Chapter 3 – Understanding Point and Figure Charts

Before you can use Point and Figure charts, you need to understand what the charts are telling you. Because no time is involved in their construction, the chart can show one thing only: uncontaminated supply and demand. Uncontaminated, because the chart is not showing anything else – no time, no volume, nothing else which may distort the true interaction of the demand from buyers or supply by sellers. Remember, a Point and Figure chart does not change unless the price changes by the pre-determined amount. The passage of time, which causes all other chart types to ‘move’, makes no difference to a Point and Figure chart. Remember also that, in order to move the price, volume is required, so that although Point and Figure charts don’t use volume they do indirectly show volume by way of the changing price.

Point and Figure charts show the market interaction extremely clearly. Demand pushes up a column of XS and supply pushes down a column of Os. It’s as simple as that. A Point and Figure chart is, therefore, a picture of the market’s fear and greed, accumulation and distribution, and this gives rise to support and resistance levels created by these emotions. The support and resistance levels are created when the price reaches a level of equilibrium, where supply and demand are balanced. This is the change-over point. It is the point at which demand gives way to supply and an 0 is plotted, or supply gives way to demand and an X is plotted.

Point and Figure signals

One ofthe great advantages ofPoint and Figure charts is the unambiguity ofthe buy and sell signals they generate. Of course, not every signal will result in a profit, but the fact that the signals are unambiguous makes the charts easier to interpret. These buy and sell signals are created by demand overcoming a resistance level or supply overcoming a support level. This can be seen in many ways, from simple patterns to quite complex ones. Furthermore, the terminology used to identify many of the patterns has changed over the years. Although this terminology does not affect the way the patterns work, it is important to understand the differences and the changes. There are also differences in the way patterns are treated in 3-box and I -box charts; so instead of dealing with them separately, they are dealt with together so that you can compare and contrast them.

Double-top and bottom patterns

If, on a second attempt, demand, represented by a new column of Xs, overcomes supply and the column of Xs breaks above the previous column of Xs (above the blue line in Figure 3 – 1 ), this is the most basic Point and Figure buy signal. This pattern is essentially a 3-box reversal pattern that has little or no significance in I -box reversal charts. Originally, the pattern was called a semi-catapult, and that name was applied to the pattern whether it appeared in 3-box or I-box charts, although the two charts tend to have a completely different look. Since

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Cohen’s work on 3-box charts, however, it has become widely known as a double-topI I buy signal. It is an unfortunate name because many will associate double-tops and double­ bottoms with M and W patterns, which occur as reversal patterns at the ends oftrends in bar and line charts. The Point and Figure double-top (note the hyphen) and double-bottom patterns give buy and sell signals, respectively, when the double-top or double-bottom is breached, as you will see.

Because Cohen ignored I-box charts completely, it is best to refer to the pattern in Figure 3-1 a s a double-top when looking at 3-box charts and t o the pattern in Figure 3-2 a s a semi-catapult when referring to I-box charts. They are, in fact, the same pattern created from exactly the same data and in both cases the signal occurs when, after a small correction, an X is plotted above the highest X in the pattern. But recall that I-box charts offer more detail than 3-box charts and so the chart will look different. For this reason it is just as well to differentiate by using separate names.

Figure 3-1 : Continuation double-top buy signal in 3-box reversal charts

I I I n a double-top pattern, the breakout column of Xs must break above the previous column of X s . Prior t o the breakout there will have been two level Xs in a row, with an empty box between, hence the name double-top. In a double-bottom pattern there will have been two Os in a row.

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x … Buy

XXX X0XX0 X00X X0

X

Figure 3-2: Equivalent semi-catapult in 1 -box reversal charts

Whereas there is only one version of the 3-box double-top pattern (Figure 3-1), there can be many different variations of the I-box semi-catapult pattern (Figure 3-2). This is because there are a number ofways in which the price can oscillate before breaking out. The essential ingredient, however, is that there must be an advance, which is pushed back, then at some stage – the catapult point marked with the arrow – the price breaks above the highest column in the pattern.

Figure 3-3 shows a small sample of semi-catapult patterns in I -box charts.

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Figure 3-3: Variations of bullish semi-catapults in 1 -box reversal charts

Conversely, if supply, represented by a new column of Os, overcomes demand and the column ofOs breaks below the previous column ofOs (below the red line in Figure 3-4), this is the most basic Point and Figure sell signal. It is called a double-bottom sell signal in 3-box charts and a semi-catapult in I -box charts. The signal occurs when an 0 is plotted below the lowest 0 in the pattern.

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Figure 3-4: Continuation double-bottom sell signal in 3-box reversal charts

I-box variations of the semi-catapult sell are shown in Figure 3-5 below. These are the inverse of those shown in Figure 3-3.

Figure 3-5: Variations of bearish semi-catapults in 1 -box reversal charts

Continuation as well as reversal

In 3-box charts, it is important to note that double-top and double-bottom patterns can be either continuation or reversal patterns. That is to say, they can either occur after a pause during an up or downtrend, or at the end of a trend as a trend reversal. There is no distinction between them other than that continuation patterns shown in the previous Figure 3-1 and Figure 3-4 comprise at least 3 columns, and reversal patterns shown in Figure 3-6 and Figure 3-7 opposite comprise at least 4 columns. This is simply because a continuation pattern requires that the same column type (X or 0) leaves the pattern as entered it. Therefore, a column of Xs entering the pattern leads to a reversal of a single column of Os, which in tum leads to a second column of Xs leaving the pattern in the direction the pattern was entered. The same applies to a double-bottom pattern where a column of Os enters and a column of Os leaves after a single reaction column of Xs.

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Double-top and double-bottom reversal patterns in Figure 3-6 and Figure 3-7 below have at least 4 columns because, by definition, the column type leaving the pattern is the opposite to that entering the pattern. The buy and sell signals are the same, except that the buy and sell signals generated from a continuation pattern are more reliable because they are in the direction of the prevailing trend. Reversal signals, on the other hand, are a complete change of mood and may initially be unreliable, or at least should be treated with caution.

Figure 3-6: Reversal double-top buy signal in 3-box charts

Figure 3-7: Reversal double-bottom sell signal in 3-box charts

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Reversal patterns in 1-box charts

In I-box charts, continuation and reversal patterns have different names. As you have seen, continuation patterns are called semi-catapults but reversal patterns are called fulcrums and take on many forms that are discussed in more detail on page 137. However, they need to be introduced here to explain I -box reversal patterns.

For a reversal to occur, there must be a move into a pattern and a move out in the opposite direction. As you have seen, in Figure 3-6 and Figure 3-7, this is quite straightforward in 3-box charts, but in I-box charts there are many variations, as shown in Figure 3-8.

Figure 3-8: Variations in bullish fulcrum patterns in 1-box charts

The patterns shown in Figure 3-8 all translate into reversal double-top patterns in 3-box charts and this illustrates how many more variations there are in I -box charts. I -box charts issue buy signals when the price breaks above the high X in the pattern. They give sell signals when the price breaks below the low 0 in the pattern.

You will have noticed so far that in 3-box charts there is always a column in the opposite direction between the breakout column and the previous column in the same direction. This means that the minimum number of columns in a double-top or bottom pattern is three. This is not the case with I -box charts, the reason being that these can have an X and 0 in the same column during the one-step-back process as discussed on page 62. Every time there is a one­ step-back in an uptrend, there will be two Xs adjacent to one another. If the trend continues, and a second column of Xs breaks above the previous X, this is a reinforcement of the uptrend and is regarded as a continuation, or weak buy signal, shown by the thin blue lines in Figure 3-9 opposite. It is more a case of ‘all is well’ signal rather than ‘act now’ signal.

As the trend matures, it will eventually encounter resistance and some sideways congestion will occur. The breakout ofthis sideways congestion is called a semi-catapult and is regarded as a strong buy, shown by the thick blue line. The semi-catapult, as you have seen already, is in most cases equivalent to a double-top buy signal in a 3-box reversal chart.

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What defines a pattern as a semi-catapult, and therefore adds to its strength, is white space: unfilled boxes across the top ofthe pattern. In chapter 5 you will see that, when analysing 1- box charts, the Os have been dispensed with and the chart is constructed using the original Point method ofXs only. This makes pattern identification much easier and is recommended. However, for the understanding it is better to distingui——-sh between Os and XS at this stage.

Figure 3-9: Weak buy and strong buy semi-catapults in 1-box charts

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Figure 3- 1 0 shows a downtrend in a I -box chart. Weak sell signals occur on the continuation after a one-step-back, shown by thin red lines. A strong sell occurs on the breakdown from the semi-catapult.

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Figure 3-1 0: Weak sell and strong sell semi-catapults in 1 -box charts

Signals may be graded according to the width of the semi-catapult. A simple 3 column semi­ catapult is not going to be as strong as a 6 column one.

Chart 3-1 is a 50 x 1 Point and Figure chart ofthe FTSE 100 Index showing all the uptrend semi-catapult buy signals designated by a horizontal blue line, as well as the weak one-step­ back buy signals designated by a red horizontal line.

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Chart 3-1 : 50 x 1 of the FTSE 1 00 I ndex showing weak and strong buy signals

All Point and Figure patterns which generate buy and sell signals are built around the basic patterns discussed above. In the case of 3-box charts it is the double-top and double-bottom, and in the case of I -box charts it is the semi-catapult and fulcrum. Some authors go on to list tables of patterns, but the need to learn patterns indicates a lack of true understanding of how a pattern is created. Although a number of patterns are shown and discussed below, it is to illustrate how and why the patterns are created. There is no point trying to learn dozens of patterns; it is better to understand what causes them.

Triple-top and bottom patterns

As stated earlier, all Point and Figure patterns which generate buy and sell signals are built around the two basic double-top and double-bottom patterns; however, the stronger the resistance or support, the more important the subsequent buy or sell signal. Consequently, a triple-topl2 buy (Figure 3-11) or triple-bottom sell (Figure 3-12), where the level breached has been attained twice already, will lead to a stronger move.

1 2 You will have seen that in a double-top pattern, the breakout column of Xs must break above the previous column of Xs. In a triple-top, it must break above two columns of Xs. Prior to the breakout there will have been three Xs in a row, hence the name triple-top.

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The reason that the wider pattern generally leads to a stronger and more reliable signal is that the battle for control has taken three upthrust columns instead of two. Having been forced back twice, demand from the bulls eventually manages to overcome supply on the third attempt by breaking up above the resistance level. This catches the bears off-guard because they will have built-up confidence every time they managed to push the bulls back when the price reached the same level as the previous column ofXs. Bears taking out shorts on the blue line resistance level will find that they are on the wrong side and have to cover (buyback their shorts). It is this process that leads to potentially good moves.

Figure 3-1 1 : Continuation triple-top buy signal in 3-box reversal charts

Figure 3-12: Continuation triple-bottom sell signal in 3-box reversal charts

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Once again, the opposite applies when considering a sell signal as in Figure 3-12. The battle for control has taken three downthrust columns instead of two. The bears, having been forced back twice, eventually manage to overcome bullish demand by breaking down below the support level on the third attempt. This time it is the bulls who are caught off-guard. They will have gained confidence because every time the bears pushed down a column of Os the bulls gained control again at the same level as the previous column of Os. Bulls taking out longs on the red line support level will find that they are now on the wrong side and will have to close their longs quickly.

1-box charts

In I -box charts there is no distinction between the patterns as there is with 3-box double-top/ bottom and triple-top/bottom patterns. The only difference is that the I-box continuation semi-catapults and I -box reversal fulcrums are wider, as shown in Figure 3 – 1 3 .

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Figure 3-13: Variations in bullish fulcrum patterns in 1-box charts

In each case the patterns shown in Figure 3-13 translate into 3-box triple-top patterns. Obviously ifthe patterns were inverted, they would translate into triple-bottom patterns.

