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Implementing Point & Figure Analysis for Context: ATML


Time to drill down into the process!


After seeing the earlier piece on the ACI failed shakeout pattern, Minyan Roz wrote in to ask:

"I notice you referencing a failed shakeout pattern in ACI (Arch Coal) which closed in a hammer candlestick, while you referenced another coal company MEE (Massey) as having a triple bottom break.

However MEE, like ACI (or most energy names including APA ECA, EOG etc) also closed in a hammer or doji candlestick formation. Some are more like gravestone doji (which at the end of several days' pullback suggests the next move is up), others more like a hammer, which has similar implications after a fall.

I would love to master point and figure and figure out how to integrate it with what I currently do in selecting entries and sectors."

-Minyan Roz

Point and Figure charts provide a context for determining which way the river is flowing, but in short-term trading they are not quite as useful for keying entry points as other tools. An analyst using PnF alone may note a breakout or breakdown and suggest something very vague like "buy on a pullback" or "sell on a bounce." Unfortunately, that is not very helpful when every penny counts. And in short-term trading, even with commissions and round trips low, every penny counts.

A position trader who is willing to allow the PnF charts to "breathe" and go through their inhales and exhales, can get away with the occasional wide swings on the PnF charts if she can withstand the pain. For example, if the position trader bought ACI on the reversal up on the shakeout at 84, the nearest stop loss based on the chart (the double bottom at 80, was a 5% loss excluding trading costs; nothing inherently wrong with that, but not all traders can or want to withstand 5% losses on a trade. Therefore, it is critical to define time frame and style and build your tool kit accordingly.

I find it helpful in trading to know which way the river is flowing. It's almost always easier to paddle with the current than against it. The most important PnF characteristics I look for are trend (what is the primary trend?), signal (are we on a buy or sell signal) and location (where is the most recent pattern taking place?). Finally, as a trader, I want to ask "what time is it?" For that I use other tools. Let's look at an example.

Atmel (ATML) is a stock that might have shown up on a screen for a spread triple top breakout. I like breakouts through spread triple tops because the "spread" part of the formation (indicating an interval between the prior touches at resistance) often show that an important area of prior resistance has been broken after an interval of time, or a pause to regroup. So, I pull up a PnF chart of ATML, which I know has broken a spread triple top.

Here is ATML with the spread triple top identified.

The move through 4 pushed through two prior tops, creating the spread triple top breakout. But that is only part of the story. If we were reading a book, this pattern would be like the very first sentence. It says, "Something happened one day." And that's it. No context.

So let's look at the trend. Here is ATML with the long-term trend defined.

The stock has broken the spread triple top and is now closing in on long-term, multi-year trendline resistance.

Now, what about the location of the pattern itself? The buy signal is positive, the long-term, multi-year trend is negative, what can we learn from the pattern's location?

Here is ATML with the pattern located within its neighborhood.

Interesting. This puts everything in a larger context; new buy signal, higher low formed in August 2005 creating a more intermediate term uptrend, former resistance at 4 now initial support, resistance overhead defined by prior top in January 2004. Now we're getting somewhere.

So, we have a stock improving in the short and intermediate term, but approaching a long-term inflection point. What time is it right now? As we know from the work of pioneers such as Tom DeMark, the trend is not our friend, it's our enemy.

Let's look at the TD-Sequential for clues.
(Chart courtesy Thomson Financial)

So, now we have a complete technical picture of the stock. Short-term buy signal, short and intermediate term uptrends that according to the proximity of the long-term trendline and the just completed TD-Sequential 13 "sell" signal are very likely exhausted.

Since we know where nearest support is, 4, and where the intermediate uptrend is, we now have the means to formulate a game plan for trading this and establishing risk reward parameters, either short or long, that are not vague, but specific and focused.

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No positions in stocks mentioned.

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