Back to Basics
With all these Xs and Os, how do I know when I win?
Editor's Note: This is a reprint of a previous article. Illustrations are courtesy of Dorsey, Wright & Associates.
Because I have worked with them for so long, I tend to forget that point and figure charts are not as intuitive as, say, bar charts. Actually, I remember when I first saw a point and figure chart and it looked like the craziest mess of Xs and Os that I'd ever seen. In fact, I remember thinking that I would never give up bar charts for those crazy X and O things. Well, never say never.
Because so many questions keep rolling in, I want to take some time to go over point and figure basics.
The basic point and figure chart shows a column of Xs, which simply indicates the stock is rising and a column of Os, which means the stock is falling. Put in simple supply/demand terms, Xs mean demand is in control, Os mean supply is in control.
Columns of Xs and Os alternate back and forth -- they never appear in the same column. Remember, point and figure charts move according to significant price action, not time. For the first action taken in a month, a number or letter is used to designate that particular month. This is how we show the time on the chart and it's used more as a marker or time line than to suggest anything important about the action itself.
We use the three-box reversal methodology of charting. This means that it takes 3 boxes to reverse from one direction to the other. For example, if a stock were trading in a column of Xs with a top of 45, it would take a move to 42 to reverse this chart to a column of Os. Going in the other direction, if a stock were trading in a column of Os with a current low at 45, it would need a rally to 48 to reverse the stock back to a column of Xs. I say three boxes, instead of points, because the box size is determined initially by the price of the stock.
Units of Charting :
0 - 5 = .25 point per box
5.50 - 20 = .50 point per box
21 - 100 = 1 point per box
102 - 200 = 2 points per box
200 + = 4 points per box
These initial box sizes are simply guidelines. It is often helpful to expand or contract the box sizes to gain a different perspective on the chart; similar to the way a barchart can be viewed in terms of monthly, weekly, daily, etc. activity.
We plot the chart based on the high and low of the day, not the closing price. While the closing price can be significant, it can also simply be the last transaction of the day; in other words, sometimes a cigar is just a cigar. The high and low is a better descriptor of what the chart is representing.
To recap our initial lesson:
- Xs mean the stock is rising; demand is in control
- Os mean the stock is falling; supply is in control
- I follow the three-box reversal method, which means each column must have at least three Xs or three Os
- Never will you see an X in a column of Os or an O in a column of Xs
- Charting is based on the high and low
As I mentioned before, I do look at other types of charts, but for most of my decision-making I rely on the point and figure chart. A point and figure chart has both advantages and disadvantages. Advantages include the fact that it is easy to quickly evaluate a stock on a point and figure basis, noise is eliminated and only significant price movements are recorded, trend lines are easy to draw and identify, and price targets are simple to calculate. Disadvantages include the fact that gaps are not recorded and that time and volume is not a consideration. But those disadvantages, in my opinion, are easy enough to overcome with the addition of those tools. In the old days, before fast computers, this was more of a problem, and consequently technicians were more inclined to specialize in certain charting techniques and specific types of analysis.
Tomorrow we'll look at a simple flow chart that helps us determine how to chart a stock price in the point and figure methodology.
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