There are dozens of variations of these basic patterns. There is no need to list them all, provided you understand how the basic patterns are formed and what they represent. Remember, they represent the fear and greed leading to distribution and accumulation within a range where one side of the pattern – support or resistance – gives way. The wider the pattern and the more times the levels are tested, the stronger the resultant signal and subsequent move in that direction. Just like double-top and bottom patterns, triple-top and bottom patterns can be continuation, as well as reversal patterns.

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The Definitive Guide to Point and Figure

Compound patterns

There is no point looking for the perfect pattern, you won’t find it. Instead, you will see combinations and variations ofthe standard patterns like the ones below. The important thing in Point and Figure analysis is ‘looking left’ and understanding what creates the patterns. Look left on the chart and make a subjective decision as to the support or resistance being offered by previous columns of Xs or Os, remembering that the more times a level has held, the stronger it will be. Figure 3-14 has probably been given a special name by someone, but the name is not important. What is important is that this is just a variation of the triple-top. In fact, the diagram in Figure 3 – 1 4 would be a semi-catapult if it was a I -box reversal chart.

Figure 3-14: Variation of triple-top buy signal in a 3-box reversal chart

In Figure 3 – 1 4, column 3 fails to reach the level of column 1 , which has bearish implications, but column 5 breaks above column 3, generating a double-top buy signal. However, looking left shows that column 5 has only reached the level of column 1 . If column 1 is the highest level reached in the near-term, then it is advisable to wait until that level is broken first. This does occur in column 7 and so the pattern becomes an extended triple-top pattern. There are literally thousands ofvariations ofthe pattern, once more columns are considered. Figure 3-15 opposite shows what could be loosely termed a multiple top pattern. Notice that it is composed of double-top and triple-top patterns.

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Knowing when to ignore signals

It is sometimes advisable to ignore the minor double-top buy and bottom sell signals, especially as the pattern becomes larger and more complex, as shown in Figure 3 – 1 5 .

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Figure 3-1 5: Knowing when to ignore signals
A number of minor signals in the context of a bigger pattern can be selectively ignored.

The first signal, marked A, is a double-bottom sell in column 6, where the 0 goes below the previous column of Os. The analyst may, however, look left and see that there is an o in column 2, which is one price box lower, and decide to ignore the minor double­ bottom signal. This decision would be made by considering how the pattern was entered. If the pattern was entered from below with a column of Xs, as is the case with this pattern, it is unlikely that a simple double-bottom sell signal will reverse the trend. If, however, it was entered from above, with a column of Os before column 1 , then the double-bottom sell at A is a continuation signal and should be taken.

•

•

The next signal is a triple-bottom sell, marked B, where the 0 in column 10 goes below the previous two columns. Once again, looking left shows the 0 in column 2 as support and, although this is a triple-bottom sell, it may also be ignored.

Progressing along the pattern, the third signal is a triple-top buy, marked C, in column 1 1 . Looking left again shows Xs at this level in columns 3 and 5 as well as another in column 1 . Although it is a triple-top buy, it is weakened by the presence ofXs to the left,

in columns 1 , 3 and 5, and may therefore be ignored.

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The Definitive Guide to Point and Figure

A minor double-top, marked D, is shown in column 15 and ignored by looking left again. As more ofthese signals occur within the pattern, so more support and resistance is built up, making it easier to spot which signals should be ignored.

Finally, the signal marked E is a multiple top buy signal in column 1 7, breaking the Xs in columns 1 , 1 1 and 1 5 . The buy is taken because looking left shows the demand has exceeded the supply for the first time in the overall pattern.

This example shows that although Point and Figure signals are unambiguous, a certain amount of subjectivity must be applied. That SUbjectivity is only possible if you are able to go inside the chart, so to speak, and understand the psychological make-up of the bulls and bears within the pattern.

Remember, in all cases, the patterns work in the reverse as well.

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Exactly the same scenario takes place in Figure 3-16, but in reverse. The signals are marked as before.

Importance of reassertion of control

What all these patterns are showing us is the reassertion of control by one group over another. In fact, the more times the bears can overcome the bulls, preventing an X column breakout, the more important the eventual X column breakout becomes. Similarly the more the bulls can overcome the bears, preventing an 0 column breakout, the stronger the sell signal becomes. It is the act of reaching a support or resistance level only to be forced back that

makes the subsequent breakout more significant, and hence the trend, stronger. As in life, being able to reassert yourself after a setback makes you that much stronger.

234567891011 Figure 3-1 6: Knowing when to ignore signals

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The strength of the pattern

Knowing whether the pattern is likely to be a continuation or reversal pattern has important implications for Point and Figure analysis. Whilst the pattern is being formed, there are clues to the strength of the pattern and the subsequent breakout. Strength is influenced by two things:

Sloping sides Breakout and pullback

Upside and downside triangles – sloping bottom or sloping top

An up-sloping bottom (Figure 3-17) makes any compound pattern bullish to the upside because the slope means that the demand is coming in at higher levels on each reaction. A down-sloping top (Figure 3-18) makes the pattern bearish because supply is coming in at lower and lower levels. These triangles are known as upside and downside triangles. They are much harder to spot in bar and line charts.

Figure 3-17: Continuation upside triangle in 3-box charts

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0
0
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0 … Sell
Figure 3-18: Continuation downside triangle in 3-box charts

It is important to note that the signal is not generated until the breakout from the pattern occurs, but the sloping bottom or top gives you a clue to the direction of the breakout. These are very similar to triple-top and bottom patterns seen earlier and like those patterns, they can be continuation, as they are in Figure 3-17 and Figure 3-18 above, or reversal, as they are in Figure 3-19 below and Figure 3-20 opposite. The only difference, as explained earlier, is that a reversal pattern has a different column type entering the pattern from that leaving the pattern.

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Figure 3-1 9: Reversal upside triangle in 3-box charts

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Figure 3-20: Reversal downside triangle in 3-box charts

Remember these are much more likely to be seen in their neat form in 3-box charts. The same pattern in a I -box chart will have more price action and may not be quite as easy to spot. The upside triangle in Figure 3-17 on page 129 may translate into Figure 3-21 in a I-box reversal chart. This pattern falls into the category of a semi-catapult discussed earlier.

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Figure 3-2 1 : Semi-catapult or continuation upside triangle in 1 -box charts

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Like all patterns, upside and downside triangles can fail as the chart of the S&P 500 Index in Chart 3-2 shows. The perfect upside triangle within a strong trend failed to break up and instead broke below the sloping bottom triggering a sell signal. This reinforces the view that while the pattern provides you with the likelihood of the break, the signal only comes when a double-top or double-bottom signal is issued. The pattern in the chart is identical to that in Figure 3 – 1 7 until the part where it does not break up.

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Chart 3-2: 5 x 3 of S&P 500 Index showing failed upside triangle

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Symmetrical triangles – sloping top and sloping bottom

When you see a sloping top and bottom in a pattern, this indicates uncertainty on the part of the participants and therefore the direction of the breakout cannot be predicted with any degree of certainty. There is some evidence that the breakout is more likely to be in the direction of the underlying trend, and this tends to be the case with smaller patterns. The bigger the pattern the more likely it is to be a reversal pattern.

Figure 3-22: Buy signal following a symmetrical triangle

The important thing to note with these symmetrical patterns is that the signal is not given by the break of the trend line. As in all Point and Figure Analysis, the signal is generated when a breach of a previous column occurs. The buy shown in Figure 3-22, and sell shown in Figure 3-23, occur after a double-top and double-bottom breakout, respectively. You may wonder why looking left and seeing resistance does not cause you to ignore the signal. It really depends what the greater pattern looks like. If it is simply a triangle, then the signal should not be ignored, especially if the signal is with the main trend.

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x
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Figure 3-23: Sell signal following a symmetrical triangle

The patterns shown so far are idealised, so when you look at a real chart they may not be quite as clear. Chart 3-3 of Whitbread pIc shows two patterns with sloping sides. Pattern A is a typical upside triangle with up-sloping bottom and flat top, similar to the ones in Figure 3 – 1 7 and Figure 3-19.

Pattern B shows a typical symmetrical triangle with sloping top and bottom, similar to Figure 3-22. It is not a perfect pattern but it is still a symmetrical triangle with a break to the upside. Note that the signal only comes with the break of the triple-top.

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Chart 3-3: 10 x 3 of Whitbread pic showing upside and symmetrical triangles

The breakout and pullback

The second factor which influences the strength of a pattern is the ability to breakout, then pullback into the pattern and finally breakout again. It is one ofthe strongest signals you can get in Point and Figure charts and enhances the first breakout signal. It occurs when the price breaks out of a multiple top or bottom pattern by one or two boxes but then, instead of continuing, it pulls back into the pattern, before breaking out again.

It is important when considering any pattern to think about the psychological make-up of the participants. The bulls are euphoric that they have managed to overcome the bears at the breakout. The bears take the opportunity of the higher prices to sell and push the price back down below the breakout point. The bulls are so keen to buy the stock that they once again overcome the bears to push the stock to a new high. It is the determined demand that makes the pattern so much stronger.

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Figure 3-25: 3-box bearish catapult showing the breakout and pullback

Once again, as you can see, the 3-box catapult is just a variation of the basic patterns discussed earlier. The bullish catapult has a triple-top breakout, followed by a pullback and then a double-top breakout. It is the pullback into the pattern and the subsequent breakout that makes it stronger. The converse applies to bearish catapult patterns. It is a triple-bottom breakout, followed by a pullback and a double-bottom breakout.

The essence of the catapult pattern, and why it is so strong, is one of reassertion. There has been reassertion on the part of the bulls in the case of a bullish catapult, or the bears in the case of the bearish catapult. Having been pushed back after the first breakout, they are strong enough to reassert their position and drive the price past the previous resistance or support level, leading to another breakout. This is highly significant and signals the next big move in the price.

3-box catapults can be continuation or reversal patterns. There is no distinction between the two types in 3-box reversal charts but there are differences in I-box charts, as you will see onpage 138.

1-box catapult patterns

Whereas the definition ofcatapult is narrow in 3-box charts, and only applies when there is a breakout, then a pullback followed by a second breakout, the I-box catapult definition is far wider. You have already seen that a continuation 3-box double-top is a semi-catapult in a I-box chart. In fact the name, semi-catapult applies to any continuation pattern in I-box analysis. For example, a continuation triple-top in a 3-box chart is a semi-catapult in a I-box chart.

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If a semi-catapult breaks out but fails to advance, and instead the price falls back below the catapult point, it is called a ‘false catapult’ which is the same as the half-way situation with the 3-box catapult. If, after the pullback into the pattern, the price then breaks out again, the false catapult becomes a larger full semi-catapult, as shown in Figure 3-26.

Figure 3-26: 1 -box false semi-catapult

When discussing reversal catapults, the terminology becomes slightly confusing. A reversal pattern in a I-box chart is actually called a fulcrum, which was discussed on page 120. The point at which the fulcrum is complete, and breakout occurs, is called the Full or True catapult. This is the point at which the price has exceeded the high of the pattern. It sounds as if a I -box fulcrum is different from a 3 -box catapult, but if the I -box fulcrum has a false catapult point part-way through, it is equivalent to a 3-box catapult.

Figure 3-27 shows a I-box reversal bullish fulcrum, with a false catapult buy part-way through and a full catapult buy at the end. Figure 3-28 shows the equivalent 3-box reversal bullish catapult. The same sequence of prices was used in both diagrams. Most students of Point and Figure know the 3-box catapult but are unfamiliar with the I -box fulcrum version. The 3 -box version is a condensed version of the I -box chart.

Both charts can be inverted to show sell signals from tops, rather than buy signals from bottoms.

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IX +– Full Catapult -X–

Note that all the semi-catapults and fulcrums shown so far are bullish. Bearish patterns are the inverse and work in the same way. There will, of course, be many variations in the patterns. The key thing is to understand the make-up of the pattern in order to recognise the variations.

With 3-box catapults, there is always an initial breakout of a triple-top, followed by a retracement into the pattern, which does not give a reverse signal, followed by another breakout to a new level. With I -box false fulcrums and false semi-catapults, there is a move in the middle with creates the false catapult, then the price retraces into the pattern before breaking out in the same direction.

