Understanding Point & Figure Charting

July 9, 2022No Comments

Hello, and welcome once again to the Smart Money Dumb Money show and I’m your host, Keith Richards. I’m a technical analyst and I’m also the president and chief portfolio manager here at ValueTrend Wealth Management. And today is, I had to check there, July the seventh, it’s Thursday, July the seventh. And I’m going to talk about something a little different today. We’re going to do a bit of an educational video. Now, many of you that are watching this video, read my blogs on a regular basis, and I’m sure quite a few of you have even taken the technical analysis course, or at least have enrolled in it. Now that course describes everything that I do. I shouldn’t say everything, but I’ve condensed the most important things I do as a technical analyst when I am trying to discern what the market is going to do and how much cash I should hold.

 

I talk about different things like trading rules, identification of trends, how to go in, how to go out. How do you stop out of a losing position? How do you take your profits? How do you know when to do these things? Talk about the psychology, but I always refer during that course and in my books and on my blog to traditional type of charting methods. And that usually comes down to either line charts, bar charts, or my preferred way of doing things, which is candlesticks. Now, from a realistic point of view, that is what I do on a daily basis. I look at candlestick charts and I draw the moving averages and whatnot that I am sure you are very familiar with. However, once in a while, I like to look at what’s called point and figure charts. And it’s interesting because this is a methodology that is not used a lot.

 

Now, when I first got involved with technical analysis, it was interesting because I used to draw my own point and figure charts. Now I’m not an expert on point and figure. It’s something I don’t use enough or fanatically enough to say that I could trade off of a point and figure chart. Now some people do and they do it very successfully, but I thought I would give you a basic introduction to point and figure charts on this video, just to introduce you to the charts and just introduce how I use them. As I said, I don’t use them every day, but once in a while, like when I’m looking at the big picture such as the S&P 500, which we will look at today on a point and figure chart, I want to know what is the bottom line trend. And if we’re seeing any kind of reversal, and that is the benefit of point and figure charts. They help you identify, you know, no nonsense chart trends and no nonsense reversals. Is it happening or not?

 

And so I think it’s a way of simplifying our outlook on the markets. It’s got its flaws just like everything else, but let’s take a look at the point and figure method of charting. I’m not going to get into all the different nuances of using point and figure, but I’ll get into the basics and maybe this will help you with one more tool just to do a quick glance at the markets and have a pretty darn straightforward answer as to whether it is trending up or down. So let’s, let’s go right to it. And I’m going to, I put together a little bit of a PowerPoint and I use PowerPoints whenever I have to insert both charts and concepts and drawings. So that’s what I’ve done today. So this is point and figure made easy. It’s not a full on lesson on how to use point and figure.

It’s just a simplified understanding of how to use them. So some of you may be familiar with point and figure charts. And if you are, this will be basic for you. In fact, this entire video will be basic for you, but for those who are not, the point and figure charts are a series of X’s and O’s just like Tic Tac Toe and the difference between Tic Tac Toe and a point and figure chart is that it’s involving stock prices. And we’re going to assign a positive move on the market by a certain amount of price point, an X, and we’re going to assign a negative move by a very defined level of price point, a zero, an O actually. So we’re going to use an example here. This is very simplified. We’re going to say that the market must go up at least a dollar in order for a new X, and it must go down at least a dollar for an O on the chart.

 

So when we say a dollar, though, it can be anywhere from $1 minimum to less than $2, because $2 is a second X. I hope, you know what I’m saying? So if we got a $2 and 25 cent move, we put two Xs on the scale, but if we got a $1 and 99 cent move, we’d only still have one X on it, because it hasn’t hit a second full dollar. So $1 box, we call these boxes, means anywhere from a dollar to a dollar 99. Now the interesting thing about point and figure is that time isn’t the issue. It’s price. It’s a purists way of looking at price on a chart. So the example I’ve got here, I stole it off of some site on the internet and I’m sorry, I can’t give credit to who they are because they didn’t have the name. But it’s a it’s a pretty simple example.

 

And you’d find this in almost any textbook of point and figure. And basically they’re using a $1 box with a $1 reversal, like you only need $1 in the opposite direction for a reversal. Now typically in real life, and we’ll be looking at real life examples in a minute, people tend to use three boxes before they do a reversal and trend. And you’ll understand what I mean by this in one second, but let’s use just, let’s just get the basic understanding of how this works. So this is a ABC stock and on day one it’s 22 bucks. The next day it’s 23 bucks. The next day it’s still $23. The next day it’s 24, 25, goes down to 24 and then 21. So let’s see how we would draw this. So remember the X’s are going up when the market’s going up. So day one it was $22.

 

So you put the X in the box. Well, we had a $1 move the next day. It went from 22 to 23 and it could have been 23, 25, you know, a dollar 25 move, but to keep it simple, it went up to 23. So we put another X. There’s your $23. It goes up to 24 there. We put another X 24. Goes up to 25 here, we put another X here. Now it falls a dollar. Goes down to 24 on day six. So you put an O right there. All right? And so on. Now I want to just explain. So the next day it fell from 24 to 21. So you had to draw an O, an O, and an O all the way down to 21, alright, to represent the new trend. I want to explain something. If this was a three box reversal, what would happen is when it went from 25 to 24, it would’ve not put an O here yet.

