the charts, of course – as with other technical graphs – is that the price movements are not random but follow a predictable and recognisable pattern.
 
<h3>The Double Top and the Double Bottom</h3>
The two basic formations in the point and figure chart are the double top and the double bottom. These provide the basic buy signal and sell signals on the charts, and they also form the basis of the more complex formations.
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure5.jpg" alt="" />
<figcaption class="figure-caption">Figure 5 - The basic double top (a) and double bottom (b) formations</figcaption>
</figure>
 
The illustration above (a) shows the double top formation. This is the basic buy signal in a bull market. The formation always consists of an up-move followed by a correction and a second up-move which surpasses the first. You will notice that the buy signal (B) occurs when the price breaks through the previous high (known as the “upside breakout”). The double top refers to the two X’s at 4900c.
The double bottom is simply the inverse of this pattern, shown in (b) above. It consists of a down move followed by a rally and another down move which goes lower than the first. The sell signal (S) occurs on the downside breakout.
Simple double tops and double bottoms are reasonably common throughout point and figure charts, either on their own or embedded inside more complex formations. Most analysts do not act on a simple double top or double bottom unless there is confirmation in the trend lines and supporting formations.
When a share has peaked or bottomed out it is customary to find the buy or sell signal occurring after a long rise or fall. This produces a formation which appears somewhat different but is just a variation on the straightforward double top or bottom. It is often characterised by a double bottom before an upside breakout, and a double top before a downside breakout (see diagram 6).
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure6.jpg" alt="" />
<figcaption class="figure-caption">Figure 6 - Upside breakout on a double bottom and visa versa</figcaption>
</figure>
 
As you will see further on, all of the more complex formations contain double tops and double bottoms. The investor is therefore often faced with the choice of acting on the first signal given by the double top or bottom, or on the later signal.
<h3 style="text-align: justify;">The Bullish and Bearish Formations</h3>
These signals are widely regarded as reliable indicators of bullish or bearish sentiment, and as confirmation of a trend. The basic principle of the bullish formation is a higher top followed on a higher bottom. Conversely, the bearish formation consists of a lower bottom after a lower top (diagram 7).
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure7.jpg" alt="" />
<figcaption class="figure-caption">Figure 7 - Examples of bullish and bearish formation</figcaption>
</figure>
 
In the two left hand examples, the “B” indicates the buying signal. In the third example, the “S” indicates the selling signal.
A share or sector can be regarded as bullish as long as the price continues to achieve higher tops or higher bottoms; likewise, a share can be considered fundamentally bearish as long as it continues to make lower tops and lower bottoms.
The first time that a share hits a high after bottom can usually be regarded as a very reliable buy signal, and vice versa on the bearish side.
<h3 style="text-align: justify;">Other Formations</h3>
The formations outlined thus far form the basis of all point and figure patterns. The other formations described by chartists are variations and combinations of the basic formations.
The triple top and triple bottom formations are obvious extensions of the double top and double bottom formations. The bullish and bearish symmetrical triangles are extensions of the bullish and bearish formations. Spread triple tops and bottoms are variations on the basic formations where the legs of the tops or bottoms are interrupted by shorter movements. The main variations on the basic formations are illustrated by Diagram 8.
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure8.jpg" alt="" />
<figcaption class="figure-caption">Figure 8</figcaption>
</figure>
 
In this illustration (a) and (b) show the bullish and bearish symmetrical triangles, (c) shows a triple top which breaks to the upside, (d) a triple bottom which breaks to the downside, (e) an irregular triple bottom which breaks down, (f) a spread triple top with a break in either direction, and (g) a broadening formation where uncertainty is increasing.
The interpretation of the formations depends largely on experience, but certain guidelines can be outlined. Generally, the greater (wider) the consolidation that underlies a signal, the stronger and more reliable that signal is considered to be. The basic double top on its own is not as strong a signal as a double top in a triangle; the triple top or bottom is considered even more reliable, and a spread triple top is better still – provided it breaks to the upside. Likewise, a double top in a bullish formation (i.e., low higher than previous low) is better than a simple double top.
There are many other patterns and variations that have been identified and named by point and figure analysts, but most of them depend on the two basic principles of double tops and progressively higher lows. Obviously, the formations can be extended almost indefinitely, and one gets formations with four tops or even five. Generally, the greater the degree of consolidation the more promising the eventual breakout.
 
<h2>TRENDLINES</h2>
 
The use of trendlines with line graphs has already been covered. Trendlines are also used extensively with point and figure charts, and some chartists, such as A. W. Cohen, argue that a bullish formation on the charts must be ignored if the trend of the share is not bullish. This view is not strictly adhered to by other point and figure analysts.
Trendlines on point and figure charts can be drawn in exactly the same way as trendlines on line charts. This is done by connecting three or more points on the chart (some analysts are content to connect only two points).
<ol>
<li style="text-align: justify;">W. Cohen suggests that the trendline on a point and figure chart should not be formed by connecting points but should always be drawn at a 45% angle from the lowest point established in the last bear run, or if this is not available, from the bottom of the last significant down move. There is no theoretical basis for choosing between these two methods. As Cohen (in Cohen, A. W. “How to use the Three-Point Reversal Method of Point and Figure Stock Market Trading”, published by Chartcraft Inc. Larchmont, N.Y., 1978) says, both are simple methods of drawing straight lines on a piece of graph paper. In our experience, adherence to the 45% trendline results in very reliable signals but necessitates a very long-term position in the market.</li>
</ol>
 