0

0 False Catapult Buy – X 0XXXXX0XX 0X00XX0X0 XX0XX0X 0 0X00X0XX000 0

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Figure 3-27: 1 -box bullish fulcrum with false catapult

Figure 3-28: 3-box bullish catapult

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Chart 3-4 of BT Group plc shows a number of different catapults, two of which were successful (A & B) and one which failed (C).

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Chart 3-4: 1 5 x 3 (h/l) of BT Group pic showing two successful catapults (A&B) and one failed (C)

Catapult A in Chart 3-4 is a typical triple-top breakout of 3 Xs with a pullback right into the middle of the pattern. Notice that the pullback column of Os does not go below any previous column of Os in the pattern. After the pullback, a double-top breakout completes the pattern.

Catapult B also forms to the textbook fashion, and results in an explosive move.

Catapult C is an example ofa failed catapult. It has all the ingredients ofa successful catapult: there is the initial triple-top breakout, followed by a pullback into the pattern and then a double-top breakout. After the double-top, there is another pullback into the pattern and one could be forgiven for thinking that a compound catapult could be developing. Two failed attempts at reaching the high of the pattern result in a long column of Os against the pattern and a subsequent double-bottom breakdown at point D. This is called a trap and is discussed in the next section.

Catapults can take on many forms. Chart 3-5 opposite shows a multiple catapult in the Land Securities plc chart. There is a triple-top breakout at point A, followed by a pullback into the pattern. A second attempt is made to breakout again but it is repulsed twice, forming another triple-top. A second breakout does occur from the second triple-top at point B, followed by

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another pullback into the pattern. Finally, at point C a double-top breakout occurs, completing a complex catapult pattern.

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Chart 3-5: 15 x 3 of Land Securities pic showing a multiple catapult

Remember that catapult patterns show up differently in 3-box and I-box charts. Chart 3-6 is a lO x 3 Point and Figure ofAlliance UniChem pIc. Pattern A is a perfect bullish catapult, showing the initial triple-top breakout, then the pullback and finally the double-top breakout to complete the pattern. Chart 3-7 is a l O x 1 Point and Figure ofAlliance UniChem. Pattern A is the same section of data and demonstrates well what a bullish catapult looks like in a 1 – box reversal chart. The I-box chart gives much more detail of the way the pattern has evolved.

Sometimes the 3-box chart doesn’t show the pattern at all. Pattern B in Chart 3-6 is a series of double-top buy signals, not a particularly powerful pattern; however, in the I -box Chart 3-7 it shows a continuation or semi-catapult quite clearly.

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Terminology clarification

Because the terminology covered so far can be confusing, the summary below should help you to familiarise yourselfwith it.

A continuation 3-box double-toplbottom is equivalent to a I -box semi-catapult. A reversal 3 -box double-toplbottom is equivalent to a I -box fulcrum.
A continuation 3-box triple-toplbottom is equivalent to a I -box semi-catapult. A reversal 3-box triple-toplbottom is equivalent to a I -box fulcrum.

A continuation 3 -box catapult is equivalent to a I -box semi-catapult with a false catapult part-way through.

A r e v e r s a l 3 – b o x c a t a p u l t i s e q u i v a l e n t t o a I – b o x fu l c r u m w i t h a fa l s e c a t a p u l t p a r t – w a y through.

1-box and 3-box patterns

There are essentially only two I -box patterns: semi-catapult, if the pattern is a continuation pattern; and fulcrum if it is a reversal pattern. Within these two pattern types there are hundreds of variations.

With 3-box charts there are many more defined patterns. Because 3-box charts have been researched more than I -box charts, many of the 3-box patterns have been given names.

The rest of this chapter will concentrate on the 3-box variations. Where possible, however, the I -box translation of the defined 3-box pattern is shown.

Traps

A trap is a pattern which looks like one of those discussed so far, and which breaks out as expected, but then reverses back into the pattern and breaks out the other side. There is no way to avoid them. They will occur and you will be caught. The important thing to note is the point at which you should realise that your initial signal has failed. You cannot assume that any pullback into the pattern after a breakout is a failure, because that’s exactly what a 3-box catapult is. In fact, traps are really just failed catapults. The first clue to any failure is a double signal in the opposite direction. Remember, when discussing catapults, it was noted that there should not be an opposite signal. If this does occur, it becomes a trap.

Traps don’t have to occur from triple patterns; a simple double pattern can fail and become a trap particularly if they occur during strong trends. There is no distinction between traps in 3 – box a s opposed to I -box charts, other than the patterns will b e wider i n I -box charts. They are however much harder to see in I -box charts. The traps discussed below are the 3-box variant.

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Bull trap

If you act on a triple-top buy signal and the price then pulls back into the pattern, you must remain in the position because a 3-box catapult may be building. In fact, you should remain with your initial signal until there is a double-bottom sell signal, as shown in Figure 3-29.

Figure 3-29: Bull trap: triple-top buy becomes double-bottom sell

Bull traps take on many guises. The essential ingredient is that there has been a top (double or triple) buy signal, which has been reversed into a double-bottom sell signal. The important thing is not to pre-empt the sell signal because you may be in the middle of a strong, bullish, 3-box catapult pattern. If you panic during the pullback into the pattern and close your position, you will have lost the advantage gained by buying at the first breakout, ifthe pattern does tum into a 3-box catapult. So, you have to sell on the opposite side ofthe pattern, losing an amount equivalent to the depth of the pattern.

Bear trap

A bear trap is the opposite of a bull trap. There must be a bottom sell signal, which is then reversed into a top buy signal, as shown in Figure 3-30 opposite.

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Figure 3-30: Bull trap: triple-bottom sell becomes double-top buy

Trading traps

By their very definition, traps are there to ensnare you, so there is no easy way to trade them without the benefit of hindsight. The assumption is that the first signal is taken. The opposite signal on the other side of the pattern needs to be taken as well, and a loss equivalent to the depth of the pattern is incurred. Can you predict if the pattern is going to tum out to be a trap? The answer is ‘no’. It is most likely that the last signal in a bull trend will be a trap, but how do you know that it is the last signal at the time? You could ignore any buy signal in an extended trend, but that would mean missing some good moves if a trap does not emerge. The only way to trade a trap is to grit your teeth and take every signal in the hope that the trap does not tum into a broadening formation, discussed on page 147.

Chart 3-8 (overleaf) of the FTSE All Share Index shows a number of examples of traps.

Trap A is a compound trap. During the strong uptrend, the price gives a double-top buy signal, signalling a further advance. It is, however, reversed by the next column of Os giving a double-bottom sell signal, thus closing the position. The next signal is a strong triple-top buy signal. It is again reversed by a double-bottom sell signal eventually leading to a fall. In fact trap A turns into a broadening formation which is discussed in the next section.

Trap B starts with a triple-top buy signal, one of the strongest, most bullish signals you can get. The price runs up and back down again, giving a double-bottom sell signal. Trap B is also a high pole, discussed on page 155.

Trap C i s another strong triple-top buy signal which on first glance could b e the start o f a new uptrend. After the triple-top, there is a pullback into the pattern, setting it up for a bullish catapult, but a new double-top buy does not occur; instead, a double-bottom sell signal cancels any notion of the pattern being bullish.

Trap D is another triple-top buy, which leads to some consolidation at a higher level, and another double-top buy. Two buy signals followed so closely by one another is a bullish sign.

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However, a double-bottom sell shortly after that cancels the bullishness and a number of double-bottom sells confirms the bull trap.

Trap E is a double-top buy being reversed into a double-bottom sell. The initial double-top buy is such a weak signal, and is in a downtrend, that it is unlikely it would have been taken.

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Trap F starts with a continuation double-top buy signal, which worked a number of times during the strong uptrend. It is cancelled by a double-bottom sell in the next column, which in tum is cancelled by a double-top buy signal, which leads to a strong advance. Again, this is more of a broadening formation. Some of these traps, namely C, D and E, could have been avoided by trading with the trend. The others are painful traps from which there is little escape. You can see that ignoring the reverse signal can lead to actual losses or a loss of profit.

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Shakeouts

Closely related to traps is the shakeout. The difference between the two is that a shakeout occurs at the start of a new trend, usually a bull trend. The trend starts, a new bull trend is established, but then there is a double or triple-bottom sell. It was Earl Blumenthal in his book, Chartfor profit Point and Figure Trading, who first suggested that the first sell in a bull trend should be ignored. Far from being a sign of weakness, it is actually a sign of strength. The bulls push the price until it is overbought and then stop buying, allowing selling pressure to take the price down below the previous 0 column low. The first occurrence ofthis should be ignored unless it falls and breaks below the trend line. The shakeout bottom, or mini-bottom, becomes an important part ofthe chart when assessing Point and Figure counts, discussed on page 207.

Shakeouts are double-bottom sells in 3-box charts or fulcrums in I-box charts. When they reverse back up again, they provide the opportunity for a new trend line to be established. This should be read in conjunction with the section on trend lines on page 176. Pattern F in Chart 3-8 is an example of a shakeout – the first sell signal in a new bull trend.

The question remains whether shakeouts can occur in downtrends, and whether the first buy in a downtrend should be ignored. They do, there is one in Chart 3-8, in the 4th column after the all time high. Normally however all buy signals in a downtrend are ignored except to close short positions.

Broadening patterns

The logical progression froin bull and bear traps is the broadening pattern, because it starts off as a double or triple-top (or bottom) pattern which turns into a bull or bear trap, where the initial signal is reversed by an opposite signal, which is in turn reversed by another signal in the direction ofthe initial one. The problem is that confidence is usually shaken. It could also be termed a ‘whipsaw’ pattern because ifyou take every single signal you will be whipsawed out and in again.

The broadening patterns described above are the 3 -box version. The I -box version starts with a continuation semi-catapult signal. The semi-catapult is part ofa larger fulcrum which reverses the signal, and which in turn is part of a larger semi-catapult that reverses the signal again.

You will hear some Point and Figure practitioners say that a broadening pattern within an uptrend is very bullish, but that is with hindsight. It may indeed tum out to be very bullish, but, at the time, you have no idea that it will. Remember it starts off as a double or triple-top, which is reversed by a double-bottom sell, which in turn is reversed by a double-top buy signal (see Figure 3-3 1). Bullish indeed, but the likelihood oftaking the final buy signal after being whipsawed is small. In fact, it may not be the final signal. Another reversal into the pattern may occur and another sell signal generated, until the final buy signal comes.

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Pattern A in Chart 3-8 is an example of a broadening pattern which did not lead to a good up move; in fact it led to a severe correction, so do not assume all broadening patterns will be bullish.

Pattern F in Chart 3-8 is also a small broadening pattern that did eventually lead to a strong advance.

Point and Figure chartists hate broadening patterns and usually ‘bail out’ after the first reversal signal never to return. In order to benefit from a broadening pattern, you have to ignore some signals. The first signal in a broadening pattern in an uptrend, like the one in Figure 3-3 1 , is a buy signal. You may already be long, but if you are not, you would buy especially if it is a triple-top breakout like this one. The next signal is a sell. The question you will have to ask yourselfis, would you ignore the sell signal? It is unlikely and any longs you have would be closed out. With no position open, the next buy signal is easier to take and you would go long again. If that is the final signal from the pattern, you would remain long, but what would you do if the price turns round and gives another sell from the bottom of the pattern? You could ignore it, but that could lead to bigger losses. You could take it and be whipsawed out ofyour trade again, incurring another loss. Ifthe price turns round and breaks out above the pattern again, how confident would you be to take a third buy signal from the same pattern? The simple fact is that there is no easy answer. Either you move on to another instrument after the first whipsaw, or you take every buy and sell signal in succession, incurring losses each time, on the basis that when the price does run from the signal, you make up for any losses incurred during the whipsawing action. But this strategy will only work if you trade the long as well as the short side, so you profit from a fall, should the final break be to the downside. If you are merely closing out longs each time there is a sell, losses will be incurred and no profit will be gained ifthe final sell does lead to a big downmove as it does in pattern A in Chart 3-8.