 

You would wait. And then here it went from 25 to 24, then 21, well, a three box would be $3. So 25 less three would bring us down to 22. Well, we certainly got below 22. So you would’ve actually put your O’s. You still would’ve started at 24, but you’d go 1, 2, 3, boom, all the way down to 21, because you hit your minimum of $22 in this case. Okay? So that’s how these things are constructed and I’m just going to bring you to the next step, which is, well, how do you know what box size to use? Like I use an example of $1 there for your box size, but if a stock is trading at say, Bitcoin is trading at $25,000 or something like that, then a dollar move, you’re gonna have so many X’s and O’s on your chart. It’s crazy.

The whole idea of using point and figure charts is to condense the information so you can just see the raw trend and not have too much noise on the screen. So let’s look at, if we were actually looking at Bitcoin, we’d probably use a $500 box. All right? And in fact, this scale that you’re seeing on the screen is the standardized scale. Now you could change that, but in the case of the S&P 500, because the S&P 500 right now, anyways, is between 2500 and 25,000, you’re gonna use $50 boxes. And that’s just sort of the standardized you’ll find that everywhere. Doesn’t mean you can’t change it. Okay? Because maybe closer to $25,000 on the index is a big difference between 2500 and 25,000. So you might wanna make it a hundred dollars and $200 or $500 or something like that, but this is a standardized skill.

 

So that’s the traditional way of doing it. There’s also percentage scaling. And what’s interesting about percentage scaling is it’s a little bit similar to using logarithmic charts with traditional charting methods. And that means that we can assign a percentage move. So not just a dollar because what we were just looking here, like gosh, a stock or an index that’s 2,500, a $50 movement is a lot different on this index that has moved say to 24,000 versus when it was 2,500. You’ll agree with that. It’s a more significant move. So percentage scaling is taking away that problem, just like using logarithmic charts do on traditional charts. And that is that, we’re using a make believe example here, a 5% box would be pretty big box. But we’re using a hundred dollar stock and if it had 5% scaling, it would have to go to $105 to get another X.

 

Now of course, as the stock price goes up or down, that percentage is always a percentage. So instead of it being a box dollar size, it’s now a percentage. So let’s pretend it went from a hundred to 105 so you put an X. Well now it’s got to go up, if you think of it, 105 times, 5% is something like $5 and 5 cents or something around that range. So we’re going to say that it’s going to be an exponential increase over time based on this percentage thing. So it actually more accurately reflects the importance of the move. So I’m a big believer in logarithmic charts, which are basically percentage based. Or if you’re going to look at a point and figure chart, it’s not a bad thing to use the percentage scaling. And if you use stockcharts.com, then you can actually adjust the point and figure from traditional, which is using this scale, to percentage.

And it’s just a little drop down box and you can do that. All right. So we’re just gonna focus here on a $50 box still because the S&P is where we are. But just before we get to the S&P 500, we’re going to just understand a couple of the things you can do without getting complicated, because boy, there’s a lot of stuff that you can look up on point and figure and just confuse yourself to death. But here we have the example. So we had the market going down then it reversed, three box reversal by whatever the dollar figure was. And then you started drawing X’s and so on. You can see how it works here. We had an X and then it stopped and it reversed. And then it started to climb again, but it stopped at exactly the same level within, let’s pretend we’re on the dollar scale, between one and 1.99.

 

It stopped within that price range. So it’s a very neat and tidy point of resistance. And as soon as we get two X’s, we call that a resistance level in point and figure. So as you get two O’s, same thing. Okay. Now, so that would be, two O’s would be a point of support. Now here we have three O’s and in traditional point and figure speak, we would call that a triple bottom. So again, you can go into a much bigger deep dive on point and figure, and you’ll learn about things like double tops and triple bottoms and that kind of thing. But I just want you to understand that it’s a very neat and tidy way of identifying support and resistance. It’s also a very neat and tidy way of identifying the near term trend. If the X is, if you’re getting X’s, you’re in an up trend, at least on the near term.

Now obviously the faults of this is that your box size may be too small or too large, and that may cause reversals quicker or slower, depending on the box size and the reversal. So do you use three boxes to reverse the trend or did you use two boxes? So that’s completely up to you to change that, but the tradition in the industry is to use three boxes. Okay. And use that price scale per box based on what we just saw a minute ago or a percentage. So let’s take a look at a traditional chart first, and we’re just going to do a quick look at this, just to see one way that the point and figure charts can kind of eliminate a lot of the noise. So what I want to look at is in 2021, there was a very low volatility period on the S&P 500.