<h3>Support and Resistance Lines</h3>
As with line graphs, point and figure chartists use both support and resistance lines. The basic trendlines are usually divided into four categories.
<ol>
<li>Bullish support lines</li>
<li>Bullish resistance lines</li>
<li>Bearish support lines</li>
<li>Bearish resistance lines</li>
</ol>
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure9a.jpg" alt="" />
<figcaption class="figure-caption">Figure 9 (a)</figcaption>
</figure>
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure9b.jpg" alt="" />
<figcaption class="figure-caption">Figure 9 (b)</figcaption>
</figure>
 
The various support and resistance lines are illustrated in diagram 9 (a) and diagram 9 (b). They are largely self-explanatory. The bullish support line is drawn from a low at 45%, or by connecting successive low points; the bearish resistance line is drawn by connecting highs or with a 45% line taken from the highest peak. The bullish resistance line is always drawn from against a “wall” of O’s; the bearish support line from a “wall” of X’s.
The investor with a long-term position can ignore formation signals as long as the share remains above its support line in a bull run. Likewise, the long-term investor should not buy on formation signals unless the share has broken through the bearish resistance line. Obviously, the short-term trader can buy and sell between the lines.
You will notice that in chart (a), which has a 45 degree trend line, the buy signal at 1200c would have been ignored because the consolidation area had not yet penetrated the bearish resistance line. Similarly, the sell signal at 4000c in chart (b) would have been ignored because the formation did not penetrate the support line. 
<h3 style="text-align: justify;">Price Objectives</h3>
As we have already said, one of the great advantages of the point and figure chart is that, unlike the line graph, it allows the investor to make a rough prediction as to how high or how low the price of a share will rise or fall. Again, there is no theoretical basis for this technique, and no one – as far as we know – has satisfactorily explained why the vertical and horizontal counts work. But they do seem to work, and many analysts swear by the technique.
Before moving on to the counts, it should be noted that the bullish and bearish resistance lines in themselves give a rough indication of the maximum possible price move on any particular leg of the move. It is fairly uncommon for a share to penetrate its resistance line, especially if this is a 45 degree line.
<h3> The Horizontal Count</h3>
Of the two methods of counting for a price objective, the horizontal count is the more widely used. The principle is that an area of consolidation can be used to predict the subsequent price movement. In practice, the technique involves counting the maximum number of blocks (or points) across a horizontal consolidation area. The count is taken from the column in which the buy signal is identified and should include as many points as form an uninterrupted line. Provided one begins in the column giving the buy signal, one can use any line in the area of consolidation. Once the count has been established, it is multiplied by the reversal size and added to the last low in order to give the price objective.
In chart figure 10 (a), we have a buy signal at 1250c with a combination bullish formation and an irregular triple top. In order to determine how high, the share could go at the time of the buy signal, we would have begun with the column in which we had the buy signal and counted to the left to establish the degree of consolidation in the period of accumulation. Our best count was at the 1100c level (adjacent to the letter “H”), giving an unbroken count of 10. As this is a 3-point reversal on a 50c box, our count is 50 x 3 x 10, which gives us 1500c. This, added to the 850c low, gives us a price objective or 2350c.
In general, you will find the horizontal count is conservative and usually bull runs exceed their targets by about 20%.
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure10a.jpg" alt="" />
<figcaption class="figure-caption">Figure 10 (a)</figcaption>
</figure>
 
For an example of the horizontal count go to an article in the PDSnet forum - <a href="/index.php/upside-target/">Upside Target</a>
You should read the article referenced above and then consider what has happened to the S&P500 index since:
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/images/SP_500.jpg" />
<figcaption class="figure-caption">S&P500: February 2014 - April 2021. Chart by ShareFriend Pro.</figcaption>
</figure>
 
Here you can see that the S&P500 has far exceeded the target predicted by the horizontal count in the article.
 
<h3>The Vertical Count</h3>
The vertical has generally not achieved the same popularity as the horizontal count and is usually regarded as slightly less reliable. It can be used on volatile stocks where there is not sufficient consolidation for a horizontal count, or where the share oscillates dramatically with long legs on the up and down moves.
The vertical count is always made in the column that gives a buy signal, and ideally after a double bottom. The count in the up-move giving the buy signal is multiplied by the box size and the reversal size, and this is added to the low to arrive at the price objective.
In figure 10 (b) below the share gave a buy signal at 2800c (where the “B” is). The column contains 9 points, and our count is therefore 9 x 100 x 3 = 2700c. This is added to the 2100c low to give a price objective of 4800c. The share reached 4700c.
 
<figure class="figure"><img class="figure-img img-fluid" src="/onlinecourse/img/mod27_figure10b.jpg" alt="" />
<figcaption class="figure-caption">Figure 10 (b)</figcaption>
</figure>
 
<h2>CONCLUSION</h2>
In general, point and figure charts are slower than the more modern line charts, but their signals are more reliable. They are especially suited to the medium term trader who wants to take advantage of the major swings in the market rather than the smaller fluctuations.
For a good example of the horizontal count and point and figure charting, refer to an article on the PDSnet website by clicking <a href="/index.php/sp500-going-to-3506/">here.</a>