Figure 3-31 : Broadening pattern in an uptrend

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Broadening patterns don’t have to start with a buy signal; they can start with a sell, as shown in Figure 3-32. The same dilemma applies: which, if any, signals do you take and which do you ignore?

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Figure 3-32: Broadening pattern in a downtrend

1-box broadening patterns

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Broadening patterns in I-box charts start with a continuation semi-catapult buy (or sell), which is reversed into a reversal fulcrum, which in turn is reversed and becomes a larger semi-catapult with a false catapult part-way through. Once again, this does not occur in such a defined way as the 3-box version.

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Bullish and bearish patterns that reverse

Traditionally, these are 3-box patterns and are called bearish signal reversed, or bullish signal reversed, which is a confusing name. They should probably be called bearish pattern reversed and bullish pattern reversed. It’s because bearish and bullish pattern reversed patterns are essentially bearish or bullish trends, which turn in the opposite direction and generate a buy or sell, respectively. Bar chart analysts will recognise them as flag patterns, which occur against the prevailing trend. Unlike flags in bar chart analysis, however, these bullish and bearish patterns reversed can be either trend reversal patterns or continuation patterns, the difference being the trend of the pattern prior to reversing. In continuation patterns, the trend of the ‘ flag’ is against the prevailing trend. In top and bottom patterns, the trend of the ‘ flag’ is with the prevailing trend. Once again they are more visible and defined in 3-box charts, although they can be spotted in I -box charts, as you will see.

Bearish pattern reversed

The bearish pattern reversed is a series of X/O columns with consecutive lower highs and lower lows, indicating bearish downtrend behaviour. A column of Xs then breaks above the high of the previous column of Xs and the pattern, and trend, is reversed. Some writers specify that there must be 7 columns in the pattern in order to qualify. Some specify the exact make-up of the columns. Both are too rigid. It is better to observe that there is a potential pattern in the making, understanding that it may not look just like one in a book, and then wait for the signal. As with most Point and Figure patterns, there is one essential ingredient that defines the pattern. In this case, it is that there must be a series of lower highs and lower lows, the trend of which is eventually broken by a double-top buy signal. Remember what lower highs and lower lows means: it means repeat double-bottom sell signals but no double­ top buy signal until the one that breaks the pattern. Furthermore, there should be no strict

specification as to the number of these columns, nor that each high and low must be only I box lower than the previous column. Point and Figure patterns should not be learnt by heart, but rather fully understood so that any variation in the pattern can be catered for. You will know by now that the greater the number of columns, the greater the potential from the breakout, the reason being that complacency has set in and those who have confidently taken positions with the trend are shocked when it suddenly reverses leading to short covering and position altering.

Remember, however, that at the end of the pattern the buy signal may never come. The pattern may give repeat sell signals and lead to a significant fall. What is powerful about these patterns is that they take time to build and, as they do, you can start to see what is forming. The pattern, however, is only confirmed when the final signal – buy, in this case – is generated.

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Bullish pattern reversed

Bullish pattern reversed is the exact opposite of the bearish described above. Instead of a series of lower highs and lower lows, there is a series of higher highs and higher lows which eventually reverse with a sell signal. This is the essential ingredient that defines the pattern.

Figure 3-34 shows three variations ofthe bullish pattern reversed. They are the inverse ofthe bearish patterns shown on the previous page. Patterns D and E are continuation patterns, and pattern F is a reversal pattern. In each case, a sell, reversing the bullishness of the pattern, is issued at the end.

Figure 3-34: Examples of bullish pattern reversed

Bullish and bearish pattern reversed patterns are not that common but they tend to be reliable. For the obvious reason that the final buy or sell signal is with the prevailing trend, continuation patterns are more reliable than top or bottom patterns. Acting on the buy signal in pattern C, or the sell signal in pattern F, is far more risky than the buy in patterns A, B, D and E. Of course, some of these patterns will fail but, by this stage, you will have realised that no pattern works every time.

You may be thinking by now that there are too many exceptions or that you can easily get caught out. Of course, all techniques have a failure rate. That is the reason for having stops in place. These will be discussed later. One advantage of Point and Figure charts is that you know if a pattern has failed early on. Furthermore, you will see when trend is discussed that this can dramatically reduce the chance of being caught out by failed patterns.

Perfect examples of any pattern are usually hard to find, but there could be no better example than the continuation bearish pattern reversed that occurred in the Dow Jones Industrial Average during 2004. Chart 3-9 opposite shows 100 x 3 Point and Figure ofthe Dow. The

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circled pattern A is a typical continuation bearish pattern reversed. Notice that it has 9 columns. The pattern has taken the Dow to a new local high. If you were applying a strict 7 column rule, you would have ignored this pattern. The simple fact is that it is rare to find an exact textbook pattern; you must be prepared to look for variations that still tell the same story and lead to the same result. Pattern B is one such example. It is a continuation bullish pattern reversed; it is not exactly the same as the textbook, but it has the essential ingredients – higher highs and higher lows which are then reversed with a sell signal. The last X column didn’t make a new high but that doesn’t invalidate the pattern, in fact if anything it shows the inherent weakness in the pattern reinforcing the expectation of a sell signal.

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Comparing 3-box and 1 -box charts

As usual, the patterns tend to be more compact and neat in 3-box charts. They are much harder to spot in I-box charts because the ‘flag’ is not so clear-cut as Chart 3-10 shows. However, if you know what you are looking for – a series of higher highs and higher lows, or lower lows and lower highs – then they should be easy enough to spot.

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Chart 3-11 is a .01 x 3 Point and Figure ofCable (USD/GBP). PatternA is a perfect example of a bearish pattern reversed. There is some discussion to be had as to whether it is a continuation in a flat trend or a bottom pattern, but it doesn’t actually matter. There are 13 columns in the pattern. O n the same chart, pattern B can b e considered as well. It fits the essential ingredient of lower highs and lower lows, although one of the lows was at the same level as the previous. Although variation patterns should be treated with suspicion, they should always be observed as potential patterns. In the case of pattern B, the buy signal at the end of the pattern was very profitable.

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As stated earlier, patterns sometimes fail. One advantage of Point and Figure is that it does tell you when the pattern has failed. Pattern C in Chart 3 – 1 1 is a potential bullish pattern reversed. There is a series of higher highs and higher lows. There is the final double-bottom sell in the 8th column and the pattern is complete. The sell is, however, cancelled in the next column by a double-top buy and the pattern has failed.

Poles

Poles are also a 3-box pattern although, as you will see, they can be translated into I-box patterns. They are different from other patterns discussed so far in that they are reversal patterns, never continuation. A pole is a long column of Xs or Os with a column of Os or Xs alongside it. Although poles are reversal patterns, not every pole you see will work as such. There are specific conditions which must apply before the pole can be considered as a reversal. High poles were first identified by Earl Blumenthal in his book, Chartfor Profit: Point and Figure Trading. Low poles were introduced by Michael Burke subsequently. Both authors are proponents ofthe 3-box reversal method and, for this reason, poles are essentially 3-box chart patterns. It is, however, possible to see them on I -box charts, as you will see below.

For a pole to occur there should be some sideways consolidation prior to the pole. Usually there is further sideways consolidation on the other side ofthe pole before the pattern breaks. The pole is an opportunity to enter a trade before the pattern is complete.

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Poles occur when price breaks above (or below) previous price action and a long column of XS or Os is created. This breakout column must exceed previous highs or lows by at least 3 boxes; this is what Blumenthal specifies but this may not be enough. The less the number of boxes, the greater the chance of a failure, so you should be looking for more than 5 boxes in height for poles to be effective. The reason has to do with the psychological make-up of the

pattern discussed below. After the initial breakout column, the very next column must be an opposing column of Os or Xs in the opposite direction, adjacent to the breakout column. This column must retrace the previous breakout column by more than 50% for a pole to be in the making; so if the breakout column was 1 0 Xs, the pole will be made after the 5th 0 in the next column.

Poles can occur in uptrends or downtrends. High poles indicate near-term weakness and low poles indicate near-term strength.

As with all Point and Figure patterns, it is important to consider what is going on in the minds of the participants. Considering the high pole in Figure 3-35, there is a long breakout column of Xs showing strong demand and buyers prepared to pay up to get the stock. At some stage that demand ceases and the column ofXs comes to an end. All participants expect there to be a small correction of perhaps 3 Os to bring the price back, before demand comes back in again, but that doesn’t happen. The next column of Os is as determined as the previous column of Xs. Sellers, who are now receiving higher prices, push the price back, trying to

find new buyers, but the buyers are not forthcoming because all the available buyers were ‘sucked’ into the initial breakout column, so the price continues to fall, effectively cancelling out the column of Xs. The bulls that bid up the stock, especially those who bought in at the top of the column of Xs, will be totally shocked. Many, already showing losses, will close their positions, which removes the bulls from the market and adds to the list of sellers. It is the shock reverse column of Os that makes the high pole such an important reversal pattern. It is as if the buyers have been slapped in the face. After the high pole is complete there is usually, although not always, an unwinding of positions that takes place resulting in some sideways movement in a tight range before a complete breakdown of the pattern takes place.

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Figure 3-35: High pole

The converse is true for the low pole in Figure 3-36. Bears, which may include short sellers, push the price down aggressively. They will then expect some demand to come in to push the price up a touch to allow them to start selling again. The bulls, however, use the lower prices to accumulate stock, and are so keen that they push the price right back to the start of the bear move, wiping out any advantage the short sellers had gained. In fact, sellers covering shorts will contribute to the rise as well. As with the high pole, there is some unwinding that takes place before there is a breakout to higher levels, as the bulls continue to demand stock and short sellers are cautious about selling.

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Figure 3-36: Low pole

The main issue with poles is the complete reversal of sentiment and the shock and disbelief it gives those caught on the wrong side of the move.

Trading strategy with poles

Most patterns should not be anticipated. The final signal from a pattern may never come, so it is best to wait for it before acting. High and low poles are different. It is possible to act while the pattern is being formed. The common strategy with a high pole is to sell when the reversal column of Os retraces 50% of the X column length. This is fine in theory, but, in the heat of the moment, it is quite a difficult strategy to follow, especially if you have been involved in buying during the X column. The tendency instead is to wait for further columns to build before selling on a double-bottom breakdown. There is nothing wrong with waiting, but early action does allow extra gains.

If you do take the early signal at the 50% retracement, consider what is the risk in doing so. The risk is that the column of Os does not continue down but instead turns round into a column of Xs. This would cancel the high pole and the pattern would have to be re-assessed. The risk from the first sell point is the number of boxes that make up your reversal on the chart you are using – 3 Xs if it’s a 3-box chart, I if it’s a I -box chart. The reason is that if the down-column of Os does not continue uninterrupted, then it is no longer a high pole.

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The risk is also related to your trading style. If your initial sell is simply a close of a long position that you had taken during the breakout column of Xs, you are at less risk than a sell which opens up a short position. A sell at the 50% retracement to close your long position leaves you neutral to assess the pattern to see what builds from it and so the simple reversal of the column of Xs would not trigger a buy signal. In this case, you must wait for the next double-top or double-bottom buy or sell signal to open a new position.

However, if your sell at the 50% retracement was a short, then the simple reversal of the column of Xs should be taken as a buy to close a short position. Figure 3-37 shows the situation.

Chapter 3 – Understanding Point and Figure Charts

Figure 3-37: High pole early signal

Poles are one of the most effective, yet most dangerous, patterns. They are so clear in their formation and so clear in their completion but they often fail to provide the expected move.

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Chart 3-12 below is a 25 x 3 ofthe Dow Jones Industrial Average. After a nearly 1000 point uptrend, the price consolidated for three columns and then broke out upwards again by 1 1 XS setting up the basis for a high pole. In the next column, the price fell by more than the length of the rise, confirming a high pole. Whether you exited on the 50% retracement or whether you exited on the double-bottom sell signal, the expectation would have been for a reasonable correction. Instead the price fell and set up a low pole bottom, leading to a double-top buy signal. This is quite a common occurrence. A high pole followed immediately by a low pole, as in this example, is very bullish and less common, while a low pole followed immediately by a high pole is very bearish. It’s really a special case of a broadening formation.