 

You can see that, you know, normally markets move up and down. This was the COVID crash, but you do get sort of pullbacks here and there, and they can be reasonably big. You know, you scare people a little bit, even if the trend is up. But in 21, up until about August or September, we saw very, very flat moves. We didn’t get a lot of the bigger moves up or down. So that was a period where it was really just going up without the need for really looking at all this noise, because the moves down weren’t tradeable, let’s say, the pullbacks weren’t tradeable. So if we look at a point and figure chart using the $50 boxes, which is what the traditional scale suggests, and we say three box reversal, which is 150. So this is the S&P 500 we’re looking at.

So you need 150 points before you start drawing O’s, okay. Or X’s if it was in a down trend. So here’s, if we go into 2021, basically see how condensed it is compared to 22, which so far has probably twice as much distance as the entire year of 21 had. And that’s because a lot of that move was taken up in one big up trend here. You could just do a whole bunch of O’s, of X’s I should say. All right, same with COVID, boom, crash and bang. It was a big move down, followed by a rally and another big move down and followed by a giant up trend. And then, you know, sort of some volatility after that, but you can see that sort of it takes time out of the equation. It reduces the noise you’re looking at.

And if we go to the percentage box, you’ll see something very similar. In fact time, this is 21, this is 22, was very much reversed. You can see, I shouldn’t say reversed, it was very much condensed by using a percentage scale. Like the year was more or less up. And you can see on the percentage scale, you had one little drip down there, but generally speaking, it went up, reversed a little bit and then went up some more. So pretty straightforward way of looking at what happened in 21. The market went up and I was using here, this is my own adjustment, I decided to use a one and a half percent box. So the market would have to move one and a half percent. And remember, that’s a logarithmic way of looking at things because one and a half percent is always, as the market goes up, it’s always a higher amount of dollars for the stock price.

 

I use one and a half percent in a three box reversal. Okay. So you can see it’s a slightly more condensed way of looking at the market sometimes. Okay. Not always, but it can be. So just as a quick summary, the point and figure charts, I think one of the real values is that they can be used to discern the near term trend. And it’s also good for identifying support and resistance levels. If you’ve got two X’s in a row that is a, or at least within a period of time, that’s a pretty darn crisp, clean way of saying here is where resistance is and same with two or more O’s in a row. You have a good level of support. It’s a very clean price. So that’s the positives. The hard part about point and figure is adjusting the box sizes and the number of boxes to get a reversal.

 

It’s really an art. And I must say, I typically use the default when I’m looking at stockcharts.com or any other software package. Now, the other thing is I’m going to disclose again, is I don’t look at point and figure all the time. I look at it when I’m trying to discern what the near term trend is. So I’m looking for the X’s and the O’s, and see if I have seen enough of a move to decide that this move up or down is significant within the context of an existing trend. Is it reversing anything? And we’re going to just go back to the S&P charts in a minute to actually exercise on that. So I don’t use them in isolation. I use them as a quick way of looking at the market. So let’s take another look here at the S&P 500.

 

And you can either look at the traditional $50 boxes or the one and a half percent boxes that I’ve drawn here. But what you’ll see is, I’m doing this on July 7th, the market is moving up right now. Okay. A little bit. It’s having a rally within the bigger context of a bear. All right. So the fact that as of yet, we do not have that three box reversal. So four and a half percent or whatever or $150, if we want to use a $50 box, we don’t have those figures in place to cause an X to be put, say here, a reversal like we got right here. All right? So we are still maintaining a series of O’s, which is a series of at least 1.5% draw downs periodically. Doesn’t have to be per day. It can be accumulation of 1.5% down, and then you get another O over the next few days.

 

So we’re still in that negative looking chart, even though if you looked at a traditional chart you’d see, oh, we’re getting a rally right now. Well, the rally’s pretty tepid. And the point and figure chart is telling us that that rally is not strong enough yet to influence too much confidence in this market. So you see, that’s why I did this video. I actually looked at a point and figure chart this morning just to see, oh, has this rally changed anything based on a one and a half percent reversal or based on a series of three $50 reversal? And the answer is no. The market is still making Os. And that’s the simplest way of looking at it. It’s going down despite the very, very near term tepid rally we’ve had. So that’s probably the, the conclusion for today on how I like looking at point and figure charts.

 

There are many more ways of looking at them, discerning patterns and stuff like that. I don’t use them in that way, but you may be interested enough to check that out for yourself. And I hope you do. You never know if maybe I’ve introduced you today to something that will work out to be a very, very good trading method. My method is more using traditional charts, and particularly candlestick charts because I like candles. And if you take my course or read my books, you’ll know that I do, but at the end of the day, it’s whatever works for you. And I think you can incorporate, even if you follow my methodology which is more traditional analysis, I think you can incorporate using point and figure when you’re just a little bit puzzled as to whether you should jump on this train. So in the current market, we’re having some upticks on the market, but maybe the point and figure chart suggests don’t jump on it. Okay. So I hope that helps. It’s just one more method of filtering out the noise and that’s all we’re after doing. And thank you for watching the video today. And I hope that helps. And as always, I’ll be back next week. See you then.

 

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