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Poles in 1-box reversal charts

Nothing has ever been written about poles in I -box reversal charts. Awareness of the pattern didn’t exist when De Villiers, & Taylor and Wheelan were writing about I -box charts, so they have only ever been discussed in relation to 3-box charts. At first sight, it is less likely that you will ever see a long unbroken column of Xs or Os in a I -box reversal chart, but that is not the way to look at it. In a 3-box reversal chart, the price could reverse by up to 2 boxes without interrupting the unbroken column, so it is really the reversal that is preventing you from seeing the interplay as the column builds. But that is exactly the purpose of3-box charts – to filter out any countermoves of less than 3 boxes. With I -box charts, however, every reversal is shown. This means that a column interrupted by a step back of one or two boxes can, for the purposes of a pole, still be considered as an ‘unbroken’ column, because if it was on a 3-box chart it would be.

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Figure 3-38 shows a high pole using a I-box reversal chart. Compare it with Figure 3-35 on page 157, which is constructed with the same data. You can see that the advance shown by the blue line is uninterrupted by a reversal of 3 or more boxes, as is the decline shown by the blue line. It is, therefore, a high pole, but perhaps not as easy to spot as it would have been in a 3-box chart.

Figure 3-38: High pole in a 1-box reversal chart

The example given here will not always be the case. Sometimes the initial move and the adjacent correction are so severe that even on a I -box reversal chart there is no step-back.

Chart 3-13 is a 0.5(Yz) x 3 ofWhirlpool Corp. As you can see, there are a number ofpoles, both high and low, marked on the chart. Whilst looking at them, consider also Chart 3-14 which i s a 0 . 5 x 1 o fWhirlpool. When comparing the charts you will b e able to see how poles show up on I -box charts compared to 3-box charts. In the case of each pattern described below, try to put yourself in the position of a participant. This will give you a better understanding of the psychology that goes to create the patterns.

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Pattern A is an unusual high pole. Normally, high poles occur at the end ofuptrends. This one has occurred part-way through a downtrend. Consider the make-up of the participants. After a severe downtrend, there is some congestion, then a long column of Xs shows confident buying by the bulls. The bears take advantage of the higher prices to push the price down again leaving the bulls shocked. The triple-bottom sell completes the pattern.

Pattern B is a low pole. There is some congestion prior to the long column of Os down to the bottom. Notice that the column ofOs in the I-box reversal chart is interrupted by a step-back of two Xs. This does not, however, invalidate the pole in the I -box reversal chart. The

adjacent column of XS back up again completes the low pole. So strong was the move, that even on a I -box chart there was no step-back.

Pattern C is a high pole. Once again, there is congestion prior to the long breakout column of Xs, which is followed by a retracement column of Os. The I -box reversal chart shows that the breakout column ofXs had a number ofone-step-backs during the building ofthe column. This does not invalidate the pole in the I-box chart.

Pattern D is a low pole with only a small congestion before the long 0 column down. Remember, bears and short sellers will be euphoric, but then the adjacent column of XS changes everything. What is interesting is that the pole in the I -box chart is identical. There are no one-step pauses during the 0 or X column.

Pattern E is a very long high pole taking the price to new highs. Bulls riding this X column will also believe that there are higher prices to come. Although they will expect a small, perhaps a 3 box, retracement, they will not be prepared for complete retracement of the X column by the next column ofOs. This strong retracement shows that the bears are in control and not the bulls. In the I -box chart, the retracement column of Os has two one-step-backs

during its construction.

Pattern F is a low pole that looks very different on the I-box chart. In fact looking at the 1- box chart on its own, you could b e forgiven for missing it completely. The long column of Os in the 3 -box chart consists of a number of one and two-steps-back in the I -box chart. This does not invalidate the pattern. The adjacent retracement X column also has a step-back in the I -box chart.

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Chart 3-1 3: 0.5 x 3 of Whirlpool pic showing high poles and low poles in 3-box charts

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Poles are easier to spot in 3-box charts. Ifyou are using I-box charts for your analysis, the above gives you a clue what a pole looks like. It may be better, however, to switch to a 3-box chart if you are in any doubt.

Opposing poles

You will sometimes see opposing poles occurring within a few columns of one another; such as high pole A followed by low pole B or high pole C followed by low pole D. When this happens, the strength of the second pole in the sequence is considerably enhanced, allowing you to act on an early signal with more confidence. The area marked Z in Chart 3-l3 and Chart 3-14 is an example of a low pole followed by what could be regarded as a marginal high pole. Under normal circumstances the high pole on its own barely fulfils the conditions for a pole, but it is enhanced by the presence of a low pole preceding it.

Congestion analysis

The reading of Point and Figure charts is enhanced by the width of any pattern. The more columns that occur within a range, the more information you can glean from the pattern. Congestion occurs when the bulls and bears are not confident enough to engage in too much buying or selling pressure. Congestion areas tend to occur after a strong advance or decline. It is the time that profits are taken and positions are reversed after the rise or decline into the area, and it is a time for adjusting to the new price level after the strong move. Adjustments by the bulls and bears to their positions leads to a number of small changes in direction, resulting in a number of columns being formed. The market is, in effect, neutral at this point.

Congestion is a good time to take new positions as well, provided that there is sufficient evidence as to the future direction. The key to congestion analysis is to identify whether accumulation or distribution is taking place. Accumulation and distribution are identified by where the majority of the price action is taking place. Activity towards the bottom of a congestion area indicates strong support and the probability that the move out ofthe area will be to the upside. The reason is that if there is activity towards the bottom of the range – lots of small column changes – it shows buyers using every opportunity to open new positions.

Conversely, activity towards the top side of the pattern indicates strong resistance and that the break from the pattern will be to the downside. This activity shows profit taking, because sellers are taking every opportunity to close their positions or, indeed, open short positions.

Oneofthebenefitsofthe I-boxreversalchartisthatyouwill seecongestionpatternsthatare not apparent on the condensed 3-box charts. The analysis ofthe chart within the congestion area can give an indication as to the probable direction of any breakout. This is virtually impossible with 3-box charts based on end-of-day data.

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Congestion patterns are simply just a combination of the basic Point and Figure patterns discussed so far. They may take months or just a few hours to form. If you can use the action within a congestion area to predict the direction ofthe breakout, you can open low-risk trades before the breakout occurs. Although this is seen to be against the Point and Figure rule that you buy or sell on breakouts, it is a low risk way to trade.

Some congestion areas tell you nothing, some, like the fulcrum, can tell you an enormous amount.

The fulcrum

You will already be familiar with the I-box fulcrum as was discussed in the context of reversal patterns in I -box charts. It can be a fairly small pattern but in its larger form, it is the most important of all congestion area patterns. It was De Villiers who coined the term fulcrum and went to great lengths to explain it by using the analogy of leverage in the subj ect of mechanics. The fulcrum occurs when the forces of demand and supply are balanced.

Fulcrums can occur at bottoms as well as tops, as is the case with all Point and Figure patterns. It is less likely that you will see a fulcrum if you use end-of-day data and 3-box reversal charts. They are far more apparent when using tick data or I -box reversal charts with end-of-day data, but that doesn’t mean you shouldn’t look for them. In fact, ifyou do see one in a 3-box chart it is of very high significance. Fulcrums may be regarded as the head and shoulders pattern of the Point and Figure world, although some attribute that honour to the poles discussed in the previous section. The reason is that, like head and shoulders patterns, fulcrums are where the stock changes hands and positions are re-assessed.

The fulcrum takes on many guises. De Villiers listed three types, while Wheelan listed eight fulcrum tops and eight fulcrum bottoms. It is pointless listing them all, but to assist identification there are some essential components for a fulcrum bottom:

There must be a downward move or downtrend into the congestion area. This means that there are more Os than Xs and the columns of Os are longer than the columns of Xs. The downtrend is often within a clear channel.

The downtrend must be broken by substantial sideways actIvIty. Sideways actIvIty means that the columns of Xs and Os become shorter and similar in length. This is caused by position adjustment or simply exhaustion. This sideways activity takes the price action out of the downtrend channel.

There is usually, although unfortunately not always, a half-hearted mid-pattern rally usually into resistance. This is caused by a number of factors such as short covering by bears who have ridden the downtrend and believe it to be over and short-term buying by day traders looking for a quick profit from an oversold situation, but the essential thing is that no group is buying to establish a long-term position. The sharpness of the mid­ pattern rally is caused by the lack of sellers.

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Lows should be re-tested again because, after the mid-pattern rally, there is no continued buying pressure: the short coverers have covered their shorts and the day traders have taken their short-term profits.

There will be further sideways congestion after the price has come back into the region ofthe lows and further position adjustment is undertaken.

Once all the position adjustment has taken place and all the shorts are covered, bulls start taking their positions, the columns of XS start to lengthen and more Xs than Os appear as an uptrend starts.

• At this time one or more double-top or semi-catapult formations begin to occur as demand exceeds supply and the bulls push the price through resistance levels.

  Finally the price breaks above the pattern mid-point, a full catapult in I -box reversal terms, and the fulcrum pattern is complete.

• There is no time limit on the completion of the fulcrum.

  Figure 3-39 shows a typical fulcrum bottom. There is a downward move into the congestion area, often, though not always, a downtrend channel. The price action moves across and out of the channel as it consolidates sideways. There is a weak rally, which is rebuffed, and the price descends into the support at the lows. It is during this sideways stage that bulls are accumulating at the lower levels. This is followed by a more determined rally which leads to a catapult buy signal, where the X exceeds the highest X within the congestion area.

  Figure 3-39 is a I -box reversal chart and that is why the fulcrum can be seen. Figure 3-40 on the other hand, is a 3 -box chart using the same data. The resultant pattern is just a double-top buy signal. It won’t always be the case, but this really highlights the importance ofusing 1- box reversal charts.

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at all; some will have V bottoms; some will have typical double-bottom shapes; some will have flat bottoms. Some will be compound patterns, which are fulcrums within fulcrums, but they are all essentially the same because the forces that create them are always the same.

The fulcrum described above is a fulcrum bottom, while fulcrum tops are the inverse. Remember however, the psychology is different at tops and bottoms. Long position holders are less desperate to close long positions when they are on the wrong side of the market, whereas holders of shorts will cover quickly when the market goes against them. This means that you are more likely to see sharp mid-pattern rallies in a fulcrum bottom than you are to see sharp mid-pattern declines in a fulcrum top. Figure 3-41 is an example ofa fulcrum top. The sideways consolidation at the top is the distribution phase, where profits are taken and positions are unwound. The pattern is completed by the catapult sell signal followed by a number of semi-catapult sells.

Figure 3-41 : 1 -box reversal chart showing fulcrum top pattern

Strength and weakness in fulcrum patterns

Not every fulcrum will be a reliable reversal pattern. Some may fail after the breakout catapult and become continuation patterns. Weakness in the fulcrum is indicated when, after the catapult, the price does not keep going, but instead forms another sideways pattern with a sloping top in the case of fulcrum bottoms, and a sloping bottom in the case of fulcrum tops. Figure 3-42 shows the same fulcrum as shown in Figure 3-39, but instead of continuing to rise after the catapult it consolidates in a negative way around the breakout point. This points to weakness and the strong possibility that the fulcrum has failed. The width of the pattern after the catapult is what determines the extent of the failure. If the width, as it is in Figure

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3-42, is greater or equal to the height ofthe original congestion, the likelihood is that the price will break below the lowest point in the fulcrum.

What this means is that, after the catapult point in a fulcrum, the price must continue to show strength otherwise the breakout of the fulcrum is false and a complete reversal is possible. For the fulcrum to be effective, there must be a series of double-tops or semi-catapults in the uptrend out of the pattern as seen in Figure 3-39.

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The row (or rows) with the most filled in boxes controls the bullishness or bearishness of the fulcrum pattern. You will see later that this is also used for establishing targets from the pattern. The reason these rows are important is because they are at the level which the price has passed through most often in the pattern and where most ofthe battle for control has taken place. They provide the pivot or anchor about which the pattern is balanced. If the rows are towards the base of the fulcrum, it indicates strength in the base and a likely break to the upside. If they are towards the top, it indicates strength at the top and a likely break towards the downside. Often they are simply in the middle of the pattern giving no clues at all.

Weakness within a fulcrum is indicated by mid-pattern rallies caused by short covering, in the case of bottoms, and mid-pattern declines caused by profit taking, in the case of tops. If you are able to use these clues to assess on which side, top or bottom, the strength or weakness lies, you can start to take positions within the fulcrum pattern.

Considering fulcrum bottoms, you should wait for the mid-pattern rally during a fulcrum bottom and then look to take a position as close to the previous lows of the pattern as possible, provided there is more price action at the lows. Some traders prefer not to ‘fish’ for

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the bottom, instead they wait until the price has come back to within an 0 of the previous bottom after the mid-pattern rally, and then take a long position on the first reversal of 2 Xs back up again. Why 2 Xs? Because, if you are using a I -box chart, I X could just be one­ step-back in a downtrend, and you would not want to commit to a long position on the basis of a one-step-back alone, so you must wait for at least 2 Xs. In a 3-box chart, it will be 3 Xs. It may sound high risk, but in fact it is low risk, because at the same time you would place a stop one box below the low of the pattern, so your risk is two or three boxes at most. The reason for waiting for a reaction back off the low is that you don’t actually know it is a low until after the fact. The price may print a box below the previous lows. If it does, you need to see that it can recover from that position.

Figure 3-43 shows a fulcrum bottom. Notice that the strength is towards the low because that is where you find the row with the most filled in boxes. After the mid-pattern rally, the price goes below the previous lows of the pattern. Anyone taking a position on the previous lows would have been stopped out immediately. After the new low has been made, a long position is taken after the second X in the new column of Xs and a stop placed one box below the low. Of course, this strategy is not always possible. Firstly, there may not be a mid-pattern rally. Even if there is, the price may not get back down to the lows and so you will not be alerted to take a long position.

Contrast this with taking a position at the full catapult point. Your stop would still be one box below the low of the pattern. If the pattern fails, as it did in Figure 3-42, then your risk is the height of the fulcrum pattern, which is 6 boxes.

Figure 3-43: 1 -box fulcrum bottom

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Chart 3-15 is a 1 x 1 tick Point and Figure chart ofthe S&P 500 Index. This is a very short­ tenn chart for short-tenn traders. It shows a number of fulcrums of different type, some successful, some not so.

The first half of pattern A contains a number of continuation semi-catapults. This is the first requirement for an inverse fulcrum: a strong move into the highs. At this stage there is no clue that it will be an inverse fulcrum. After the highs, however, the downward sloping top gives it the look of a V-shaped inverse fulcrum. The balance of the pattern is around the centre line.

Pattern B is another V-shaped inverse fulcrum. Notice the X breaking to a new high on the middle of the pattern, giving a semi-catapult continuation buy signal. Again this is part of the uptrend taking the price into the fulcrum. Notice that the balance of the pattern is towards the top indicating strength at the top. Notice the downward sloping top in the second half of the pattern.

Pattern C is a small flat top and bottom fulcrum. With an evenly balanced pattern like this, it is impossible to predict which way it will break.

Pattern D starts off with a number of continuation semi-catapults as the uptrend takes the price into the pattern. A sharp decline mid-pattern shows profit taking; however, the price rises to new highs again. It is interesting to note that within the large fulcrum pattern D, a smaller fulcrum has built with a catapult point on the break below the blue line at point ‘x’. This would be an opportunity to take a short with a stop one box above the high ofthe pattern.

Pattern D’s fulcrum point at the lower blue line ‘y’, completes the pattern.

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You have seen that fulcrums don’t fit the textbook patterns perfectly. The deeper the fulcrum, the more necessary it is to take positions within the pattern.

Fulcrums are much more common in intra-day charts, but you will find them in end-of-day charts as well.

Chart3-16belowisa15x 1ofWhitbreadplc.Therearetwoclearfulcrumpatterns,bothof which are compound fulcrum bottoms, which means they start off as small fulcrums that fail but then become part of a larger pattern.

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Chart 3-1 6: 15 x 1 of Whitbread pic showing fulcrums and semi-catapults

The first pattern starts with the downtrend to point A. The price trades sideways, breaking the downtrend line and resistance at point B. It continues to trade sideways, eventually falling back to point C. At this stage, it can be seen that a large fulcrum is in the making and it is possible to open a low risk buy on the first 2 box reaction from point C, although some traders prefer to wait until the lows are matched. The price rallies back up again, breaking through a semi-catapult and finally through a new fulcrum catapult point at D, where longs should be added to. Notice the continuation semi-catapult at point E re-confirming the completed fulcrum and the continuing uptrend. Notice also the very clear trend channel into the fulcrum, then the sideways movement out of the channel and the clear trend channel out again.

The second pattern starts with a very bearish tight downtrend channel to point F. The price rallies to point G, moving out ofthe channel. It falls back to point H, suggesting that a bullish fulcrum is in the making. The trend channel has been broken by sideways action, and there

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has been a rally in the pattern which has aborted and gone back to re-test the lows. Notice that the price goes below the previous low, which demonstrates the danger of taking a long position at the lows. A long position can, however, be taken on the completion of the 2nd X marked with an arrowhead, with a stop one box below the low at point H. A new, tight uptrend develops and takes the price up to the pattern highs and, after a minor pullback, through the catapult point at I. The trend does not continue, and instead the price breaks sharply down through the uptrend line and falls to point J, then rallies again to newly established resistance at point K. This now has the makings of another smaller fulcrum making up a much larger one. The price makes its way down to point L at exactly the same level as point J, triggering another early buy alert on the 2nd X up from the low, which is shown at the arrow head. At point M, a second catapult point is breached. Another long could be taken, but the trader has two longs already from point H and L. As expected, after a successful catapult point, the price makes a semi-catapult at point N, then another at point 0 and another at point P, in almost textbook fashion.

So that you can see what these patterns look like in a 3 -box chart, Chart 3 – 1 7 is a 1 5 x 3 chart ofWhitbread pIc. The chart is labelled with the same letters used in Chart 3-16, so that you can compare it with the I -box chart.

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Chart 3-1 7: 15 x 3 of Whitbread pic showing fulcrums and catapults

The patterns are narrower, obviously, but you can still see the fulcrums and catapults as they develop.

The fulcrums chosen in these examples have deliberately been difficult ones because it is important that you get used to the fact that they seldom look like textbook examples.

Fulcrums are fundamental to Point and Figure analysis, and they come in all shapes and sizes.

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Signals with the trend or against the trend

You have learnt that Point and Figure signals start with double-tops and bottoms in 3-box charts and with semi-catapults in I -box charts. You have also learnt that these are weaker than triple-tops and bottoms, but many double-tops and bottoms are good reliable signals. Although we will look at this in more detail in the section on trend lines, it is worth stressing that when assessing signals, the prior trend is important.

In a strong downtrend, for example, double-bottom sell signals are much more reliable than double-top buy signals. Each sell can be taken but a double-top buy should be treated with suspicion until there is more evidence of a trend reversal.

Figure 3-44 shows the price in a strong downtrend. Each double-bottom sell signal is good for acting on. However, the double-top buy signal should be used only for closing out short positions and not for gomg long until more price movement confirms the end of the downtrend.

You can dramatically Improve your success rate just by taking clear signals with the prevailing trend.

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The converse is true for strong uptrends, where double-top buys can be relied on and double­ bottom sells treated with suspicion.

It is worth noting at this point that generally prices can only rise if there is an increase in demand, but prices are well capable of falling due to a simple lack of buyers with no real increase in supply.

Trend lines on Point and Figure charts

Trend lines play an important, ifnot an essential, part in Point and Figure analysis. They bring Point and Figure charts alive. There is, however, a subtle difference between trend lines drawn on line or bar charts and those drawn on Point and Figure charts. With line and bar charts, trend lines show the line at which there is constant rate of change. This is because line and bar charts show price versus time. The trend line on a bar chart therefore shows constant change in price per unit time. With Point and Figure charts, however, there is no time. Instead, the x-axis shows the number of columns, which is the number of times the price has reversed. So, a trend line on a Point and Figure chart shows constant price change per reversal.

In the Figure 3-45, the price rose from 1 00 to 230 (the shaded box) and, in doing so, it reversed its price direction ten times. Therefore, the rate at which the price has risen is 130/10 = 13 points per reversal. As you will see, this figure is important because if it is less than the value of one box, it indicates that the trend has weakened. For the moment, however the illustration shows that the trend line is the rate at which the ‘change in price per reversal’ is constant.

Figure 3-45: Rate of price rise per reversal

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Trend lines on Point and Figure charts are drawn in exactly the same way as they are on bar or line charts. Uptrend lines connect higher lows and downtrend lines connect lower highs. Chart 3- 1 9 shows a l O x 1 chart of the S&P 500 Index. The downtrend line connects lower highs and the uptrend line connects higher lows.

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Chart 3-19: 10 x 1 of the S&P 500 Index showing trend line breaks

Trend line breaks

In Point and Figure analysis, signals are generated by double-top and double-bottom signals in 3-box charts, and by catapults and semi-catapults in I -box charts. These have to be taken into account when assessing trend line breaks and the validity of the trend line. At point A in Chart 3-19, the downtrend line from the top was breached, but there was no Point and Figure signal at the time. This allows the trend line to be continued through the data. Notice how many times the price touches the line (shown by the arrows), increasing its validity. The break at point B however, is accompanied by a semi-catapult buy signal, confirming the break.

Here are some guidelines for breaks of a downtrend:

If, at the time the break occurs, there is also a double-top (or wider), a catapult or a semi­ catapult buy signal, as shown at point B in Chart 3- 1 9, then the break is valid and should be acted on. The break at point A is invalid.

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If, at the time of the break, there is no Point and Figure signal, look to see if one occurred just prior to the break. ‘Just prior to’ means that the signal must have occurred within an X or two of the trend line break. This still makes the break at point A an invalid break.

If, at the time of the break, there is no Point and Figure signal and no signal prior to the break of the trend line, then take any Point and Figure signal that occurs after the break. Point A remains an invalid break.

If, at the time of the break, there is no Point and Figure signal, no signal prior to the break of the trend line and no Point and Figure signal after the break, then it is much more difficult to assess the break. Point A in Chart 3 – 1 9 is a good example. In a case like this, you must look to see if a wider pattern has been breached. Has there been a breakout of an extended top, or a catapult or fulcrum pattern? If you look left at point A you will see two columns of Xs at the same height as the X at point A. If at point A another X had printed, there would have been a catapult breakout and that would have made the break of the trend line valid. In the case of Point A as it exists, this did not occur and it remains an invalid break.

The converse ofthe above applies in the case ofbreaches ofan uptrend. As you become more familiar with Point and Figure charts, so you will be able to modify these rules according to your trading strategy.

Bullish support and bearish resistance lines

Subj ective trend lines (those which you decide on yourself) like those in Chart 3 – 1 9 on page 177 can be used to good effect, but one ofthe great advantages ofPoint and Figure charts is that you can also draw objective trend lines. The objectivity means that you do not need to decide on the angle of the trend line: it is already established. Because of the ‘ square’ nature of Point and Figure charts, it is possible to draw 45° trend lines, something which is impossible on bar or line charts because of the aspect ratio. Bar and line charts have no fixed aspect ratio – the ratio ofthe height ofthe chart to its width. Ifthis is not constant, trend lines at fixed angles cannot be drawn because the angle changes as the aspect ratio changes. With Point and Figure charts, the aspect ratio is a constant 1 : 1 because they are constructed on a squared grid. To maintain a 45° trend, therefore, and the price action above the trend line, the price must rise by more squares up than squares sideways. Squares up or down are created by the price rising or falling by the box size and squares across are created by the price oscillating without any direction. The latter tends to occur during periods of distribution at

the end of an uptrend, or accumulation at the end of a downtrend.

Bullish support lines are rising trend lines drawn at 45° from an important low. Bearish resistance lines are falling trend lines drawn at 45° from an important high.

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45° lines are not drawn just for the sake of it. They have an important meaning. They show the rate at which the price is rising or falling by one box every time a new column is formed, in other words, every time the price changes direction. They therefore demarcate the line at which price is considered to be in a bull or a bear trend and hence the last level of support or resistance to a trend change. Although they can be placed on I -box charts, bullish and bearish 45° lines are essentially a 3-box tool.

Rationale for bullish and bearish 45° trend lines

The rationale for the importance of the bullish support line at 45° is that, if the price cannot maintain a rise of at least the value of I box every time it makes a reversal, it can no longer be considered to be in a bull trend. This is because the 45° line is drawn diagonally through the imaginary comers of the boxes, meaning that speed or trend of the line is I : I , or I box up and I box across. If this doesn’t sound that onerous, then you probably haven’t thought carefully about what is required to maintain that 45° trend.

Remember how a 3-box chart is constructed. A reversal means the price must change direction by at least the value of 3 boxes. This means that no column can have less than 3 boxes. Ifthe price rises by 3 boxes and then falls by 3 boxes, the trend is horizontal. In order, therefore, to maintain a 45° trend, the 0 marking the bottom of each alternate column must be 2 boxes higher than the 0 at the bottom of the previous column of Os. To do this, the price must rise by 2 boxes more than the reversal. This means that to maintain a 45° trend in a 3- box reversal chart, the price must rise by 5 boxes each time it reverses by 3.

The thought that Point and Figure analysts regard the most important trend in Point and Figure charts to be constructed using 5 boxes up and 3 down will certainly make any Elliottician13, who has picked up this book in error, much more interested in Point and Figure charts.

Figure 3-46 shows three possible trends on a 3-box reversal chart. The first is the condition where each reversal is 3 boxes. The trend is, therefore, horizontal. The second is where the price rises by 4 boxes before reversing by 3. This results in a trend that is described as I box up and 2 boxes across or 22.5°. The third is the 45° trend that can only occur when the price rises by 5 boxes before reversing by 3. The trend is described as 1 box up for every 1 box across or 45°.

13 An Elliottician is a follower of Elliott Wave theory which is based around the observation that prices move up in five waves and down in three and are related by Fibonacci Ratios, ofwhich 5 by 3 is one.

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3up/3down 4up/3down 5up/3down Figure 3-46: 3 possible trend angles on 3-box reversal charts

So, although the 45° trend is one box up and 1 box across, in order to comply with the trend the price must rise 5 boxes for every reversal of 3 boxes. Any rise of less than 5 will result in a correction of 3 boxes breaching the 45° trend line. So, what sounded like a mild condition turns out to be a fairly strong condition. To maintain a 45° uptrend, each upthrust must be at least 5 boxes worth. It is this that makes the 45° line so important.

The converse is true for bear trends. Bearish resistance lines at 45° demarcate the line at which the price is falling by 1 box every time it changes direction. If the price is below that line, then it is falling by more than 1 box and that would be considered as being a bear trend. This means that the price must thrust down by at least 5 Os each time. If it does not do this, the bearish resistance line is at risk.

Obviously, in both cases, an initial thrust ofmore than 5 boxes takes the price away from the 45° trend line, which means that the next thrust does not have to be as strong to maintain the 45° trend.

Changing the reversal from 3-box to 1-, 2- or 5-box has an effect on the interpretation and strength of the 45° lines. In each case, to maintain the 45° trend, the thrust column must be 2 boxes longer than the reversal column. So, in a I -box reversal chart, the thrust column must contain 3 boxes, in a 2-box chart, it must contain 4, and in a 5-box chart, it must contain 7. This means that the 45° trend line has varying importance, depending on the reversal you use. For instance, a 45° trend line breach in a 5-box reversal chart has greater implications than in a I-box reversal chart.

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Where to draw bullish support and bearish resistance lines

Bullish support lines are drawn at 45° up from a known important low point. They are drawn by taking a diagonal through the comers of the square below the low of the lowest column of Os. The advantage is that as soon as a bottom is made, and a column of Os reverses to a column of Xs, the bullish support line can be drawn. There is no need to wait for a further reaction to give a second touch point, none is needed. Bearish resistance lines are drawn at 45° down from an important high point in the same way, by drawing a diagonal through the comers of the square above the highest column of Xs.

Figure 3-47 shows an idealised chart with bullish support and bearish resistance lines to illustrate the point. Immediately when column 2 is drawn, the blue bullish support line, can be drawn at 45° from the low. Notice that the line goes through the diagonal comers of the boxes. Columns 3 to 12 show the price well above the bullish support line indicating that it is rising by more than one box every time it changes direction. In column 13, the price is on the 45° line, which means it is rising by one box per reversal. In column 15, the bullish support line is broken as the price penetrates below it. This means that the price is no longer rising by one box per reversal.

As with all Point and Figure patterns, it is only when the double-bottom sell signal is given, and an 0 goes below the red support line in column 15, that the bull trend is clearly over. Once this happens, however and the price has moved into a bear trend, a bearish resistance 45° line may be drawn from the high in column 14. (This is the red trend line in the diagram.) Columns 15 to 23 show the price well below the bearish resistance line indicating that it is falling by more than one box every time it changes direction. This is typical bear market action. In columns 24 and 25, the price is on the bearish resistance line, meaning that it is falling at one box per reversal. In column 26, the price breaks above the bearish resistance line and confirms the break with a triple-top buy above the blue resistance line.

Whilst this pattern is idealised, it is an extremely common scenario in real-life charts, and one that you will see played out repeatedly.

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Figure 3-48: Where to draw 45° bullish support and bearish resistance lines

The blue bullish support line in Figure 3-48 is broken with a double-bottom sell signal in column 15. This means a new red bearish resistance line must be drawn. Although the top at point A is higher, a new bearish resistance, shown dashed in red, cannot be drawn from the top because it is penetrated in column 14, prior to the break of the uptrend. The new bearish resistance line must, therefore, be drawn from the top at point B.

The bearish resistance line is broken with a double-top buy signal in column 28. The new bullish support line, shown dashed in blue, cannot be drawn from the low at point C because it is penetrated in column 27. The bearish resistance line is, therefore, drawn at point D.

Implications of different box reversals on 450 trend lines

Although early authors on Point and Figure charts used trend lines, 45° lines were not used until Cohen’s work in 1947. Until then, trend lines were drawn subjectively to follow trends. What was different between early works and Cohen’s was the fact that Cohen completely ignored I-box reversal charts in favour of 3-box charts. He also abandoned tick Point and Figure charts and used the daily high/low method (explained in chapter 2) exclusively to construct his charts.

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Chart 3-22: 50 x 3 (cI) of the FTSE 100 Index showing the drawing of 45° trend lines

45° lines and log scaled charts

The issue of trend lines on log scaled charts is always a point of contention, not only for Point and Figure analysts, but also for Technical Analysts in general. Some will argue fiercely that they are only valid on log charts, others will say arithmetic. The fact is that some prices rise and fall arithmetically and some do so exponentially. There is no right or wrong way. The only way to tell is to draw both log and arithmetic charts and draw the lines on both.

Chart 3-23 shows the FTSE 100 Index again but this time using a 1% box size instead of 50 points. The bullish support and bearish resistance lines are shown as before. The breaks of trend are at slightly different points but it is clear where they are.

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You may also view support and resistance over different time horizons by drawing internal 45° trend lines closer to the price action. Each reaction low during an uptrend, or each reaction high during a downtrend may be used to draw further 45° lines, called internal 45° lines, which then provide additional support levels. The reason and logic behind this is that although bull and bear trends on the chart are defined by the 45° line from bottoms and tops, during any trend there will be reactions (corrections) where the price is forced towards the 45° line but stops short of it. The question is, why does it stop short? The answer is that there is support, in the case of an uptrend, or resistance, in the case of a downtrend, at that point. This being the case, we can project that support and resistance forward at 45° because we know that the limit to the trend is one box per reversal. These internal 45° lines don’t show the main bull and bear trends, but rather support and resistance during uptrends and downtrends, which when broken may result in a correction to the next 45° line.

The S&P 500 Index in Chart 3-24 shows how these internal 45° lines are drawn. The lines are numbered in the order they are drawn.

Line 1 is the main 45° bullish support line from the bottom. Notice that the price moved well away from it during the strong bull trend, rendering it useless for intermediate support. At the first reaction, therefore, internal 45° line 2 may be drawn closer to the action, then line 3 when there is another reaction, then line 4 and finally line 5 . Each of these internal 45° lines demarcates a level at which support may be found in the future. The further these internal lines are away from the main 45° line 1 , the shorter-term they are.

The first time support is found is at point A on line 5, where the price rallied away very strongly. This means the reaction at the start of line 5 has had some influence on the price in the future. However, this is a short-term trend, which may not last long. Line 5 is eventually broken and the price falls to point B on line 4. Line 4 now becomes the shortest-term trend until the price falls back to allow line 6 to be drawn. Line 6 did provide some support around the top where the price oscillated above and below the line, before falling to points C and D on line 4, making line 4 an important internal trend line showing the intermediate trend. A break of line 4 must be considered an important break because it has had two important thrusts from it at points B and C.

Line 4 i s broken strongly with a double-bottom sell at point D . Support should now b e sought on line 3. It should be remembered that line 3 has not been reinforced by any previous reactions and so is not expected to provide significant support. Furthermore, line 3 was not drawn from a mini-bottom, but rather just a corrective column of Os. A mini-bottom occurs when the price makes an intermediate low, as it did at points 5 and 6, for example. Points 3 and 4 are not mini-bottoms. 45° lines drawn from mini-bottoms have more significance.

Line 2 also provides no support at all for a strongly falling price, leaving the last level of support as line 1 , the main bullish 45° support line from the chart low. Although the main bull trend has not been broken, a tentative main bearish resistance line 7 can be drawn. In addition, an internal 45° downtrend line 8 can also be drawn.

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Notice how the price falls to point E, picking up support on the main bullish 45° support line 1 , although there is actually a break of line 1 because there has been a double-bottom sell signal. Notice too that it rallies to point F, where the price meets resistance on two fronts, from internal uptrend line 2 and internal downtrend line 8. The second touch here reinforces

line 8 as an important internal 45° downtrend line.

As you would expect, the main bullish support line 1 provides support again at point G, but this is only temporary and the price breaks through with a double-bottom sell. With no more support left, the price is unambiguously in a downtrend and the main 45° bearish resistance line is line 7. The price remains in a bear trend until, firstly, line 8 is broken and, shortly after that line 7. Once this happens, a new bullish 45° support line 9 may be drawn. As is normal in strong bull trends, the price rallies away from the line, and, on the first reaction, internal 45° line 10 may be drawn. Notice that the price soon finds support near internal line 10 at point H. Because the price did not actually touch line 10, a new internal 45° line 11 can be drawn from the reaction low at point H.

Chart 3-24: 1 0 x 3 S&P 500 I ndex showing drawing o f internal 45° trend l ines

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Now that you have become more familiar with the way that main and internal 45° lines are drawn, you will notice that there are other lines that could have been drawn on the chart. Draw them yourself to familiarise yourself with them.

When drawing these internal or shorter-term 45° lines, it is just as well to note that they are stronger if drawn off an actual reaction high or low, rather than just a single reversal column. This means that those drawn off mini-bottoms or mini-tops are more important than those drawn from a corrective column. For example, trend line 8 is drawn from a mini-top, whereas trend line 3 is drawn from a corrective column. If a trend line is drawn from a corrective column, like trend line 4, and it provides support to a mini-bottom like point B, the trend line is regarded as if it had been started from a mini-bottom. The converse applies to mini-tops.

Parallel trend lines

Channels are important. Prices tend to move up and down within channels, and so lines parallel to the trend, but on the opposite side of the price action, which delineate trend channels are important for understanding the strength of the trend. In an uptrend, these lines offer resistance to the price and in a downtrend they offer support. If the price fails to reach the upper channel in an uptrend, this is a sign of weakness. Conversely, if they fail to reach the lower channel in a downtrend it is a sign of strength.

In Point and Figure analysis, the parallel line to the uptrend bullish support line is called the bullish resistance line. The parallel to the downtrend bearish resistance line is called the bearish support line.

When using line and bar charts, these parallel lines are usually drawn by studying the chart and placing the line in the most obvious place. Much has been written about how these lines should be drawn on Point and Figure charts; it is difficult to reconcile the strict rules that must be applied when a parallel line is drawn.

Any trend line, whether up or down, can be enhanced by the drawing of a parallel line on the other side of the price action. That is not in dispute, but what is, is the matter of where these parallel lines should be drawn. Rules that cannot always be followed are difficult to accept.

In his 1996 book, Carroll Aby suggests that once a bullish support line is drawn, the analyst should place the parallel on top of the highest X in the column to the right of a large column of Os. If that line is broken then locate the next column of Os to the left and repeat the procedure. It is good to have a guideline like this, but sometimes no such wall exists or if it does exist, the column of Os may be short, forcing the parallel line through the price action. There is nothing wrong with adopting this approach but you must be flexible. By all means, look left and, if there is a significant column of Os, then place the parallel line on the highest X to the right of the column of Os. However, if you look further left and see a more obvious one, then use that instead.

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Bearish resistance line 2 shows the 45° downtrend. Parallel P21 is the first parallel (bearish support line) to be drawn according to the rule for downtrends. That is, find a ‘wall of Xs and place the parallel on the lowest 0 in the column to the right of the column of Xs, at point H. Parallel P2 1 is breached by the long column of Os after the top.

The next parallel, P22, may be drawn according to the rule from point I. P22 is breached at point J, from where a new parallel P23 may be drawn. As the market fall becomes steeper, P23 is breached at point K and another parallel, P24, can be drawn, using the support at K as the point of contact. Further steep falls result in P24 being breached as well. Parallels need to be adjusted as the price rises or falls. It is important to remember that if your parallel is breached, it means that the price is accelerating. In the chart above, the uptrend is orderly and within the channel; however, the downtrend is steeper than the initial channel predicted and so new channel lines have had to be drawn to contend with it. The action ofhaving to reassess the parallels shows the bearish nature ofthe market. Parallels are less likely to be continually breached in uptrends and more likely in downtrends.

Bullish support line 3 in Chart 3-25 shows the 45° trend from the low. Once again applying the panillel rule leads to parallel line P31 from point L, which serves no useful purpose. Applying the rule again results in parallel P32 from point M which has not yet been tested. Parallel P33, however, drawn subjectively is a better bullish resistance line for the time being. The drawing of 45° trend lines as parallels is so easy with modem software that it is simple to test a number before deciding which is best.

Parallels are not as important as the trend lines themselves. They can be used to assess the limits to the uptrend or downtrend. Breaches of significant parallels tend to indicate that the price is overbought (in an uptrend) or oversold (in a downtrend) and result in a reaction in the opposite direction.

Summary of the use of 45° bullish support and bearish resistance trend lines

45° trend lines are called bullish support and bearish resistance lines. The rules for the type of Point and Figure charts to be used with them are:

For the definition of major bull and bear trends, 3-box reversal daily close data should be used.

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For the definition of major as well as intermediate bull and bear trends, 3-box reversal daily high/low data should be used.

For the definition of minor bull and bear trends, I -box reversal close only or high/low data should be used.

For the definition of short-term as well as minor bull and bear trends, I -box tick data should be used.

Any other interval data can be used for varying degrees of short-term trends.

Remember 45° trend lines alternate. The price is either subject to an uptrend line (bullish support) or a downtrend line (bearish resistance). Only once the bullish support line is broken, can the bearish resistance line be drawn, and only once the bearish resistance line is broken can a new bullish support line be drawn. This means that the price is in either a bull trend or a bear trend. It can’t be in both at the same time. However, you will often see charts with both bull and bear to show how one has been breached, as you will see in the example onpage 194.

Trend lines and signal rules

Trend lines, whether subjective or at 45°, can affect the validity and strength ofany Point and Figure buy or sell signal and, therefore, play an important part in Point and Figure analysis. The rules are:

Point and Figure buy signals generated above an uptrend line can be considered good for opening a long or adding to an existing position.

Point and Figure sell signals generated above an uptrend line should be used to close or reduce a long position, but should not be used for going short.

Point and Figure sell signals generated below any downtrend line can be considered good for opening a short or adding to existing shorts.

Point and Figure buy signals generated below a downtrend line should be used to close an open short position but should not be used for going long.

Of course, these rules can be broken by experienced traders who are aware of the risks involved. The rules, therefore, can be adjusted according to personal trading strategy and whether the position is long- or short-term. Trend lines can also be combined with congestion pattern analysis to enhance the signals generated by the patterns.

For example, a long-term investor may sell a portion of the holding when a sell signal is generated above an uptrend line and consider selling the whole holding only if the trend line is broken. Alternatively, the investor may ignore simple buy and sell signals, waiting rather for a compound pattern like a catapult or fulcrum to develop. There is a risk in doing this, as the compound pattern may not develop at all. A short-term trader, on the other hand, may take all simple signals and may sell the whole position on a sell signal above the trend line but wait for a trend line break to go short.

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Exercise in drawing 45° trend lines on a log scale chart

This exercise is intended to show the process ofdrawing trend lines; it is not a trading exercise. Chart 3-30 of British Airways pIc on page 199 has been split up into sections so that the process of drawing trend lines can be followed. The lines are numbered in the order in which they were drawn, so you can see the procedure. Try to follow the logic of each line as it is drawn.

Referring to Chart 3-26, the first line to be drawn is bearish resistance line 1 . Notice that it is breached at the same time as an extended triple-top buy signal is given at point A, which is a valid breach. Remember, 45° trend lines alternate and so bullish support line 2 can be drawn. The price then falls back to bullish support line 2. Notice that it positions itself for a double­ bottom sell signal but nothing comes of it. The bullish support line 2 holds and is the new uptrend. Line 2 is breached at point B, but because there is no double-bottom sell, the breach is ignored. It is breached again at point C combined with a double-bottom sell and the bull trend is over. Bearish resistance line 3 can now be drawn.

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Chart 3-26: Exercise in drawing trend lines using 1 % x 3 of British Airways pic

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Line 3 is breached with a double-top buy at point D and, although the price fell back, the buy signal was not cancelled because the column of Os did not fall below the previous column of Os.

The breach of bearish resistance line 3 allows new bullish support line 4 to be drawn. Line 4 is well away from the price action and so, because the price consolidated at point 5 an intermediate/internal 45° bullish support line 5 can also be drawn. This allows a shorter-term trend to be followed.

The exercise follows on in Chart 3-27. This shows trend line 5 being broken at the same time as there is a double-bottom sell signal at point E. Notice how much earlier you would receive the signal than if you had waited for the break of trend line 4. This shows the advantage of drawing internal 45° lines closer to the price action as the trend matures. Whilst these lines do not define the major bull and bear trends, they do show the important shorter-term trends.

On the break oftrend line 5, the price continues to fall and breaks the main bullish support line 4 at point F, also with a double-bottom sell signal. This indicates the end of the bull trend and allows new bearish resistance line 6 to be drawn. You may ask why line 6 is not drawn from the high to the left. The reason is that the 45° line from the high (shown in light red) is breached at point 6. Although this is not a valid breach, it is customary to re-position the 45° line.

Chapter 3 – Understanding Point and Figure Charts

Chart 3-27: Exercise in drawing trend lines using 1 % x 3 of British Airways pic

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New bearish resistance line 6 is breached at point H, with a double-top buy signal allowing a new bullish support line 7 to be drawn from point G, indicating a resumption of the bull trend.

Line 7 does not survive very long when it is broken at point I with a double-bottom sell. This is the last possible support from any 45° bullish support line. No others can be drawn, and so a main bear trend is in place. Bearish resistance line 8 can now be drawn.

The breach of bearish resistance line 8, which just occurs at point J, is accompanied by a double-top buy signal at point J. This is a valid breach that turns out to be false and the downtrend resumes. You must accept that, as in all analysis, there will be the occasional false signal.

The process continues with Chart 3-28, where bearish resistance line 8 is finally breached with a double-top buy at point K. This means that bullish support line 9 can be drawn from the low. Line 9 is breached at point L resulting in a new bearish resistance line 10. The breach of line 1 0 does not occur with a double-top break; however the 4th rul e l 4 of trend line breaks states that: “If, at the time ofthe break, there is no Point and Figure signal, no signalprior to the break of the trend line and no Point and Figure signal after the break, then you must look to see ifa wider pattern has been breached. ” The wider pattern encompasses the top at point K. Although this is a little obscure, if you think about it, resistance has been broken at that level.

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Chart 3-34 below is a 50 x I Point and Figure chart ofthe FTSE 100 Index. In order to show all the price history, it has had to be further reduced in size. By definition, the use of I -box reversal means wider congestion patterns and, therefore, more breaches of 45° trend lines. The blue subjective uptrend line, that starts on the left, has picked up all the major turning points during the uptrend and is, therefore, far more useful than a number of 45° lines have been in this case.

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Trend line summary

Trend is everything. Never analyse a Point and Figure chart without carefully considering the trend using trend lines. Trends enhance the signals from Point and Figure charts. A break of a trend line puts you on an alert to look for the next Point and Figure signal. Without trend lines, Point and Figure charts lose much of their meaning.

45° trend lines are most important when analysing 3-box reversal charts.

45° trend lines apply on other reversals but are less likely to be of benefit on I -box charts.

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Chart 3-34: 50 x 1 (cI) of the FTSE 100 Index comparing subjective trend lines with 45° lines

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I -box charts require normal subjective trend lines connecting higher lows or lower highs.

Internal 45° trend lines change the time horizon ofthe trend.

Breaks of trend lines are valid only if the break is combined with a Point and Figure signal .

Parallel trend channels are important for showing the strength of the trend. Touches of the upper channel in an uptrend indicate the price is overbought. Touches of the lower channel in a downtrend indicate the price is oversold.

1-box patterns:

Chapter 3 – Understanding Point and Figure Charts

Understanding Point and Figure charts

summary

This chapter has covered many aspects of Point and Figure charts. Below is a brief summary of what you should remember:

Point and Figure charts show the demand and supply: demand pushes up a column of Xs, supply pushes down a column of Os.

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When demand overcomes supply, and an X breaks above the previous column of Xs, a basic Point and Figure buy signal is generated. When supply overcomes demand, and an o breaks below the previous column of Os, a basic Point and Figure sell signal is generated.

All Point and Figure patterns and signals are based on these basic patterns in various combinations.

The wider the pattern, or the more times a level is challenged, the stronger the buy or sell signal from the pattern.

Point and Figure patterns can be continuation, as well as reversal, patterns.

The ability to breakout, be forced back and then breakout again is a strong sign.

Patterns vary according to the reversal size used.

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Less rigid formations than 3-box patterns.

Fall essentially into two categories: semi-catapult and fulcrum.

Semi-catapults are continuation patterns.

Fulcrums are reversal patterns.

A breakout from either pattern is called the catapult point.

A false breakout from either pattern, and pullback into it, is called a false catapult.

A successful breakout from a fulcrum is called a true or full catapult.

3-box and other box patterns:

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More rigid and recognisable formations than those in 1-box charts.

Easier to categorise and name.

All decompose into either of the 1 -box chart patterns.

Not every buy and sell signal should be taken, as it could be part of a larger, more complex pattern.

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